The Single Business Tax Burden on Michigan Industries

Executive Summary

Objective Questions

The objective of this analysis is to answer three questions:

The Variation of SBT Burdens Across Industries
Is there a substantial and consistent difference in the relative SBT burdens of various industries, across different time periods and economic situations?
The Taxation of the Financial Industry
In particular, how does the Financial Industry compare with other Michigan industries in their SBT burden?
The SBT and Business Expansion
What peculiar facets of the SBT discourage or encourage business expansion in Michigan, and what does this suggest for retaining, modifying, or replacing the VAT concept for Michigan business taxation?

Findings

The analysis produced the following findings:

The Single Business Tax

Comprehensiveness of the Single Business Tax System
The use of a single, comprehensiveness tax system has built-in advantages in the equality of treatment among industries. Multiple tax systems must overcome the built-in disadvantages of complexity and redundancy. The legislature's purpose in creating the Single Business Tax included greater equality of treatment. The recreation of multiple tax systems would work against this purpose.

Cyclicality of a VAT
The VAT-type SBT limits the cyclicality of revenue to the State government, but increases the cyclical pressures on taxpaying businesses. The benefits of better cyclical stability of tax revenue under a VAT must be discounted by the cost of increased cyclical instability for the taxpaying businesses and individuals.

The SBT and Capital Expenditures
Because the depreciation deductions allowed in most profits tax systems understate the true cost of capital expenditures, consumption-type VAT's like the SBT are more favorable to capital expenditures than profits taxes. Because many of Michigan's major industries are capital-intensive, this more-neutral treatment of investment is a major advantage of the SBT over the profits tax systems in other states. The full expensing of capital investments under the SBT encourages businesses to invest in Michigan.

The 1985 Treasury Report

The government study of record on the SBT was authored by the Michigan Department of Treasury in 1985. The quantitative analysis in this study relies on the data gathered for the Treasury study, and critically reviews its methodology. The findings below summarize the limitations of the Treasury data, and the biased results introduced by the Treasury methodology.

1985 Treasury Report Data Limitations: Unusual Sample Year
The sample period of the Treasury study was a time of extreme economic contraction, which affected some Michigan industries more than others.

Insufficient Sample Period
The sample period of the Treasury study was very short, and does not indicate the behavior of various industries over the entire economic cycle.

Old Data
The number and importance of economic changes occurring in the over-five-year time lapse between the sample period and the current date limit the predictive power of the data.

Aggregation
The groupings of industries into standard categories can hide differences between the industries. In the Financial Industry category, banks, insurance companies, and real estate companies are grouped together, even though substantial differences exist among the three in business operation. Conclusions about a group cannot be generalized to all its components without further analysis of disaggregated data.

Biased Results from the Use of an Incorrect Tax Base
The 1985 Treasury Report relied on an incorrect measure of the tax base, which ignored capital expenditures. Thus, their analysis systematically biased downward their calculated SBT burdens. The actual tax burdens of Michigan industries were higher than those stated in the Treasury study, particularly for those industries making large capital expenditures in the sample period.

Analysis of Single Business Tax Burdens on Michigan Industries

Using the proper methodology, which took into account capital expenditures in selecting a tax base, this analysis produced the following findings about the SBT burdens on Michigan industries.

View Chart 1 and Chart 2.

Relative Tax Burdens
The SBT burden as a percentage of the Adjusted Tax Base varied considerably across industries during the sample period, ranging from 1.4% for Agriculture to 3.35% for Finance, Real Estate, and Insurance. The average tax burden ratio for all firms was 1.8%.

Comparison with Treasury Results
The tax burden ratios are higher and more varied than those reported in the Treasury study. To conclusively determine relative tax burdens, data from one complete economic cycle must be analyzed, using the proper methodology.

The SBT Burden Compared with Profits
The aggregate SBT liability of Michigan firms represented over 20% of their pretax profits in the sample period. The SBT clearly intensifies the cyclical pressures faced by Michigan businesses; this ratio probably drops sharply in good economic years.

Business and Personal Tax Burdens in Michigan
Both business and personal tax burdens in Michigan are significantly higher than the national average. US Census Bureau data show that Michigan's 1984-85 Corporate Taxation burden was the second highest in the nation, double the national average. Because both theory and experience show that high tax burdens discourage economic growth, the Legislature should lower the overall tax burdens in the State.

The "Fairness" of SBT Burdens on Michigan Industries
For a tax system to be equitable and efficient, it must levy a similar proportionate burden for firms of different size and in different industries over the entire economic cycle. During the sample period, the tax burden ratios varied significantly, indicating that there may be a bias against some industries in the SBT caused by unequal use of special credits and deductions.

