In 2009, Michigan State University economist Charles Ballard met with then-gubernatorial candidate Rick Snyder to discuss tax policy at an Applebee’s off I-96 near Okemos.
As Ballard tells it, the future governor appeared set on establishing a statewide corporate income tax to replace the convoluted Michigan Business Tax, regardless of what insight Ballard was about to give him.
By June 2011, Snyder had done just that, prompting the Legislature to create a new 6 percent corporate income tax that supporters hailed as simpler and fairer for Michigan businesses.
But one of the downsides of a corporate income tax, Ballard said he told Snyder during the meeting, is its inherent volatility as a revenue stream. The corporate income tax brings in a little less than 10 percent of net tax revenues for the state’s general fund.
Ballard said history has shown that state income tax revenue will swing under such a structure, as it did when Michigan had a corporate income tax between 1968 and 1975. During a mild recession between 1969 and 1971, Ballard said corporate tax revenue fell by more than 40 percent.
On the five-year anniversary of Snyder signing his corporate income tax law, Ballard’s warnings were proven right: Earlier this month, the revenue projected from the corporate income tax is expected to drop by more than $100 million in the 2015-2016 fiscal year compared to the previous period. Lawmakers must now revise budget bills. Ballard calls it a case of “policy amnesia.”
While revenue shortfall projections happen — and making projections is “inherently very difficult,” Ballard said — they can be even more glaring when infrastructure needs around the state are not being met and overall tax revenue has continued to decline as it has in Michigan.
“Corporate tax revenues, especially for a particular state, can be pretty volatile,” Ballard said. “We have a revenue system that doesn’t work very well — I look at our revenue system and I think we’ve really made a mess of it. There has been a very long period of erosion of tax revenue and Flint is a predictable result of that.”
Relying on durable-goods manufacturing — “an unusually cyclical sector”— as Michigan does makes it even more susceptible, Ballard said.
A May 13 House Fiscal Agency report attributed the drop in corporate income tax revenue to retail sales that have “fallen off over the past several months, and these declining sales in conjunction with higher employment costs have led to a corresponding slide in corporate profits. … Because tax revenues are highly dependent on corporate profits, wage and salary income, and consumer spending on retail (taxable) purchases, significant shifts in these factors can exacerbate revenue volatility.”
Robert Schneider, director of state affairs with the nonpartisan Citizens Research Council of Michigan, said a drop in corporate profits has occurred nationally for the past couple of quarters.
“I think folks are hopeful this is a blip,” he said. “Regardless, I think it was recognized at the time (it was passed by the Legislature) that (volatility) was one of the cons. Anytime you have a tax based on profits — your revenues minus your costs — that is going to bounce around a lot more than on total sales.
“If volatility is a problem the state wants to rectify, you really need to look to a different model.”
A Snyder spokesperson said the governor met with “many economists, financial experts and business leaders” during his campaign, from which he found “broad consensus that Michigan needed to modernize its tax code.”
“As with any new tax structure in any state, there is an adjustment period and it takes time to fine-tune revenue projections,” Snyder Press Secretary Anna Heaton said in an email to MiBiz. “Gov. Snyder is confident that revenue from the state’s new corporate income tax eventually will be easier to predict than the MBT and SBT it replaced, and it’s important to note we are still feeling the effects of some still-active tax breaks from those that continue to affect revenue estimates.”
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As was the case last year when the public voted down a sales tax increase to raise $1.2 billion to pay for road infrastructure, Democratic lawmakers have been vocal again in recent weeks saying the state’s corporate tax system is inadequate. The volatility of the tax scheme has both Democrats and Republicans concerned.
“If revenue stability is your goal, a lot of reliance on a corporate income tax is going to cause you problems,” Ballard said.
Based on Michigan Business Tax refunds that are projected to be cashed in at just over a billion dollars for the 2015-2016 fiscal year, corporate income tax revenue is projected to come in at $977 million. The imbalance, which is highlighted as part of the latest consensus revenue agreement among state officials, prompted The Detroit News headline, “Projection: Michigan business taxes at a net loss,” and concerns from Democrats about a broken tax system and the need for higher corporate taxes.
The Michigan Chamber of Commerce reportedly criticized Democrats for politicizing the issue in an election year.
However, the House Fiscal Agency report also projects corporate income tax revenue to increase 2.6 percent and 2 percent for the following two fiscal years and forecasts MBT refunds dropping off.
Simply calling for higher corporate taxes isn’t an effective solution, Ballard said.
“You often hear people say, ‘Business needs to pay its fair share of taxes,’” he said. “That’s a concept economists struggle with. What share of that tax is borne by stockholders? What share is borne by consumers in terms of higher prices? What share is borne by workers in lower wages? That’s why this whole discussion is not an easy one to get into.”
Schneider of the Citizens Research Council added: “That’s where you get people arguing.”
Matt Grossmann, director of the Institute for Public Policy and Social Research at Michigan State University, said the state is still in a “transition period” from the last administration “having given out a lot of credits under the old system. … We’re still in some sense paying back for past policies. There are costs to moving back and forth between (economic) policies.”
In a year when income taxes from corporations are projected to decline, Michigan still faces serious spending issues with roads, Detroit Public Schools and Flint’s infrastructure.
Grossmann said there is “widespread public agreement” on the need to fix roads, “but there isn’t widespread public support on how to pay for it. … I see the classic problem of people want the benefits of upgrades but don’t want to pay for it.”
But whether that burden falls on businesses, the state’s addressing of those needs “is not going to happen without a tax,” Ballard said. “If you say we’re going to do X-Y-Z without raising taxes, it means you don’t want to get it done. We need revenue, period.”