Taxing that fellow behind the tree

One of the things we’ve persistently been unable to get right in Michigan is business taxes. Now we have both an opportunity and urgent need to do so.

The old Single Business Tax was passed back in 1975, but over time it was amended out of all recognition and reasonability. So in 2007, after Oakland County Executive Brooks Patterson called it “a job killer,” the legislature repealed the SBT.

Then, after the usual back-and-forth political jostling, the legislature passed the replacement, the Michigan Business Tax. While it was almost as complicated as the old SBT, it was, at first, an improvement, if only in that it no longer penalized employers for adding new workers.

But before it ever fully went into effect, the MBT became a casualty of the moronic budget wars the played out in the legislature that year.

Taxes were raised in order to balance that year’s budget. Boosting the state income tax would have been the best and most honest method of covering the shortfall, but the lawmakers were only willing to go halfway.

To make up the rest of the revenue, they first opted for an inexplicable, incomprehensible and unenforceable gaggle of taxes on a bizarre array selected services – bronzing baby shoes, for instance. At the last minute, the chambers of commerce went ballistic over the services tax, fearing that would open the door to taxing all services, period. At the very last moment, in utter desperation, lawmakers slapped a 22 percent surcharge on the MBT to balance the budget.

That may have been the worst possible way to do it. Problem was that the MBT surcharge falls entirely on businesses, rather than on a mix of businesses and individuals. Rightly, the business community seethed – and has ever since.

Now the state is facing a nearly $2 billion budget shortfall. Tax collections for February were $100 million below a year ago; Governor Granholm called it a “breathtaking” drop in revenue. Everyone knows that smoke, mirrors and baby shoes won’t do it this time. And now all kinds of people from Democratic Speaker of the House Andy Dillon to Republican Senate Majority Leader Mike Bishop are talking about making a serious effort to recast the entire Michigan tax structure.

Before the mud wrestling and the chaff throwing gets started, it might be worthwhile for everyone to remember a few important principles:

Michigan is not a high tax state. The third annual state business tax rankings prepared by the Anderson Economic Group puts Michigan at 22nd among the states in terms of business taxes as a share of profits. Michigan came in at 14.94 percent, while the national average was 16.69. According to The Center for Michigan, if Michigan collected business taxes at the national average, annual revenue to the state would have increased by $1.6 billion – nearly enough to close the $2 billion budget gap. (This analysis is based on 2006 figures, the latest available; it will be interesting to see what later data suggest.) And those complaining about high business taxes in Michigan should remember there are $35 billion (billion!!!) in business tax breaks currently on the books.

Business taxes are not the sole factor in decisions where to locate or expand. Sure, they’re important; all other things equal, if Ohio has a more favorable tax climate than Michigan, I’m going to put my business in Ohio. But all other things are not necessarily equal. As Michigan Future, the research group, keeps pointing out, the kind of jobs we want are high-paying, stable, world competitive ones, not just hamburger flippers. California, Massachusetts and New York are anything but low tax states, but their skilled workers, good schools and top notch universities and their high overall quality of life have made them economic success stories.

The Michigan Business Tax (plus the 22 percent surcharge) is a bad tax. Business tax receipts for 2008 are way up (42 percent or $835 million) compared with 2007. That’s uncompetitive with other states. Ohio, for instance, says its revised business tax code puts it fifth among all states. And the MBT, while it did shift taxes away from manufacturers, disadvantaged many other types of businesses, especially services such as insurance, and real estate. The business community is entitled to howl. Tragically, it may be more likely to leave.

Reducing taxes is not the only objective in revising the tax code. Listening to some business people, you get the impression the only policy objective is to cut state spending so we can cut business taxes. It isn’t. The point of attacking the chronic structural state budget deficit is to get our financial affairs under control. Once that’s done, we can think hard about how much revenue we need and what we should be spending it on. Should we, for example, continue to spend more on our prison system than higher education?

Plainly not, unless we want more convicts than college grads.

For once, let’s be willing to think outside the box. For instance, Michigan State economics professor Charles Ballard proposes eliminating the entire Michigan Business Tax, substituting for it a graduated income tax. He says our current flat rate income tax of 4.35% puts the tax rate on the first dollar of taxable income among the highest in the country. His calculations suggest a graduated income tax with a top rate of 7.9% could replace all current revenues from the MBT and flat rate income tax, and he adds that state income taxes are deductible on your federal tax bill – “tax exporting,” he calls it.

Those who foam at the mouth about this idea are welcome to object – just as long as they advance their own realistic suggestions.

Besides the rate, we need to think about other characteristics of a good tax code. It needs to be sustainable, i.e. one that we don’t reinvent drastically every couple of years. The worst thing we can do for a business is to embrace continued uncertainty. The code needs to be fair to all kinds of businesses. But it should encourage those sectors that are to our long-term competitive advantage: High value-added manufacturing; high-tech; entrepreneurial start-ups; alternative energy, batteries, green power.

A state tax system should be transparent, which means it should be understandable and not require businesses to hire an extra accountant to prepare the return. It needs to help us become world-competitive, which means it needs to support the kinds of public goods we know we need to make Michigan attractive over the long run: Great schools and universities, high quality of life, good communities and a sustaining environment.

There’s an old saw about taxes: “Don’t tax him. Don’t tax me. Tax that fellow behind the tree.” Rather than thinking about how to shrug our own tax burden off on the other guy, let’s think first about the kind of business and economic environment we want to encourage and only then start haggling about the details of a revised and improved tax code.

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Editor’s Note: Former newspaper publisher and University of Michigan Regent Phil Power is a longtime observer of Michigan politics and economics, and a former chairman of the Michigan chapter of the Nature Conservancy. He is also the founder and president of The Center for Michigan, a centrist think-and-do tank which publishes the Michigan Scorecard. The opinions expressed here are Power’s own and do not represent the official views of The Center. He welcomes your comments at ppower@thecenterformichigan.net.