A New Beginning: Ending the Single Business Tax

The Tax Foundation’s ratings of state corporate income taxes show Michigan’s SBT to be the worst in the nation and the Great Lakes region.

Michigan’s economy is hobbled and struggling. Only a bold stroke to the Gordian Knot of state policy can free it and unravel years of fiscal hostility toward entrepreneurs and commercial enterprise. That stroke begins with eliminating the Single Business Tax.

Michigan’s Single Business Tax — unique in the United States — is somewhat similar to a European-style, “value-added” tax. It taxes businesses on their income, compensation to employees, rent payments and other indications of business activity within the state, while granting credits for such items as in-state business investment. It raises about $1.8 billion for the state annually.

The SBT, which has plowed on for nearly 30 years, was designed to replace eight different business taxes. It is now the only general tax on commercial enterprises in Michigan. This may not sound too bad, but in fact, the tax is a nightmare. A firm that loses money during the year may still owe the SBT, multiplying its financial losses. Complying with the convoluted tax creates an accounting burden that is a trial for any but the largest corporations. And the high cost of the tax drives up prices for consumers.

As a result, the SBT was recently ranked 50th — the absolute worst — among U.S. corporate state taxes by the widely respected Tax Foundation. 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.

Ending the SBT’s negative effect on Michigan’s business climate is vital because it is not the only area where Michigan is at a competitive disadvantage with other states. In the nonprofit Pacific Research Institute’s recently published index of economic liberty, Michigan ranked 34th among the 50 states, and it ranked 38th on measures of state fiscal policy. The PRI study was detailed, examining 143 variables in five categories, and it found a statistically significant link between less economic liberty and slower economic growth, lending weight to what common sense suggests.

Nor is Michigan’s labor climate competitive. Thomas Holmes of the Minneapolis Federal Reserve Bank found that between 1947 and 1996, manufacturing employment increased 150 percent in “right-to-work” states, while in other states, such as Michigan, it was nearly unchanged.

And the perception that the tax cuts of the 1990s made Michigan a low-tax state is simply wrong. While they were helpful, they did not go far enough in offsetting other tax hikes, and Michigan’s state and local taxes as a percentage of personal income remain above the national average, according to the Tax Foundation.

Michigan’s economy can’t continue to bear this burden. In recent years, the state’s growth in employment and per-capita income has been abysmal. Michigan was the only state in the union to lose jobs between January and November 2004.

There is an emerging consensus that the SBT, already slated for elimination at the end of 2009, should be deep-sixed even sooner. Gov. Jennifer Granholm has asked State Treasurer Jay Rising to develop an alternative to the current system. Published reports have suggested a possible switch to a “revenue- neutral” system that would yield the same total amount of tax revenue by eliminating the SBT and expanding our current sales tax to cover not just retail and manufacturing businesses, but the growing service sector as well.

Gov. Granholm has not endorsed this idea. But history suggests that the Legislature will be tempted. When the SBT was introduced in 1975, it, too, was designed to be revenue-neutral. According to the state House Fiscal Agency, however, legislators briefly allowed the new SBT to overlap with the previous taxes, creating “a cash flow advantage” to cancel the state’s $210 million deficit.

State government is now facing a potential $500 million budget deficit for fiscal 2006, but neither a “cash flow advantage” nor a revenue-neutral approach is sustainable given Michigan’s economic weakness and tax burden. Only eliminating the SBT and ensuring a bold net reduction in business taxes can begin to trump Michigan’s other handicaps in its economic competition with other states and nations. Even eliminating the SBT and cutting state spending dollar-for-dollar is not impossible; the Mackinac Center for Public Policy has detailed billions in potential state budget savings in areas like Medicaid, education and corrections.

Eliminating the SBT is no small task politically, but today’s policy successes, such as ending General Assistance, were once considered too bold. Legislators who want courage need only look at the increasingly ugly status quo.

Michael D. LaFaive is director of fiscal policy for the Mackinac Center for Public Policy, a nonprofit research and educational institute headquartered in Midland, Mich. Gary Wolfram, Ph.D., is the George Munson Professor of Political Economy at Hillsdale College and an adjunct scholar for the Mackinac Center for Public Policy. Permission to reprint in whole or in part is hereby granted, provided that the authors and the Center are properly cited.