Breaking the Business Tax Deadlock

Four years into a national economic recovery Michigan is still bleeding jobs, due in large part to a burdensome and complex state business tax system. Both the Democratic governor and legislative Republicans offer reform proposals that are timid at best. Yet without dramatic changes, Michigan’s malaise will almost certainly continue indefinitely.

The situation is reminiscent of July 1993, when the state faced a full scale school finance crisis. One school district had already shut down in March after a millage vote failure. Funding varied wildly across the state from $3,277 to $10,356 per pupil. Property owners groaned under constant millage and assessment increases, and headlines reported elderly pensioners forced to sell their homes because of tax increases.

Michigan’s political establishment had failed in repeated reform efforts. Everyone wanted to cut property taxes, but partisan mistrust and fear of change led to a stalemate.

On the night of July 20, both sides decided to take a risk. Senate Democrats offered a proposal to eliminate local property taxes as the primary funding source for public schools and replace them with – nothing. When asked what he would do if this measure passed, Republican Gov. John Engler paused and said, "Well, then I'd sign it," according to a Gongwer News Service retrospective.

The dual problems of exploding property taxes and underfunded schools had been assumed to be both inseparable and insoluble. Ignoring the first assumption allowed leaders to disprove the second. Specifically, cutting taxes first gave both sides the freedom to make compromises that otherwise would have been impossible. The result was Proposal A, Michigan’s unique school finance system. Though it has its critics, few of them seriously doubt that the current system is far superior to the previous one.

Fast forward to 2005. Michigan’s 7.5 percent unemployment rate is the nation’s highest. We were the only state to lose jobs in the last 12 months. It’s no coincidence that our business climate is ranked 36th among the states by the respected Tax Foundation, and our Single Business Tax is rated worst in the nation.

Recognizing the problem, Gov. Jennifer Granholm has proposed a highly problematic business tax restructuring plan. Because it is "revenue neutral," the proposal would help some industries only by harming others, and our overall business tax burden would still be the highest in the nation – some 50 percent above the average.

For their part, legislative Republicans offer piecemeal tax cuts targeted at particular types of business, or remedying specific perverse incentives in the Single Business Tax. While both sides have good intentions, both are trapped in a box comprised of budget constraints and fear of proposing alternative revenue sources.

As in 1993, we face a dual problem – deficits and business taxes this time – that cries out for the same kind of creative thinking and audacity. How to do it?

Pass the pro-growth parts of the governor’s proposal — its 36 percent rate cut, and its big credit against property taxes on industrial tools and equipment. Extend the latter to all business equipment. As happened in 1993, the prospect of real relief will create a "moment of clarity" in which all sides recognize the vital need for these changes.

Yes, this will open a $900 million "hole" in the budget. But that is really a separate issue, and should be dealt with separately, just as in 1993. As happened then, passing the tax cut first will give both sides the freedom to take less popular votes that otherwise would be impossible. Compromises will be necessary, and no one will be completely happy. (Many Mackinac Center scholars will be disappointed if the solution doesn’t rely solely on spending cuts.)

But in the end everyone can come away a winner, just as in 1993. The governor and the Legislature at that time showed real courage and demonstrated a key component of leadership: the willingness to take risks. Who can say that the people who occupy their places today are incapable of similar leadership?

Virtually all the players in the 1993 drama today feel great pride in their accomplishment, and even that it may have been the most significant thing they ever did. Maybe 10 years from now people will reminisce about that legendary spring of 2005, when Michigan’s political establishment broke the deadlock and took the first step in reviving the state’s ailing economy.

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.