The Tax Burden of the Financial Industry
During the sample period, the tax burden of the Financial industry was the highest of all industries. While data from a complete cycle are needed to conclusively establish relative burdens, there is no basis to conclude that the Financial industry escapes its share of the SBT burden.

I. Introduction

The Michigan SBT is the only Value-Added state business tax system in the United States. The federal income tax, the federal corporate income tax, the Michigan income tax, the business taxes in most states, and the local income tax all use some type of "income" or profits as their base. Most economists and the general public are familiar with the concept of income as an appropriate tax base, and as an appropriate measure "ability to pay."

By contrast, the SBT uses a value-added concept as its base. A Value-Added Tax (VAT has advantages and drawbacks, some of which are discussed in this report. VAT's are common in Europe (especially in Common Market countries) and Asia, but almost unknown in the U.S. and Canada. This unique VAT concept of the SBT has helped itbecome one of the least understood and most maligned of tax systems in Michigan, and allowed considerable confusion over the relative tax burdens of businesses of different sizes and industries.

The January 1985 document Analysis of the Michigan Single Business Tax, published by the Michigan Department of the Treasury, had as its purpose "to investigate how Single Business Tax liabilities vary between businesses in different product groups, or different sizes, and in different economic situations." [1] While this study illuminated many poorly-understood facts about the SBT, it did not quell the controversy about relative SBT burdens among industries in Michigan. Further analysis of the SBT and its effect on Michigan businesses was needed.

A. Objective Questions

The objective of this analysis is to answer three questions:

The Variation of SBT Burdens Across Industries
Is there a substantial and consistent difference in the relative SBT burdens of various industries, across different time periods and economic situations?

The Taxation of the Financial Industry
In particular, how does the Financial Industry compare with other Michigan industries in their SBT burden?

The SBT and Business Expansion
What peculiar facets of the SBT discourage or encourage business expansion in Michigan, and what does this suggest for retaining, modifying, or replacing the VAT concept for Michigan business taxation?

B. Recommendations to the Michigan Legislature

The answers to the above questions will produce recommendations to the Michigan Legislature:

If a thorough analysis reveals that certain industries pay a significantly higher or lower tax burden than the average Michigan business, and do so consistently during different economic situations in different years, then the legislature would be advised to consider changes in the relative tax burden of various industries. This could be done by increasing or decreasing the burden on any one industry, by changing the tax treatment of certain practices under the existing system, or taking some industries out of the current system.

If, on the other hand, the variation among industries is relatively small, or the relative tax burdens fluctuate considerably with no industry consistently ahead or behind, or it the available data do not provide a conclusive determination, then the legislature would be advised to consider instead the overall business tax burden.

In particular, if the tax burden of the Financial Industry remains consistently higher or lower than that of all other industries, then the legislature should consider changes in the taxation of that industry.

Finally, if the VAT structure of the SBT inherently discourages business expansion in Michigan, the legislature would be advised to consider replacing or modifying it. If it favors business expansion in the state, then the legislature would be advised to consider other factors, such as the business climate or personal taxation levels, that also affect business growth prospects.

C. Outline of this Study

This study introduces the relevant questions about the SBT in the first section, describes the SBT and the VAT concept in the second section, and outlines a methodology for comparing relative industry tax burdens in the third section. Finally, it presents the results in the fourth section.

The objectives, and the key findings, are indented and titled, and summarized in the Executive Summary. The quantitative analysis in this study relies primarily on the summary data compiled by the Michigan Department of the Treasury for its 198i analysis of the SBT.

II. The Single Business Tax

A. History of the Tax

The SBT was adopted in 1975 to replace a number of taxes: the state corporate income tax, the financial institutions income tax, a corporate franchise fee, a savings and loan association privilege fee, domestic insurance company privilege fee, local government property tax on inventories, and the intangibles tax on business. One major motivating factor for the adoption of a VAT-type SBT was the desire to tax all business activity fairly and comprehensively, rather than with a hodgepodge of taxes on various types of firms. [2] Note that a number of the taxes replaced by the SBT were specifically placed on the financial industry.

B. The SBT: A Consumption-Based Value-Added Tax

The SBT is a consumption-based value-added tax. While most business and individual tax systems in North America tax income, the SBT taxes the added value given to products by business organizations. The SBT is technically referred to as a consumption-based VAT because its tax base includes all consumed resources. Investments are deducted from the tax base when made, but the value-added from those investments are included when consumed by the business enterprise.

