The liberal vortex (updated)

Thomas Lifson
The liberal recipe of higher taxes and more government as a cure for economic distress sparks a vicious cycle of diminished employment, higher demand for services, lower tax revenues and consequent deficits. Which provides a feedback loop demanding yet more taxes. I call this the liberal vortex.

The state of Michigan is creating a liberal vortex that is just now about to activate the feedback loop for more taxes. The Wall Street Journal's "Review and Outlook" column reports:

...the latest news of Michigan's deepening budget woe is a national warning of what happens when you raise taxes in a weak economy.

Officials in Lansing reported this month that the state faces a revenue shortfall between $350 million and $550 million next budget year. This is a major embarrassment for Governor Jennifer Granholm, the second-term Democrat who shut down the state government last year until the Legislature approved Michigan's biggest tax hike in a generation. Her tax plan raised the state income tax rate to 4.35% from 3.9%, and increased the state's tax on gross business receipts by 22%. Ms. Granholm argued that these new taxes would raise some $1.3 billion in new revenue that could be "invested" in social spending and new businesses and lead to a Michigan renaissance.

Not quite. Six months later one-third of the expected revenues have vanished as the state's economy continues to struggle. Income tax collections are falling behind estimates, as are property tax receipts and those from the state's transaction tax on home sales.

The Journal goes on the predict that the "Detroitification" of the entire state is underway, as high taxes drive away business, resulting in a higher burden on the remaining income-producers.

Update -- Rosslyn Smith writes:

While I agree with your vortex theory the Wall Street Journal's story is simply not accurate as to what is happening in Michigan.  I used to be quite an expert on business taxation in that state because one of my firm's largest clients was located there.
In 2008, Michigan finally consigned to the trash heap a truly pernicious system of business taxation that had been the legacy of the days when the automotive industry was seen by politicians and voters alike as a cash cow  available to finance all manner of government services.  In fact, the business tax system changed so much between 2007 and 2008 I am not sure how one could in fairness compute a meaningful percentage rate increase.  This change was overdue by three decades and almost every Michigan politician knew it. One problem many politicians had was that they knew that to change the business tax system would probably also require a substantial increase of the individual income tax rate.  Interestingly enough, the needed change came via voter-initiated legislation, a provision in the state constitution that requires the Legislature to either approve bills originated by a petition of the citizenry or to put them before all the voters at the next general election. 
Until 2008, all businesses in Michigan paid a Single Business Tax (SBT), so named because it applies regardless of the legal form of the business). A more anti growth tax cannot be imagined.  The base for the SBT started with net taxable income and then added back all labor costs, including all employee benefits, all interest and royalty expense, all depreciation expense and all state income and replacement tax expense. Even though the tax rate seemed low at 2.3%, because of the add backs it was not unusual for a Michigan based manufacturing corporation to pay far more in SBT than it paid in federal corporate income tax!  The more people a business hired and the more equipment it bought and depreciated, the more SBT it would owe, even when the bottom line was bad.  From a corporate governance standpoint, it's pretty hard to justify to shareholder paying a huge tax to the state in which one is operating in years when there is little or no net income, but that happened all the time with the SBT.  To make matters worse for heavy industry, Michigan retained its personal property tax on business equipment long after most other states abandoned such taxes as hard to administer drags on economic growth.  Michigan based businesses had been building their new facilities in other states for decades when NAFTA caused a further drain.  Drawn by a favorable exchange rate, helpful local governments and immigration policies that encourage highly educated foreign born engineers to settle there, automakers flooded into Ontario.
By the late 90's Michigan tried to ease the burden on corporations that sold most of their product out of state by tinkering with apportionment concepts.  In 1999, the legislature entered into a plan to phase out the SBT a tenth of a percentage point per year from 2.3% to zero. (In 2007, the SBT rate was 1.9%) The plan was to hold spending constant and let growth in personal income and sales tax receipts make up the decreasing SBT revenue until a new way of taxing businesses could be agreed upon at some future date.  Within four years, a great many people in Michigan decided reform of the SBT couldn't wait on the politicians another 20 years. In  2006, the Michigan Legislature approved the voter-initiated legislation to repeal the SBT effective for tax years beginning after December 31, 2007.  Unlike conventional bills introduced by legislators, voter-initiated bills are not subject to veto by the Governor. The 2007 legislative session was so contentious, in part, because there was a most heated debate over how to replace the revenue generated by the SBT, including the dueling sets of revenue projections that attend all such debates.   
The new Michigan Business Tax (MBT), which replaced the SBT has a much higher rate but the tax base is considerable smaller, That's because it allows almost all the deductions against income the SBT disallowed.   The MBT consists of a tax of 4.95% on net income plus a .8% tax on the business's gross receipts minus its purchases from other firms for inventory, depreciable assets and certain other items.  No more will a Michigan corporation that lost $20 million for federal income tax purposes end up paying a million in annual business tax to Michigan because it has a thousand residents of Kalamazoo and Grand Rapids on the payroll. 
The liberal recipe of higher taxes and more government as a cure for economic distress sparks a vicious cycle of diminished employment, higher demand for services, lower tax revenues and consequent deficits. Which provides a feedback loop demanding yet more taxes. I call this the liberal vortex.

