Fiscal Fact No. 25
Introduction
As Michigan state lawmakers consider changes to their 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.
system in 2005, they should adopt those changes that will improve their state’s business climate and eschew proposals that will make Michigan less competitive in attracting new labor and capital. The Tax Foundation developed its State Business Tax Climate Index (hereafter, the Index) to rank the features of a state’s tax system that are most helpful in seeking and attracting new investment in the competitive international economy. A rational, competitive tax climate is essential to a state’s fiscal health and is therefore a crucial component of a state’s overall business climate.
This study analyzes how Michigan could improve its business tax climate if the Single Business Tax (SBT) was eliminated and the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. base expanded to include consumer services. According to the Index, the SBT harms Michigan ’s business climate, making Michigan less competitive in attracting new jobs. It also harms Michigan ’s ability to keep the jobs currently located there, as can be seen in the recent troubles experienced by the auto industry (most notably, General Motors). If the SBT had been eliminated before the last Index rankings were calculated, Michigan , which ranks 36 th best overall in the Index, would have risen to 13 th. SBT elimination would give Michigan the best business tax climate of any state in the Great Lakes region.
Background on Michigan’s Single Business Tax (SBT)
The SBT is the only state-level value-added tax (VAT) in the United States . The base of the tax is the difference between a business’ sales and the cost of its materials. The SBT levies a rate of 1.9 percent of the entire SBT base in excess of $45,000. Since the SBT base does not rely exclusively on profits, it provides a more stable flow of revenues to Michigan , even during a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years.
. This stability comes at a great cost, however, as many firms are forced to pay the SBT even if they are not profitable.
In 2001, the Michigan Department of Revenue estimated what rate Michigan would have to levy on corporate income to generate the same revenue as the SBT. The 20-year average of the estimates is equivalent to a 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. rate of 14.83 percent. The effective rate was as high as 58.17 percent in 1992 (in the middle of a recession). The state with the highest corporate income levy, Iowa , imposes a top rate of 12 percent on income in excess of $250,000. Thus, the SBT gives Michigan the highest effective tax rate on corporate income of any state in the nation—giving them the lowest rated corporate tax system in the Index.
Michigan lawmakers are currently debating the possibility of reforming or eliminating the SBT as a means of improving Michigan ’s rapidly declining business climate. One popular proposal eliminates the SBT entirely in order to remove the heavy burden the value-added style tax imposes on businesses. This proposal also expands the sales 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. to include consumer services like haircuts and home and auto repair. The next section explores the impact this would have on Michigan ’s ranking in the Index.
SBT Elimination and the Business Tax Climate Index Model
The State Business Tax Climate Index ranks five key features of a state’s tax climate: the corporate income tax; the personal income tax; the sales tax; the unemployment insurance tax; and the state’s overall fiscal balance. These five sub-measures tier up to a national ranking.
The SBT elimination plan concerns corporate income taxes and sales taxes only, so Michigan’s ranking on the other three measures are unaffected and Michigan will retain the scores of 12 th on the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , 41 st on the unemployment insurance tax, and 39 th on fiscal balance.
Table 1: Eliminating Single Business Tax (SBT) Gives Michigan the Best Business Climate in Great Lakes Region
|
State |
Top Corporate |
Ranking in Tax Foundation’s |
|
Michigan |
0% |
13th Up from 36th |
|
Illinois |
7.3% |
24th |
|
Indiana |
8.5% |
14th |
|
Minnesota |
9.8% |
48th |
|
Ohio |
8.5% |
32nd |
|
Wisconsin |
7.9% |
41st |
Source: Tax Foundation
The proposed changes would eliminate all corporate taxation on income in Michigan . This would move Michigan from 50 th to 1 st in the corporate tax portion of the Index. Michigan ’s sales tax scores well in the Index as it ranks 17 th. When the base is expanded to include consumer services the rank falls to 23 rd, a drop of 6 spots. Overall, these tax changes would improve Michigan ’s standing in the Index relative to other states. Michigan ’s final Index ranking would rise 23 spots from 36 th to 13 th (see Table 1).
Eliminating the SBT Makes Michigan More Competitive
Michigan ’s SBT is currently harming the state’s business climate, which directly hurts Michigan residents. Lawmakers need to take steps towards rectifying this situation so that the business climate does not deteriorate any further. A continued erosion of the business climate in Michigan will drive more manufacturing from the state and worsen an already hurting industrial sector. Michigan currently has one of the highest unemployment rates of any state in the nation—6.9 percent in March, 2005 (the second worst rate of any state), with 17,000 job losses.
Lawmakers in Michigan will undoubtedly be concerned about the loss of almost $2 billion in revenue from elimination of the SBT. Some (if not all) of this revenue will be replaced by expanding the sales tax to consumer services. A recent study by the Council on State Taxation (COST) estimated that states apply their sales tax to only 11 percent of the $3.5 trillion in consumer services in the United States.1 If Michigan applied its sales tax to these consumer services, it would undoubtedly recoup many of the tax revenues lost by eliminating the SBT.
What Michigan certainly cannot afford, however, is to allow the business climate to continue in its current condition, which is already causing tremendous strain on state coffers. In the 1990s, Governor Engler understood that the state needed to cut taxes to recover from the recession in the early part of that decade. Today’s lawmakers in Michigan should look to his example as they address the current crisis.
Conclusion
Michigan ’s SBT is the most damaging state corporate tax in the United States . Governor Granholm has a plan to address some of the issues with the SBT, but her plan will not go far enough. Even if the SBT rate were lowered significantly, the SBT would still require Michigan corporations to make significant tax payments during periods of recession. The SBT is crippling Michigan and driving business away to other states. Michigan lawmakers need to take bold action to fix the problem, and only by eliminating the SBT can Michigan hope to offer a competitive business tax system.
Footnotes
1 See Robert Cline, John Mikesell, Tom Neubig and Andrew Phillips, Sales Taxation of Business Inputs: Existing Tax Distortions and the Consequences of Extending the Sales Tax to Business Services, Council on State Taxation (January 25, 2005).