Borrowing Time?

On Tuesday, Feb. 8, 2005, Gov. Jennifer Granholm gave her annual State of the State address. In the speech, the governor proposed borrowing $2 billion for direct or indirect subsidies to companies in "technology and emerging industries," while borrowing another $800,000 for public works spending. This proposal was one of the centerpieces of her program to repair Michigan’s broken economy.

Following the speech, Jack McHugh, a legislative analyst for the Mackinac Center for Public Policy, participated in a panel discussion on the Delta College public television program "Currently Speaking." Shown below is an edited version of McHugh’s prepared remarks for the program. Some of McHugh’s material was excerpted from other Mackinac Center publications, such as Lawrence W. Reed’s Jan. 31 "State of the State" address, but McHugh’s remarks represent an original and specific response to the governor’s proposal.

To put the governor’s proposed borrowing into perspective, it may be useful to view this as if the debt were structured like a four-percent, 20-year mortgage, borrowed all at once and amortized in monthly payments. Here is what those numbers look like:

These numbers are for illustration purposes only. The debt will probably not be structured like a mortgage with monthly amortization payments, and the money will not be borrowed all at once — the governor proposes stretching the $2 billion in borrowing for "technology and emerging industries" over 10 years, and the $800 million in borrowing for public works spending over three years.[2] The figures in the table are intended to help put into perspective the magnitude of the proposed principal and interest payments.

Here’s the real question: Why is it that when bad public policies contribute to high unemployment, politicians think that going into debt will make things better? This was the first response recently of the City of Detroit and the Detroit School District to an ongoing demographic and economic meltdown, and now Gov. Granholm is going down the same path.

Let’s step back for a moment and try to put our current situation into perspective. Since December 1995, Michigan has finished 50th out of the 50 states in percentage employment growth. We’ve placed 43rd in percentage per-capita income growth over roughly the same period, and we have fallen from above the median in percentage per-capita gross state product to well below the median.[3] Michigan was the only state to lose a large number of jobs last year, and our 7.3 percent unemployment rate is now the worst in the nation.

We did not get in this fix because of a lack of subsidies and "targeted incentives" to favored businesses and industries. Indeed, if these things worked, Michigan would be a leader in economic growth, because we’ve done plenty of this sort of thing. Nor did we get here because of a lack of public works spending. We’ve done plenty of that, too, including many millions that were misspent using so-called "Clean Michigan Initiative" bond money.

No, the reason that Michigan is struggling is because we have a horrendous business climate.

Michigan ranks 34th out of 50 states in the Pacific Research Institute’s index of economic liberty. We’re 36th in the Tax Foundation’s business climate index, and the unemployment tax burden we place on job providers is the ninth worst in the nation. On the issue of corporate income taxes, the Tax Foundation ranks Michigan dead last — 50th out of 50 — and our Single Business Tax has been found to take 50 percent more from employers than the national average for state business taxes.[4]

So why in the world would anyone think that piling on more debt and public works spending would fix the problem?

The real medicine that Michigan’s sick economy needs is to eliminate or drastically reduce the Single Business Tax and the property tax that we impose on the tools and capital equipment that businesses use to make things, provide services and create jobs. Given the demonstrable failure of false economic cures like corporate welfare subsidies and public works spending, prescribing more of them is like sending a cancer patient to a witch doctor instead of an oncologist.

If we did take a real cure and eliminate the SBT, Michigan would move from 50th in the corporate tax ranking to a tie for first with four other states. Our general business climate ranking would climb from 36th to 12th. If we simply cut the SBT in half, Michigan would move from dead last on the corporate tax ranking to approximately 20th place, and our general business climate ranking would go from 36th to around 27th place.

But why won’t spending $2 billion on subsidies for particular corporations and researchers in "technology and emerging industries" work? In a dynamic economy, no one can say which industries will replace the jobs that used to be provided by manufacturing. To position our state to be a winner in such a fluid environment, legislators and the governor essentially have two choices.

The first is to think that they somehow can predict which businesses or industries will dominate the future economy (if any), and then to tailor tax or training "incentives" for just those particular enterprises. This approach is always tempting for politicians because it is easy, has no immediate political cost and makes it look like they are "doing something."

But these gimmicks will never work, for two important reasons. First, politicians in Michigan are not the only ones seduced by them. Most states have their own "economic incentive" programs. The governor acknowledged that California has already trumped her $2 billion subsidy proposal with a $3 billion corporate welfare handout of its own. Separating yourself from the competition in this arena is difficult, and it’s ultimately a losing game anyway.

Second, the basic assumption behind special breaks for certain businesses is that central planners have better information and make better decisions than the market, where the aggregated knowledge and decisions of millions of individuals really do pick winners and losers. This form of hubris was dubbed "the fatal conceit" by Nobel Memorial Prize-winning economist Friedrich Hayek. Handouts from Michigan taxpayers to firms like Webvan, KMart, and Optical Imaging Systems are memorials to government planners’ folly.

The other choice is to adopt such major business tax and regulation reductions that Michigan becomes irresistible to investors and entrepreneurs who want to grow a business. This approach works every time it is tried.

Michigan can improve its economy. We can reduce our unemployment rate. But doing so will require political courage and an end to "business as usual" attitudes in Lansing.

Jack McHugh is a legislative analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.

[1] Assuming a state population of roughly 10 million people.

[2] The actual borrowing methods could reduce the overall size of the interest payments — but they might increase it, too, since interest rates may climb in the next few years. Ultimately, there won’t be major differences from the debt calculated in the table above. Debt is debt, and however you structure it, you can’t fool Mother Finance.

[3] In percentage per-capita gross state product, we have fallen from above the median — 18th from 1993 to 1997 — to well below the median — 44th from 1998 to 2003.

[4] An analysis by James R. Hines Jr., a professor of economics at the University of Michigan, found that from 1977 to 1995, Michigan corporate taxes as a percentage of gross state product were on average 50 percent higher than those of other states.