Imagine running a small business and being assessed a penalty by the IRS. Then imagine being told by the IRS that the only way to avoid the penalty is to commit a serious felony, laundering money. This Kafkaesque...
- Tax Reform in Michigan: Replacing the Single Business Tax
Tax Reform in Michigan: Replacing the Single Business Tax
Special Report No. 149
On January 1, 2008, Michigan's dreaded Single Business Tax (SBT) will phase out of existence. This presents a historic opportunity for pro-growth tax reform during the 2007 Michigan legislative session. It is anticipated that the incoming legislature and governor of Michigan will spend much of 2007 forging a consensus on what taxes--if any--will replace the SBT.
Unfortunately, the current tax debate in Michigan is marred by a focus on replacing the revenue generated by the SBT--approximately $2.1 billion per year--and several political constraints.1 Recent news of a $500 million budget deficit will also make things difficult for lawmakers. All told, there is a real danger that lawmakers will replace the SBT with a business tax system that is decidedly less than optimal from an economic perspective, which is a luxury they can no longer afford if they also raise taxes to fix the deficit.
The SBT will disappear thanks to at least ten years of effort by a cross-section of Michigan citizens and businesses, culminating in a 2006 initiative drive by Oakland County Executive Brooks Patterson. After Governor Granholm vetoed a legislative initiative that would have repealed the SBT, Patterson took his case to the voters and when he received enough signatures to get the issue on the ballot, the legislature again passed the bill without the need for the Governor's approval.
The SBT purports to be a tax on value-added, but it deviates from that base in numerous, complex ways. Hence the outcry from the Michigan business community for repeal.
The SBT debate in Michigan is a prime example of the crucial importance of business tax structure. Unfortunately, most state tax debates center around the tax burden--i.e. the total amount of taxes paid (as a percentage of income) by citizens to government. While tax burden is an important tax policy consideration, it should not overshadow the issue of tax structure--i.e. the system of laws, rules and regulations by which the government collects the tax burden.
Most of the complaints concerning the SBT are centered on how it is structured, not on how much revenue it generates. Tax burden has not been an issue because Michigan's business tax burden is below average, according to a report released annually by the Council on State Taxation (COST).2
This crucial debate features a number of rhetorical arguments that are not helpful in a debate about the sound economics of SBT replacement. First, almost all legislators are arguing that the SBT should not be replaced by taxes on individuals. Second, they are insisting that any SBT replacement should fall as much as possible on out-of-state taxpayers. Third, many proposals rely on gross receipts taxes to replace the SBT. Fourth, all the replacement plans on the table are just as "outside the mainstream" of state taxation as the SBT.
As the SBT replacement debate heats up in the 2007 legislative session, it will be helpful for both sides to avoid these four pitfalls. Otherwise, there is a real danger that the SBT replacement tax could be based on misleading political rhetoric and not sound tax policy.
Various groups across Michigan have floated at least seven SBT "replacement plans" with unofficial revenue estimates. One proposes no replacement revenue, a substantial tax cut. Three propose replacing most of the SBT revenue, leaving a small tax cut; and three propose revenue-neutral, dollar-for-dollar replacement.
The best replacement taxes for the SBT are those that are consistent with the Tax Foundation's principles of sound tax policy:
1) Simplicity: The tax system should be simple, easy to understand, and not impose excessive compliance burdens.
2) Transparency: Taxes should be visible to taxpayers, who should easily be able to understand who and what is being taxed.
3) Stability: Tax law should not change continually, and changes in tax law should not be retroactive.
4) Neutrality: Taxes should aim to raise revenue with a minimum of economic distortion, and should not attempt to micromanage the economy.
5) Growth-promotion: Taxes should raise revenue for programs while consuming as small a portion of national income as possible, and should interfere with economic growth, trade and capital flows as little as possible.
As lawmakers move forward with replacing the SBT, they should look to the motto of the medical profession: "First, do no harm." Lawmakers can certainly avoid doing "harm" to the Michigan economy by only adopting proposals that are consistent with the principles of sound tax policy.
• Single Business Tax replacement plans should be consistent with the principles of sound tax policy: simplicity, transparency, stability, neutrality, and growth-promotion.
• SBT replacement plans have some differences, but most of them rely on business taxation and a majority rely on a business gross receipts tax.
• A gross receipts tax is an economically flawed tax and would not-by itself-constitute an improvement on the SBT.
• Both sides of the SBT replacement debate should acknowledge that business taxes are ultimately paid by individuals.
• The SBT debate currently lacks a proposal that would rely on mainstream revenue sources (i.e. taxes on sales and corporate and individual income) to replace the SBT.
1. According to Table 11 of the 04-05 Annual Report of the Michigan State Treasurer, the SBT collected over $2.1 billion in revenues in Fiscal Year 2005. See http://www.michigan.gov/documents/AnnualReport2004-05_170764_7.pdf.
2. See Robert Cline, Tom Neubig, and Andrew Phillips, Total State and Local Business Taxes, Council on State Taxation (2006).
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