Michigan lawmakers approved significant corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform last year that went into effect at the beginning of 2012. Previously Michigan had a dual corporate tax system called the Michigan Business Tax (MBT). Under the MBT corporate profits were taxed at a rate of 4.95 percent, and all transactions were taxed at a rate of 0.8 percent (a gross receipts taxGross receipts taxes are applied to a company’s gross sales, without deductions for a firm’s business expenses, like compensation, costs of goods sold, and overhead costs. Unlike a sales tax, a gross receipts tax is assessed on businesses and applies to transactions at every stage of the production process, leading to tax pyramiding. , or GRT). In addition, there was a 21.99 percent surcharge on the total tax liability from the MBT. We had been critics of the MBT, specifically the gross receipts tax, since it was implemented in 2008. GRTs are an outdated, economically damaging tax that leads to tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. (read more here).
But in 2011, recognizing the mistake, the Governor proposed and lawmakers approved a significant package of corporate tax changes. Most importantly, they eliminated the GRT, implemented a flat 6% net income tax (a tax rate which is very close to the previous rate after accounting for the 21.99% surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. ), and broadened the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. by eliminating tax preferences. These reforms were set to come online beginning in 2012.
The Tax Foundation’s State Business Tax Climate Index measures which states have the most neutral, simplest, most business-friendly tax structures. In the most recent edition of the Index, which reflects tax law that applied on July 1, 2011, before Michigan’s reforms were implemented, Michigan ranked 18th overall (and 49th on the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. component). If Michigan’s tax reform had been in effect on July 1, 2011, the state would have ranked 12th overall (and 7th on corporate income tax component). While the state’s actual rank in the next edition will depend on changes other states may make between now and then, it is clear that this set of reforms is a major improvement for Michigan’s business tax system.
| Effects of Michigan’s Corporate Tax Reform on Their State Business Tax Climate Index Rank | ||
| FY2012 Index Rank | Rank With Reforms* | |
| Overall | 18th | 12th |
| Corporate Tax Component | 49th | 7th |
| *Rank if Reforms Been in Effect on July 1, 2011, the first day of the standard 2012 state fiscal year. |
Note that we wrote about the reform when it was still in the proposal phase last year, and at that time provided an estimate of how much it would improve Michigan’s ranking on the Index. But now that the reform has been implemented in its final form we thought it would be good to update our estimate of the reform’s impact. The new estimate differs from last year’s because, as is common with tax policy proposals, it developed and became more defined over time.
Finally, it should be noted that Michigan’s reform also included some changes to the personal income tax, most of which do not come on line until 2013. These changes are not included in the estimate above.
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