January 24, 2007

Don’t let misconceptions ruin reform

(The following commentary appeared in the Detroit News on January 24, 2007.)

Michigan lawmakers are sifting through seven plans to figure out what mix of taxes — if any — will replace the much-condemned Single Business Tax. The projected $800 million annual budget deficit does raise the stakes in the tax debate, since Michigan’s economy will not survive a poorly crafted business tax replacement on top of a tax increase to fill the budget.

But two major misconceptions have surfaced about how business taxes should work. If these wrong-headed beliefs prevail, Michigan will find itself needing tax reform again in a few short years.

The most damaging idea is that the Single Business Tax should not be replaced with a “tax on individuals.” This idea overlooks what every business owner knows: Real people — not inanimate business entities — pay the true burden of business taxes. Any tax paid by business is immediately transferred onto individual Michiganians in higher prices, stagnant wages and lower returns for shareholders.

Another misguided notion is that the new tax should fall as much as possible on nonresidents. This “tax exporting” — through atrociously high hotel and rental car taxes and an aggressive auditing of sales of out-of-state companies even if they have no personnel or property in the state — historically leads to overspending by government officials, who are unaccountable to those paying the tax.

These tax-thy-neighbor strategies invite retaliation and congressional regulation.

With these two mistaken ideas as a foundation, Michigan is in danger of blundering into a gross receipts tax. It appears to spare individuals. And tax exporting occurs frequently under this kind of a tax.

But creating a gross receipts tax would merely trade one set of structural problems for another. To avoid a tax on gross sales, businesses will start buying the companies that sell to them or the ones they sell to. This artificial tax incentive to “vertically integrate” will cause businesses to take on jobs they are less qualified to handle. This loss of time and money lowers economic growth for everyone in Michigan.

States with gross receipts taxes are routinely (though unsuccessfully) trying to fix them. Lawmakers in Washington state are constantly legislating more favorable tax rates for industries that suffer because they are unable to vertically integrate. Most states end up repealing their gross receipts taxes within a few years, and we suspect Washington state’s has survived only because the state has no personal income tax.

Kentucky added a new gross receipts tax two years ago, and businesses are already howling over its impact — even after the Legislature provided small business relief last year.

All is not lost in Michigan, however. A huge opportunity remains for an energetic leader to propose SBT replacement through some mix of a corporate income tax and an expanded sales tax base. Such a plan could at the very least provide a baseline of comparison for the other plans.

We remain hopeful for the fiscal future in Michigan. Politicians on both sides of the aisle should work together to find a mainstream replacement tax that finally gives Michigan some stability in its business tax system.

Chris Atkins is staff attorney and Jonathan Williams is an economist for the Tax Foundation, a Washington-based research organization. E-mail letters to letters@detnews.com.