20 April 2008

More Problems for Michigan

The Detroit Free Press today reports complaints of service industry owners that their business taxes are skyrocketing, often by more than 100%. There’s a fascinating back story.

Years ago Michigan replaced a complex series of business taxes with the Single Business Tax, which was supposed to be simpler and fairer. The SBT taxed labor, capital and profits. Businesses hated it, and fought for years to get rid of it. Taxing labor and capital discouraged investment and expansion, and many have argued that is one of the causes of Michigan’s poor economic performance.

But the structure of the tax hit manufacturing businesses harder than service businesses, and with the slump in manufacturing in Michigan, the SBT hit the state’s revenue base hard, and the legislature finally pulled together enough to change it.

So now, while the majority of Michigan businesses are supposed to pay less under the new tax, the businesses that were treated favorably by the SBT are faced with substantial increases. One the one hand, this seems only fair, as some of these were clearly not carrying their share of the public expenditure load before. On the other hand, with manufacturing’s struggles in recent years, it may be bad policy to hit service industries with a big tax increase, just when they are becoming an increasingly important part of the state’s economy. And with an unemployment rate greater than 10% (that’s the official rate, the real rate is probably over 20%), those businesses may find it hard to pass on their tax increases to their customers through price increases.

I’m no expert on tax policy, and I never did really understand the Single Business Tax (although, apparently, that was true of most business’s accountants, too), nor do I really understand the new tax. But this is one area where I both despise and sympathize with legislators. Too many of them simply think that increasing taxes on business will result in greater revenue, but trying to raise enough revenue to give the public everything it demands while not creating real business disincentives is a task far beyond me, and I can hardly blame them if they don’t get it right.


James K said...

Its a common saying among economists that businesses do not pay taxes. The level of profit a business has to make is driven by capital markets, so shareholders don't really suffer much of a tax burden. Instead the tax is paid by consumers (in terms of higher prices) and workers (in terms of lower wages).

James Hanley said...

Whether businesses can always pass on the taxes is something I've wondered about. Clearly owners want all business costs passed onto the consumer, and I would see higher taxes as no different than higher energy costs or increased prices of raw materials, which is why I'm skeptical of the "make the businesses pay their share" rhetoric.

On the other hand, we have minimum wage laws, which reduce the ability of businesses to lower wages, and--in Michigan at the moment--high unemployment and a sluggish economy overall, which I think would make it hard to raise prices.

Perhaps the answer is that businesses will hire less, eliminating the least productive employees, switch to lower grade toilet paper in the employee bathrooms, etc.?

I think the ones that are worried most are the small owner-operator businesses that are often operating on a shoe string anyway.

WCTaxpayers said...

It is apparent that their only concern is money, not good government. The expanded Service Tax, then the switch from that to the Michigan Business Tax and Gov. Granholm's recent comment that she was willing to make changes as long as it does not cut revenue is proof positive. If we do not make this an issue and expose this for what it is, we are making a sad mistake. They have made no effort to cut spending as evidenced by the 8% increased in the General Fund Budget. Our reduced incomes plus the 12% tax increase on our incomes should make it evident that if we must do it they can too.

You are correct in assuming that business will pass their costs down to the consumer. Who else could pay it?

Rose Bogaert,Chair
Wayne County Taxpayers Association
Taxpayers to Recall Andy Dillon

James Hanley said...

Oh, dear, an ideologue. Another chucklehead who thinks it is only about government wanting to take more money from us.

No recognition that these politicians are responding to the demands of constituents for all kinds of services, and that any spending cut will cause them to scream loud and long. No, it's just gummint, it ain't us.

I'd like to see spending cut, too, and Ms. Bogaert and I might even agree on some things to cut. But every cut we make affects other Michiganders, not just the legislators, and it is those other Michiganders who will fight back, not just their legislators.

It's just not so simplistic as these ideologues would have us believe. If Ms. Bogaert can shoe me just one spending item that only the legislators want, and that no Michigan residents are demanding, then I'll shut the f*** up.

James K said...


If they can't reduce wages they will either increase prices or lower output / cut perks as you identified. But in any case capital markets are too elastic to bear any but the tiniest burden of taxation.

I agree with your point about the legislators as well. After reading The Myth of the Rational Voter I am very sceptical of the ability of politicians to defy the will of the people. The trouble is that people want to have lower taxes, but try to get them to agree on the commensurate cuts to spending.

The enduring tragedy of 21st century government is not the the people aren't getting the government they want, its that they are getting the government they want.

James Hanley said...

"The enduring tragedy of 21st century government is not the the people aren't getting the government they want, its that they are getting the government they want."

Yes, I agree. It's a case of individual rationality adding up to collective irrationality. And that's why I consider myself a public choice-style political scientist. They're the ones who figured that out, and too many others still fail to see it.

By the way, James K, could you explain to me your comments on "level of profit needed is driven by capital markets" and "capital markets are too elastic to bear much taxation"? I've hear similar statements elsewhere recently, but have to confess wholesale ignorance on capital markets. And I think I need some enlightenment.

James K said...

The profit required to sustain a business activity is the opportunity costs of the capital employed, adjusting for risk.

For a tax to reduce the profit a business will accept, you would need to increase the cost of all alternative uses of the capital, everywhere in the world. Otherwise you get capital flight until the marginal unit of capital is producing sufficient profits to justify the investment. Or prices go up, or wages go down.

The exception is monopolistic or oligopolistic industries, where profits can be reduced without making investment uneconomic. However, even then profit taxes would lower the level of investment the firm makes (though that may or may not be a bad thing).

James Hanley said...

Thanks. I was figuring it had to do with opportunity costs. (Doesn't everything?)