The use of a consumption tax base does not eliminate the taxation of investments. Instead, it matches taxation to the time period in which the value of the investment is consumed. The SBT includes the entire value of an investment in the tax base, but spreads it out over the life of the investment.[3]

Before returning to a corporate income tax in 1967, Michigan relied on the VAT concept with the 'Michigan Business Activity Tax, from 1953 through 1967. Thus Michigan businesses have faced a VAT for most of the latter half of the 1900's.

C. Advantages and Disadvantages of the Single Business Tax

Three advantages cited in the 1985 Treasury Report are of interest in this inquiry: comprehensiveness, revenue stability across the economic cycle, and better treatment of capital investment.

1. Comprehensiveness of the Single Business Tax System

Since all industries, both manufacturing and service, create value in their product, value-added taxation is a comprehensive approach to business taxation. Profits tax systems rely on the fact that all industries try to maximize profit, and are also comprehensive. One advantage of a VAT over a corporate profits tax is that VAT's can easily apply to all forms of business organization, rather than corporations alone. The various forms of business organization – individuals, partnerships, proprietorships, publicly and privately held corporations, etc. – each have different incentives to earn profit. A comprehensive business VAT eliminates much of the incentive to shift income between various business forms.

In general, the more comprehensive the tax system, the less distortion it creates in the marketplace. [4] The use of a single tax system, rather than a number of overlapping systems, is a step towards greater comprehensiveness and equality of treatment. [5] The SBT taxes the value-added by all firms in all industries. Separate tax systems for separate industries have built-in disadvantages of increased complexity, potential redundancy, and possible gaps in coverage. This intrinsic superiority of a single, comprehensive tax system was one of the reasons the Michigan legislature formulated the SBT, and remains one of its advantages. [6]

Therefore, proposals to place Michigan industries once again under multiple tax systems must prove that multiple systems would bring more comprehensive coverage and better equality of treatment than a single system. [7] The basic superiority of single, comprehensive systems is a powerful advantage, as Michigan recognized with the establishment of the SBT.

This produces the first finding of this report: (Findings are indented and collected in the Executive Summary.)

Comprehensiveness of the Single Business Tax System
The use of a single, comprehensiveness tax system has built-in advantages in the equality of treatment among industries. Multiple tax systems must overcome the built-in disadvantages of complexity and redundancy. The legislature's purpose in creating the Single Business Tax included greater equality of treatment. The re-creation of multiple tax systems would work against this purpose.

2. Cyclicality of the VAT

The Treasury points out that a VAT system provides better revenue stability (for the State government) than a profits tax. This occurs because business income is far more affected by cyclical swings in the economy than business revenue. While this stability in revenue is often cited as beneficial to the state, the converse of that cyclical stability for the taxing authority is increased cyclicality for the tax-paying business. [8]

In poor economic years, SBT-paying businesses must pay tax even if they lose money. In good economic years, SBT-paying businesses pay taxes out of healthy profits, although less tax than they would under an equivalent profits tax. The tax burden is far greater in bad years under a VAT than an income tax. Conversely, the tax burden is lighter in good years under a VAT than an income tax.

Thus, in terms of net (after tax) income, the use of a VAT-type business tax increases the cyclical sensitivity of Michigan businesses (making bad years worse and good years better), while reducing the cyclical sensitivity of Michigan government.[9]

Cyclicality of a VAT
The VAT-type SBT limits the cyclicality of revenue to the State government, but increases the cyclical pressures on taxpaying businesses. "The benefits of better cyclical stability of tax revenue under a VAT must be discounted by the cost of increased cyclical instability for the taxpaying businesses and individuals.

D. The SBT and Capital Investment

The third major advantage of a VAT-type SBT cited by the Treasury is its better treatment of investment:

A stronger incentive for new investment is created by fully deducting capital costs under the SBT compared with depreciation deduction of business income taxes. [10]

Both income (profits) and Value-added tax systems recognize that capital expenditures should be excluded from the tax base, with the profit (or value-added) from that investment included in the tax base. The difference between the two lies in the timing of those deductions; a profits tax allows annual depreciation deductions which sum to the cost of the investment, while a consumption-type VAT deducts the full amount in the year it was made. [11]

An ideal tax system is neutral between consumption and investment, meaning that the true, interest-adjusted cost of consuming goods today, and later consuming the proceeds from today's investment, are equivalent. Investment in the current period produces consumption in later periods, and if that consumption is fully taxed, then the full value of investment is included in the tax base at the time that value is realized. [12] See the example in Table One.