The state of Michigan is creating a liberal vortex that is just now about to activate the feedback loop for more taxes. The Wall Street Journal's "Review and Outlook" column reports:

...the latest news of Michigan's deepening budget woe is a national warning of what happens when you raise taxes in a weak economy.

Officials in Lansing reported this month that the state faces a revenue shortfall between $350 million and $550 million next budget year. This is a major embarrassment for Governor Jennifer Granholm, the second-term Democrat who shut down the state government last year until the Legislature approved Michigan's biggest tax hike in a generation. Her tax plan raised the state income tax rate to 4.35% from 3.9%, and increased the state's tax on gross business receipts by 22%. Ms. Granholm argued that these new taxes would raise some $1.3 billion in new revenue that could be "invested" in social spending and new businesses and lead to a Michigan renaissance.

Not quite. Six months later one-third of the expected revenues have vanished as the state's economy continues to struggle. Income tax collections are falling behind estimates, as are property tax receipts and those from the state's transaction tax on home sales.

The Journal goes on the predict that the "Detroitification" of the entire state is underway, as high taxes drive away business, resulting in a higher burden on the remaining income-producers.

Update -- Rosslyn Smith writes:

While I agree with your vortex theory the Wall Street Journal's story is simply not accurate as to what is happening in Michigan.  I used to be quite an expert on business taxation in that state because one of my firm's largest clients was located there.
In 2008, Michigan finally consigned to the trash heap a truly pernicious system of business taxation that had been the legacy of the days when the automotive industry was seen by politicians and voters alike as a cash cow  available to finance all manner of government services.  In fact, the business tax system changed so much between 2007 and 2008 I am not sure how one could in fairness compute a meaningful percentage rate increase.  This change was overdue by three decades and almost every Michigan politician knew it. One problem many politicians had was that they knew that to change the business tax system would probably also require a substantial increase of the individual income tax rate.  Interestingly enough, the needed change came via voter-initiated legislation, a provision in the state constitution that requires the Legislature to either approve bills originated by a petition of the citizenry or to put them before all the voters at the next general election. 
Until 2008, all businesses in Michigan paid a Single Business Tax (SBT), so named because it applies regardless of the legal form of the business). A more anti growth tax cannot be imagined.  The base for the SBT started with net taxable income and then added back all labor costs, including all employee benefits, all interest and royalty expense, all depreciation expense and all state income and replacement tax expense. Even though the tax rate seemed low at 2.3%, because of the add backs it was not unusual for a Michigan based manufacturing corporation to pay far more in SBT than it paid in federal corporate income tax!  The more people a business hired and the more equipment it bought and depreciated, the more SBT it would owe, even when the bottom line was bad.  From a corporate governance standpoint, it's pretty hard to justify to shareholder paying a huge tax to the state in which one is operating in years when there is little or no net income, but that happened all the time with the SBT.  To make matters worse for heavy industry, Michigan retained its personal property tax on business equipment long after most other states abandoned such taxes as hard to administer drags on economic growth.  Michigan based businesses had been building their new facilities in other states for decades when NAFTA caused a further drain.  Drawn by a favorable exchange rate, helpful local governments and immigration policies that encourage highly educated foreign born engineers to settle there, automakers flooded into Ontario.
By the late 90's Michigan tried to ease the burden on corporations that sold most of their product out of state by tinkering with apportionment concepts.  In 1999, the legislature entered into a plan to phase out the SBT a tenth of a percentage point per year from 2.3% to zero. (In 2007, the SBT rate was 1.9%) The plan was to hold spending constant and let growth in personal income and sales tax receipts make up the decreasing SBT revenue until a new way of taxing businesses could be agreed upon at some future date.  Within four years, a great many people in Michigan decided reform of the SBT couldn't wait on the politicians another 20 years. In  2006, the Michigan Legislature approved the voter-initiated legislation to repeal the SBT effective for tax years beginning after December 31, 2007.  Unlike conventional bills introduced by legislators, voter-initiated bills are not subject to veto by the Governor. The 2007 legislative session was so contentious, in part, because there was a most heated debate over how to replace the revenue generated by the SBT, including the dueling sets of revenue projections that attend all such debates.   
The new Michigan Business Tax (MBT), which replaced the SBT has a much higher rate but the tax base is considerable smaller, That's because it allows almost all the deductions against income the SBT disallowed.   The MBT consists of a tax of 4.95% on net income plus a .8% tax on the business's gross receipts minus its purchases from other firms for inventory, depreciable assets and certain other items.  No more will a Michigan corporation that lost $20 million for federal income tax purposes end up paying a million in annual business tax to Michigan because it has a thousand residents of Kalamazoo and Grand Rapids on the payroll.