Taxable Talk

The Michigan Wolverines football team hasn't done very well this year, losing their first two games to Appalachian State and Oregon, both at home. There are probably a lot of angry Wolverines fans. While the University of Michigan struggles, the budget in Michigan is struggling, too. Indeed, it appears that the state legislature and the governor are leading Michigan to a government shutdown come October 1st.

Michigan faces a $1.8 billion deficit. Like most states, each year the budget must be balanced. The governor and the lower house are controlled by Democrats while the upper house is controlled by Republicans. Governor Jennifer Granholm wants to increase taxes by $1.5 billion and cut $300 million in services, while State Senate Majority Leader Mike Bishop wants to increase taxes by $600 million, and cut services by about $1 billion. The two sides haven't made much headway, and time is running out.

Needless to say, if you live in Michigan, you can expect your taxes will go up. I believe quite strongly that anyone thinking of starting a business in Michigan today might want to consider a neighboring state with a better business climate, lower taxes, and a better football team.

News Story: Detroit Free Press

When an economy is having problems and jobs are leaving your state, the normal thing to do is to help businesses. Michigan has other ideas.

The Detroit Free Press' headline screams, "Chaos averted with deal to raise income tax, add tax to services." What does that mean for residents of Michigan?

Directly, your state income tax rate has just increased from 3.9% to 4.35%. Additionally, services will now be subject to the 6% state sales tax.

Indirectly, Michigan has just become an even less competitive state for businesses. Why would anyone in their right mind locate a business in the state where the only sure thing is big government?

"Chaos" may have been averted, but the people of Michigan will be long-term losers because of this budget. Interestingly (but not surprisingly), all but one of the Democrats in Michigan's state senate voted for the tax increase, and all but three Republicans voted against it.

How would you like to do business in a state where taxes are going up, yet your customers are leaving? And not only are tax rates rising, the state has implemented a tax on services. Welcome to Michigan.

Michigan's new budget has a myriad of tax increases. As I earlier reported, the state income tax increased from 3.9% to 4.35% and the sales tax will now be imposed on services—that's a 6% tax, plus the cost in time and money for businesses to comply with the tax.

The taxes were implemented to balance Michigan's budget. Apparently the legislature in Michigan (and the state's governor) haven't heard about the Laffer curve. When tax rates decrease, tax revenues tend to increase.

Meanwhile, business owners in Michigan are fuming. The Detroit Free Press is reporting that Michigan business owners have begun collecting signatures to have a vote on repealing the new sales tax next November. Oakland (Michigan) County Executive L. Brooks Patterson told the Free Press, "The governor is not in a position to dictate. She’s not entitled to revenue neutrality. Spending is going up. They don’t need that much money here."

Unfortunately, most state legislatures don't believe in cutting spending to balance the budget. Sometimes it takes the people to remind the legislature who they serve. Perhaps Michigan residents will awaken. After all, it's supposed to be government by the people, of the people, and for the people, not for the bureaucrats.

Michigan is in a recession. In fact, it has been in a recession for several years. So what do you do to attract businesses in a down economy? Do you (a) lower taxes and cut government spending, (b) do nothing, or (c) raise taxes and continue to increase government spending?

Well, since I have a cynical outlook on how government works I wasn't surprised with the outcome. Michigan raised taxes and continued to increase government spending (albeit at a reduced rate of increase). Michigan imposed a business services sales tax of 6% effective December 1st.

That tax met with universal scorn among Michigan business owners and residents, and Michigan's legislature repealed it. Well, I should say they replaced it. Now Michigan has a 21.99% surcharge to Michigan's business tax.

The surcharge is supposed to bring in $600 million this fiscal year and $750 million next year. It's unlikely to generate that revenue. The natural reaction when a tax is imposed is to do whatever behavior you can to lessen the tax's impact. And one obvious impact will be for businesses that can to shift tax-generating activity out of Michigan and into other states.

Assume you're a business owner and have two manufacturing plants: one outside of Detroit and one outside of Phoenix. You need to expand operations. Will you do that in your Detroit plant and pay extra tax? In fact, might you not consider closing your Detroit plant and shifting all of your operations to Phoenix?

Michigan has slapped a Band-aid on a very leaky wound, and in the long-term it won't work. Businesses that can will still flea the state and Michigan's long-term recession will continue. The only solution is to make Michigan attractive to businesses, and that means lowering taxes. Cutting tax rates increases tax revenues—something Arthur Laffer discovered.