Although depreciation schedules allow, deductions that sum to the historical cost of the investment, the net present value (the sum of the present and future values, discounted to account for the time value of money) of the depreciation deductions is less than that of the investment. This problem becomes especially severe in times of inflation, because the costs of replacing capital investments grow, while the depreciation deductions do not. By allowing full expensing in the year a capital expenditure is made, the SBT does not discriminate against investment, avoids compounding the impact of inflation, and remains nearly neutral between consumption and investment. [13]

The SBT and Capital Expenditures
Because the depreciation deductions allowed in most profits tax systems understate the true cost of capital expenditures, consumption-type VAT's like the SBT are more favorable to capital expenditures than profits taxes. Because many of Michigan's major industries are capital-intensive, this more-neutral treatment of investment is a major advantage of the SBT over the profits tax systems in other states. The full expensing of capital investments under the SBT encourages businesses to invest in Michigan.

TABLE 1

Example: Neutrality Between Consumption and Investment Under a Consumption-Based Value-Added Tax

	Tax Base: $100 Consumed	Tax Base: $I00 Invested
Year 1	$100	0
Year 2	$100	0
Year 3	0	$112.36
Sum	$100	$112.36
Net Present Value	$100	$100

In the first case, $100 consumed leaves $100 in the tax base. In the second case, the same $100 invested for three years at 6% annual interest leaves zero in the tax base for two years, but yields $112.36 into the tax base in the third year. The net present value of both is the same, meaning the tax system is neutral between consumption and investment.

E. The SBT and the Capital/Labor Decision of the Firm

The SBT has interesting effects on the capital/labor decision of the firm. A consumption-type Value-Added Tax is neutral between consumption and investment. However, when compared with profits taxes relying on depreciation schedules (which actively discourage investment) the SBT is significantly more favorable to capital investment.

The interaction of the SBT with other business-climate factors – notably wages, Unemployment Insurance and Workers' Compensation costs – does affect the capital/labor decision of the firm. Because these components of total labor cost are significantly higher in Michigan than the U.S. average, (while capital costs are not significantly higher in Michigan than elsewhere), the full inclusion of all payroll costsin the SBT base magnifies the already-existing cost differential. [14]

This effect is overwhelmed for some firms by the Excess Compensation Deduction to the SBT. In certain cases, the Excess Compensation Deduction provides a substantial cost advantage for the hiring of new labor over the purchase of new equipment. [15] However, this deduction is not available for all firms, and overall labor costs affect more business decisions than the narrow provisions of certain deductions to theSBT. Thus, while a consumption-type VAT is technically neutral between capita! and labor, the total cost structure (including the SBT) facing Michigan business favors capital over labor. The most powerful way for Michigan to improve employment prospects (aside from encouraging economic growth) would be to lower total labor costs, not to attempt to penalize capital or subsidize labor in the tax code.

F. Accounting for Capital Expenditures Under the SBT

The accounting procedure for capital expenditures under the SBT is the reverse of traditional profits taxation. Traditional profits taxes using depreciation schedules allow no deduction for a capital expenditure, but subtract depreciation from the tax base. The SBT adds back in the depreciation, then subtracts capital expenditure. Because the sum over time of depreciation equals the (historical) cost of the capital expenditure, the two systems both deduct the full historical cost of a capital investment.

The difference lies in the timing of the deductions; a consumption-type VAT deducts the full cost in the year the capital investment is made, while a profits tax spreads the deductions across the depreciable life of the investment.

Recognizing the essential principle behind the taxation of capital expenditures – that the historical costs of investments are deducted from the tax base, while the profits or value-added are included – is crucial to the selection of an appropriate tax base for the SBT, and will be used later in this report.

To see this more clearly, examine the hypothetical firm in Table Two. The firm makes a 55,000 capital expenditure in year one, depreciating it over three years under a profits tax, and deducting it entirely in year one under a consumption-type VAT. Under both systems, the firm reduces its tax base by exactly $6,000. Under a profits tax the deduction is spread over three years, while under a VAT it is taken entirely in year one.

The actual calculation of the SBT starts with Federal Taxable Income. which is Gross Business Income (before taxes or capital costs) less depreciation. To arrive at the SBT taxable income, add back in depreciation (to zero out the prior deduction under the federal system), and then subtract capital expenditures. Finally, add in labor and interest expenses to equal Value-Added, which is the proper base for theSBT. [16]

TABLE 2

Example: Comparison Between Consumption-based VAT and Profits Tax Systems In the Taxation of Capital Expenditures

Assumptions	Year 1	Year 2	Year 3
Gross Business income (Pre-tax, before capital costs)	$10,000	$10,000	$10,000
Capital Investment	$6,000	0	0
Depreciation	$3,000	$2,000	$1,000
Labor + Interest	$2,000	$2,000	$2,000

Profits Tax System
Gross Business Income	$10,000	$10,000	$10,000
less: Depreciation	($3,000)	($2,000)	($1,000)
equals: Taxable Income	$7,000	$8,000	$9,000

Tax Liability = tax rate * Taxable Income
Total reduction in Tax Liability because of capital investment: tax rate * SUM(depreciation) = tax rate * 6,000.

