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May 28, 2008

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. 

Posted at 10:21 AM | Email |

Comments

Does Jeff Daniels know about this?

Posted by: Gbear | May 28, 2008 11:12 AM

Michigan is a case study in the effects of liberal policy. Hint to the RNC: this would make for a very effective campaign ad against Democrats in general.

Posted by: Ed | May 28, 2008 11:47 AM

Silly liberals. Socialism ALWAYS fails.

Posted by: Anonymous | May 28, 2008 11:56 AM

Call it the free trade vortex. This is what you get when Americans are shut out of the job market in favor of low cost labor in other countries. So Americans who moved up the chain are now facing competition from those very same countries.
We can't all work in the medical field and we can't all work for the government, two areas where employment is likely to grow and both of which derive at least a portion of their income from federal and state tax revenues.

Posted by: pmk | May 28, 2008 12:44 PM

They are upset about a 4.35% rate? try 7.85% in MN, a new gas tax and andother .25% sales tax.

Posted by: Underdog | May 28, 2008 02:58 PM

This "liberal vortex" is what Ayn Rand wrote about in Atlas Shrugged. Socialism creeps in and causes economic failure, to which the proposed solution is more socialism. They are effectively pulling a massive con game by using the failure they cause to justify more socialism, and more failure.

Posted by: Mojo Wilkins | May 29, 2008 10:02 AM

Whenever governing bodies, be they municipal, state or federal, impose high taxes on individuals and especially business, the end result is reduced tax revenue as business relocates and individuals become unemployed. Lowering individual taxes and eliminating or substantially reducing taxes on business always results in economic growth and subsequent increased tax revenues for government. Unfortunately, the libs/Democrats just don't get it and keep repeating the same tried and true failures.

Posted by: Bill Moulton | May 29, 2008 10:58 AM

Rosslyn Smith has done a wonderful job of explaining the ins and outs of the specifics of Michigan taxation. The tax fight was so contentious that those who led the recent charge are now facing recall. The Michigan tax story is far from over. As for the "Detroitization" of Michigan, what that means is not a widespread slur against Detroit, but rather points out that one of the factors driving business out of the city for the last 20 years is that it has special taxes no other place in the state has. The "Detroit" exception that allowed these higher taxes have had the effect of impoverishing the city over the long term. This is understood by many people in Michigan, who have watched in horror as the states largest city became a hollow shell. (Population: from over 2 million to 900,000) Oh, yes, corrupt politicians played a big part in this too.

Posted by: Richard W. | May 29, 2008 11:51 AM

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