Value-Added Tax System
Gross Business Income	$10,000	$10,000	$10,000
less: Depreciation	($3,000)	($2,000)	($1,000)
equals: Taxable Income	$7,000	$8,000	$9,000
plus: Depreciation	$3,000	$2,000	$1,000
less: Capital Expenditure	($6,000)	0	0
plus: Labor + Interest	$2,000	$2,000	$2,000
equals: Value-Added	$6,000	$12,000	$12,000

Tax Liability = tax rate * Value-Added.
Total reduction in Tax Liability because of capital investment: tax rate * capital expenditure = tax rate * 6,000.
Example: This hypothetical firm made a $6,000 capital expenditure in year one, reducing its tax base by $6,000 over three years under both systems. The systems differed in the timing of the deductions.

III. Methodology and Analysis: Relative SBT Burdens for Different Industries

A. The 1985 Treasury Report: A Critique

1. Data

The 1985 Treasury report relies on data gathered from tax returns from firms whose tax years ended between December 1980 and November 1981. The fact that these data are confined to that particular one year period has three important consequences.

First, the 1980-81 period was one of recession in the United States, and of particular economic contraction in Michigan. Therefore, the revenue and profitability of most industries were significantly below historical trend. Importantly, some industries were affected more than others. Procyclical Michigan industries – industries such as manufacturers of durable goods, including automobile manufacturers – tend to exagerrate the national economic cycle. Typically, they have better good years and worse bad years. Because of the prominence of procyclical industries in Michigan's economy, the entire state tends to swing from boom to bust more severely than the nation as a whole. Thus, Michigan suffered worse under the recession than most states. [17]

In addition, the inflation rate was significantly higher then than it has been in recent years – another important element for manufacturers with heavy capital investment. Under profits taxes (like the federal corporate income tax) with fixed depreciation schedules, the depreciation allowances fall quickly behind the cost of investment during periods of inflation. [18]

Because of the unusual and extreme economic climate of the sample period, the relative tax burdens of Michigan industries at that time would probably differ from those calculated during peak years. Thus, the results should not be generalized to the entire cycle.

A second limiting factor of the Treasury data is the short time period: 1980-81. Because industries respond differently to the economic cycle, a minimum of one complete economic cycle must be analyzed to provide a true picture.

A third problem with the Treasury data is its age. Since 1981 began, all the fiscal and monetary policy changes under the Reagan Administration have taken effect, Michigan's economy and economic policies have changed, and the most dramatic tax code changes in a generation have been passed into law. All these have caused substantial changes in the way Michigan business operates. Therefore, the sheer time difference between the sample period and the current date limit the usefulness of any conclusions drawn from the data.

2. Aggregation

A further problem with the data stems from the grouping of different industries into standard categories. The groupings can hide differences in cyclical sensitivity among industries, which confuses the effect of different economic conditions with the differences in relative tax burdens. This is clearly the case in the Financial Industry category. High interest rates in the sample period benefited insurance companies, but hurt real estate and banking companies. Since all three were grouped together in the same category, the effect of the interest rate cycle was mixed together with underlying differences in tax burdens.

In addition, the different categories contain a widely varying number of firms. Among other problems, this makes the selection of the statistical measure for the "average" tax burden somewhat complicated, and renders impossible the calculation of a measure of variation of the tax burden. [19]

One further aggregation problem arises from the special credits allowed smaller businesses under the SBT, which lower their relative tax burdens. Those industry categories containing a large number of small businesses will have a lower relative tax burden, merely because of the size of the firms in the category. [20]

3. Conclusion: Data

Researchers in quantitative social sciences have two resources to work with: methodology, and data. Far too often, they fall in love with the former and ignore the latter. Without good data, quantitative methodology yields little but "statistical artifacts." Computer programmers have a pithy saying for it: "garbage in, garbage out."

In this study of the relative tax burdens of the SBT, the limitations of the data are significant. An honest researcher will report those limitations and qualify the conclusions accordingly.

The data have three limitations due to the sample period, and one due to their aggregation. The sample period limitations prevent an accurate prediction of later relative tax burdens from the results in the sample period. The aggregation limitation will prevent applying the relative tax burden of a category to all the Members of that category.

However, the study still illuminates. A snapshot may not be as good as a motion picture, but it is better than nothing. Moreover, the few other "snapshots" available provide some check on the results from the sample period. Furthermore, the findings that depend on the structure of the SBT hold without regard to the sample period.

Ultimately, the methodology developed here provides a basis for evaluating future data. An accurate "motion picture" of the relative tax burdens awaits only a few more frames of data.

The 1985 Treasury report indicates that similar analyses will be available for years after 1981 "as soon as SBT data are available." The proper methodology to analyze the data is developed in the next section.

B. Methodology for Analyzing Industry SBT Burdens

1. The Selection of a Proper Tax Base

To properly determine the relative tax burdens of different Michigan industries, some measure of the tax base corresponding to Michigan operations must be selected. [21] The appropriate measure would include all of the tax base included in the consumption-based Value-added concept of the SBT, but ignore special adjustments, exemptions, and exclusions. Thus, the tax liability divided by the proper tax base would give an appropriate measure of the relative SBT burden.

As discussed above, the appropriate tax base for a consumption-based VAT like the SBT is gross business income, plus depreciation, plus labor and interest, less capital expenditures: the Adjusted Tax Base. [22] Dividing the tax liability of an industry by its Adjusted Tax Base yields an appropriate tax burden ratio.

The 1985 Treasury Report supports the use of this tax base in their description of the SBT, specifically addressing the expensing of capital expenditures:

However, despite the design of the SBT, which clearly outlines the tax base, and the above reasoning quoted from their report, the Treasury did not choose to use this tax base in their 1985 report.

The tax base the Treasury used, called "Michigan Tax Base," includes all the true tax base without the expensing of capital expenditures.This Michigan Tax Base is computed by adding labor and interest costs to profit, and adding depreciation (all steps taken to reach the true tax base), but not subtracting capital expenditures.

This approach ignores capital expenditures, which distorts significantly the tax base. The measure arrived at bears no conceptual identity with a consumption-type value-added tax, does not represent the SBT base, and does not even resemble a traditional profits tax base. [26]

To give one example of the perverse indications such a tax base would produce, consider that a firm that made a large capital expenditure – such as purchasing a building – would experience no change in its Michigan Tax Base, even though its SBT tax base (the Adjusted Tax Base), its SBT liability, its federal corporate income tax base, and its federal corporate income tax liability would all decline.

The conceptual problem with the Treasury's approach is clear. The SBT, as a VAT, takes into account every employee's wages, all material costs, the interest on bank deposits, and every sale. To exclude capital expenditures from the system would be to turn an extremely broad, inclusive tax into a distorted half-view of a company, where the purchase of a box of paperclips matters more than that of a million-dollar building. [27]

Indeed, the Treasury report flatly states that the correct base to use is the Adjusted Tax Base:

In addition to the clear evidence to the contrary in the 1985 report, the Treasury's tax base selection contradicted an earlier State government analysis of the SBT. The 1981 Department of Management and Budget (DMB) publication Analysis of the Michigan Single Business Tax: A Business Development Perspective contained similar descriptions of the construction of the SBT as the Treasury's 1985 report and correctly used the Adjusted Tax Base to measure tax burdens across industries. [29] Unfortunately, the 1981 study provided only summaries of the tax burden as a percentage of industry tax bases. [30]

The 1985 Treasury report gave no explanation for its substitution of the Michigan Tax Base for the Adjusted Tax Base, despite its use in the previous analysis and the justification for it in the text of the study.

Since the appropriate measure of the SBT base is the SBT base, the tax burden analyses in this study rely on the Adjusted Tax Base for the Michigan SBT.

2. The Effect of Using an Incorrect Tax Base

The use of an incorrect tax base, such as the Michigan Tax Base, introduces systematic bias into the results. Because the Michigan Tax Base includes both the capital expenditure and its depreciation in the tax base, it biases upward the tax bases of industries that made large capital expenditures in the sample periods. Dividing tax liabilities by the (inflated) Michigan Tax Bases produces, then, tax burden ratios that are biased downward.

Thus, the indicated "effective tax rates" in the Treasury report underestimate the true tax burden. [31]

Because different industries rely on capital expenditures to a varying degree, and because different industries make large capital expenditures at varying times in the business cycle, this bias could produce very large swings away from the underlying true tax burden ratios. Therefore, the magnitude of the bias would change from year to year, meaning again that a reliance on a very short sample period would be clearly misleading.

In addition to the general downward bias on the tax burden ratios in the Treasury study, industries that made substantial capital investments relative to their Michigan Tax Bases during the sample period of the Treasury study seemed to have lower relative tax burden ratios than a proper comparison would have produced, while those who made little capital investment seemed to have higher relative tax burden ratios.

3. Tax Burden Ratios

The SBT burdens of various industries during the sample period are indicated by their tax burden ratios, or the ratios of their total SBT Liabilities to their total Adjusted Tax Bases. These ratios are not true tax rates. The marginal tax rate is the portion of the next dollar earned (or dollar added in value) that is paid in tax; it is the true "effective" tax rate because it "effects" the decisions of the firm.

The term "effective tax rates" in the Treasury Report is misleading. The total tax liability divided by the total tax base could be called the average tax rate. The average tax rate, or tax burden ratio as it is called here, is a broad-based ratio that does not necessarily indicate the marginal rate prevailing at any one level of the tax base.

The tax burden ratio simply indicates the share of the value-added tax base consumed in Single Business Tax: a good measure of the tax burden. Table Three in section IV.A., Tables of SBT Data, lists the tax burden ratios for various industries during the sample period.

4. Measures of "Fairness"

The concept of "fairness" is difficult to quantify, but economists have generally accepted two measures that are reasonably quantifiable, and have economic justification. The first is known as "vertical equity," and refers to the relative tax burdens of taxpayers of different means. Taxes that take an increasing portion of income as income increases are commonly termed "progressive," while those taking a smaller portion are termed it regressive." Those that take the same fraction of income at every income level are termed "proportional."

The economic justification for vertical equity holds that the tax system should not penalize some taxpayers with higher rates simply because of different sized income (or value-added), and hence favor economic production of one group over another. While some have argued that the state should have a "progressive" tax system, this argument does not generally rely on economic reasoning. [32]

In the context of the Single Business Tax, vertical equity would refer to similarity in tax burden ratios as the size of the firm increased. Measuring this was a major goal of the 1985 Treasury report, which concluded that the relative SBT burden increased as firm size increased. [33] However, as this result was based on the use of an incorrect tax base, the true distribution of the relative SBT burden was not established.

The credits available to smaller businesses clearly make the SBT progressive. According to the Treasury, 60% of Michigan firms paid no SBT in the sample period 1980-81, primarily small firms. This nominal progressivity must be weighed against the larger administrative burden placed on smaller businesses. Given the considerable complexity of the SBT, the compliance burden is proportionately larger for smaller businesses than larger ones. Large businesses in general can spread the administrative costs of complying with government regulations, laws, and taxes across a larger profit base. Thus, the SBT tax liabilities are proportionately less burdensome for smaller businesses, while their compliance burdens are larger.

A major objective of this study is to determine "horizontal equity," or the equivalent treatment of taxpayers of equivalent size. Economic theory holds that, if certain industries earn a higher risk-adjusted after-tax return on investment, then resources will flow from other industries to that industry. In order to maintain the most efficient use of resources, and therefore encourage economic growth, the tax code should remain as neutral as possible among industries. In the context of this study of the SBT, a similar SBT burden among various industries would constitute "horizontal equity," or "fairness."

A related objective of this study, to determine whether the SBT favors business expansion in Michigan when compared with other state business taxation systems, relies on the same theoretical foundation: if Michigan's business tax burdens are higher than in other states, businesses have the incentive to relocate to other states.

There are other questions regarding the "fairness" of the SBT that economic theory cannot answer well. For example, the SBT, as a VAT, forces money-losing businesses to pay taxes during poor economic years. For those who favor income as a measure of "ability to pay," this makes a VAT "unfair." The underlying issue is the relationship of government to society: does government serve society, or vice versa? The SBT helps government stabilize its revenue stream, but at the expense of businesses.

The State's fiscal constraints and the power to tax affect this question. Michigan, like many states, operates under a requirement for a balanced budget. This limits its flexibility to borrow in order to finance expenditures in depressed economic times. On the other hand, the creation of "rainy day funds" allows a reserve against these situations, the balanced budget requirement allows exceptions, and the legislature can always take the expenditure-cutting and revenue-increasing steps to balance its budget. By putting businesses under a tax that increases their cyclical strain, the government is essentially forcing them to take the painful steps, in order to preserve its revenue stability.

IV. Results

A. Tables of SBT Data

Source: Author’s calculations from Michigan Department of the Treasury data.

Industry	Tax Liability	Adjusted Tax Base	Ratio: Tax Liability to Adjusted Tax Base
Agriculture	1,830,107	130,546,776	0.0140
Mining	3,471,179	259,275,339	0.0134
Construction	32,642,134	2,237,827,202	0.0146
Other Durable Manufacturers	60,346,853	3,229,543,856	0.0187
Non-Durable Manufacturers	74,610,988	3,606,992,660	0.0207
Primary Metal Industries	24,380,936	1,316,492,443	0.0185
Fabricated Metal Industries	28,633,488	1,570,412,992	0.0182
Machinery-Except Electrical	37,756,652	2,064,102,691	0.0183
Transportation Equipment	124,037,723	7,188,965,137	0.0173
Transportation	3,795,374	211,251,883	0.0180
Communication & Utilities	13,022,630	581,721,184	0.0224
Wholesale Trade	33,896,755	1,752,835,773	0.0193
Retail Trade	158,087,141	9,877,218,856	0.0160
Finance, Real Estate & Insurance	32,123,947	957,616,540	0.0335
Services	102,368,436	6,848,594,769	0.0149
All Industries Sum	731004343	41833398101	0.0175
Size Weighted Mean	96105592	5978482481	0.0180
Simple Mean	48733623	2788893206	0.0185
About Simple Mean Standard Deviation	45259224	2838308037	0.0047

#	Industry	Size	Tax Liability	Business Income*	Adjusted Tax Base	Ratio: Tax Liability to Adjusted Tax Base	Ratio: Tax Liability to Business Income**
1	Agriculture	1278	$1,830,107	($12,602,299)	$130,546,776	0.0140	1.0000
2	Mining	650	$3,471,179	$27,191,969	$259,275,339	0.0134	0.1277
3	Construction	10751	$32,642,134	$101,594,020	$2,237,827,202	0.0146	0.3213
4	Other Durable Manufacturers	3884	$60,346,853	$438,663,253	$3,229,543,856	0.0187	0.1376
5	Non-Durable Manufacturers	2645	$74,610,988	$1,003,399,373	$3,606,992,660	0.0207	0.0744
6	Primary Metal Industries	504	$24,380,936	$91,085,053	$1,316,492,443	0.0185	0.2677
7	Fabricated Metal Industries	1765	$28,633,488	$171,215,354	$1,570,412,992	0.0182	0.1672
8	Machinery-Except Electrical	2118	$37,756,652	$329,437,362	$2,064,102,691	0.0183	0.1146
9	Transportation Equipment	438	$124,037,723	($1,093,328,495)	$7,188,965,137	0.0173	1.0000
10	Transportation	2062	$3,795,374	($118,151,923)	$211,251,883	0.0180	1.0000
11	Communication & Utilities	743	$13,022,630	($20,903,441)	$581,721,184	0.0224	1.0000
12	Wholesale Trade	4152	$33,896,755	$442,610,720	$1,752,835,773	0.0193	0.0766
13	Retail Trade	40183	$158,087,141	$890,310,451	$9,877,218,856	0.0160	0.1776
14	Finance, Real Estate, & Insurance	13965	$32,123,947	($52,666,508)	$957,616,540	0.0335	1.0000
15	Services	38095	$102,368,436	$1,222,578,432	$6,848,594,769	0.0149	0.0837
	All Industries Sum	123233	$731,004,343	$3,420,433,321	$41,833,398,101	0.0175	0.2137
	Size Weighted Mean	NA	$96,105,592	$723,922,000	$5,978,482,481	0.0180	NA
	Simple Mean	8216	$48,733,623	$228,028,888	$2,788,893,207	0.0185	NA
	About Simple Mean Standard Deviation	12697	$45,259,224	$533,693,460	$2,838,308,037	0.0047	NA

Industry	Ratio: Tax Liability to Michigan Tax Base	Ratio: Tax Liability to Adjusted Tax Base
Agriculture	0.0120	0.0140
Mining	0.0100	0.0134
Construction	0.0134	0.0146
Other Durable Manufacturers	0.0165	0.0187
Non-Durable Manufacturers	0.0168	0.0207
Primary Metal Industries	0.0167	0.0185
Fabricated Metal Industries	0.0165	0.0182
Machinery- Except Electrical	0.0163	0.0183
Transportation Equipment	0.0112	0.0173
Transportation	0.0115	0.0180
Communication &Utilities	0.0133	0.0224
Wholesale Trade	0.0172	0.0193
Retail Trade	0.0143	0.0160
Finance, Real Estate & Insurance	0.0125	0.0335
Services	0.0127	0.0149
All Industries Sum	0.0139	0.0175
Size Weighted Mean	0.0137	0.0180
Simple Mean	0.0141	0.0185
About Simple Mean Standard Deviation	0.0023	0.0047