by Alec Rodney, Economist, and Robert Kleine, Vice President and Senior Economist
|This Advisor discusses the proposed Michigan Economic Growth Authority and suggests alternative economic developmental tools.|
In his four years in office Governor Engler has fought successfully to create a more business-friendly climate in the state. He has delivered on his promises to cut property taxes and the single business tax (SBT), and recently cut the unemployment insurance tax rate. In the long term all businesses—large and small—should benefit from these changes.
Under the governor’s newest proposal, the Michigan Economic Growth Authority (MEGA), however, the benefits would be targeted toward a small number of businesses. Furthermore, MEGA tax credits will cut an indeterminate amount from the SBT and income tax revenue base and create a new element of instability in the tax system.
Nearly all states arm themselves with MEGA-like tools to recruit businesses. Governor Engler argues, with reason, that Michigan should have the same negotiating abilities. In the movie Unforgiven, Clint Eastwood kills a man in a bar. The man‘s friend yells out: “But he wasn’t armed.” Eastwood’s character responds: “Well, he shouldda had a gun.” Armed as Michigan may be with MEGA, this is no panacea for the long-term economic growth of our state or any other.
The Senate-passed legislation (Senate bills 350 and 351) includes the following key elements:
- Eligible businesses are limited to the manufacturing and mining sectors.
- Michigan-based and out-of-state firms must create and maintain a minimum of 75 and 150 new jobs, respectively, to be receive SBT and income tax credits.
- Businesses can be awarded tax credits for up to 20 years, but their eligibility for credits must first be certified within a four-year sunset period.
- An eight-member board appointed by the governor will authorize which businesses get the tax credits, with no limit on the number of authorizations in a given year.
MEGA was initially voted down in the House but subsequently passed when the following amendments were offered: a two-year limit on the sunset period, a limit of 25 authorized firms per year, and a threshold of 25 jobs created for companies locating in enterprise zones. (Unless the Senate makes more changes, MEGA is limited to a total of 50 projects unless the sunset is extended.)
The problematic nature of MEGA is illustrated by its growing list of opponents—including Senate Majority Leader Posthumus, the Michigan Chamber of Commerce, and the Mackinac Center—among those who usually support the governor. These opponents agree that MEGA amounts to a bureaucratic industrial policy board that will empower the state to pick winners and losers among businesses. As Senate majority leader, John Engler adamantly opposed similar policies proposed by his predecessor, Governor Blanchard.
In a March 17, 1995, editorial The Wall Street Journal charges MEGA will “make it difficult to reduce overall taxes . . ., reward one business at an implied cost to every other in-state enterprise . . ., encourage litigation . . ., and invite corruption.” The newspaper sees no reason for Governor Engler to “start handing out breaks and favors to targeted interests” after having successfully brought state unemployment down to a 25-year low using sounder economic policies.
Which Businesses Benefit?
One of MEGA’s shortcomings is that very few in-state firms have the potential to benefit from the program. First, the program is limited to the mining and manufacturing industries. Second, only larger firms (250 or more employees) will likely be able to meet the requirement of adding a minimum of 75 jobs.
The U.S. Department of Commerce publication County Business Patterns puts these numbers in perspective. In 1992 mining and manufacturing accounted for 17,000 out of 216,000 total in-state businesses. Only 3 percent of the manufacturers and less than one percent of mining firms employed 250 or more people. By this accounting only 520 firms would be eligible for MEGA credits. Even if firms employing 100–249 people are considered to have the potential to hire 75 new employees, only 1,493 firms would be eligible.
Many observers expect that all eligible firms will apply for these tax credits as soon as the legislation is enacted. From the outset the MEGA board may be compelled to pick winners and losers from a pool of 500 or more applicants.
MEGA appears to be one the most generous jobs tax credit programs in the country in terms of time and scope. We compared the MEGA proposal to existing job tax credit programs in other midwestern and industrialized states and found the longest existing period of eligibility to be ten years.1
In general, programs with more generous credits in terms of dollars had shorter (one- to 5-year) periods of eligibility. Furthermore, many of these programs tie credits to jobs created in enterprise zones or areas suffering from high unemployment not to specific industries. These programs directly benefit businesses and economically disadvantaged individuals, whereas MEGA provides no assurances that jobs will be targeted for those who need them most.
Another issue is the cost of MEGA. The annual cost is fairly low—$4–9 million—but the cumulative cost over 20 years could exceed $150 million. If the legislation is not allowed to sunset in two years and if the 25 authorizations per year limit is eliminated, the annual cost could eventually reach $45–50 million, assuming each of the 500 large manufacturers in the state takes advantage of the program and adds an average of 100 jobs.
Evidence from Other States
The governor has proposed MEGA as a response to similar programs in other states, especially Ohio and Indiana. Placed in context, however, Michigan’s business tax structure is very competitive with neighboring states’. In a recently released study the Policy Economics Group of KPMG Peat Marwick compared North Carolina’s business tax structure to that of 20 other states, including Michigan, Illinois, Indiana, and Ohio.
Using their “Business Tax Competitiveness Model,” Peat Marwick calculated the combined effective tax rate of all business taxes on investment and ranked the states. The average effective tax rate was 8.6 percent; Michigan ranked ninth with a rate of 9.74 percent. The rates in Illinois, Ohio, and Indiana, were 6.80, 10.78, and 10.97 percent, respectively. Michigan’s overall effective tax rate on individual manufacturing industries was also lower than the rates in Indiana and Ohio. It may be that Indiana and Ohio have to offer incentives just to keep up with Michigan.
In another recent report, the Commission to Study the Ohio Economy and Tax Structure2 identified economic development as its main objective and recommended the following changes be made to the Ohio tax system:
- Eliminate the net worth tax (similar to the SBT payroll tax).
- Phase out the tangible personal property tax (currently assessed on 25 percent of the market value of machines, equipment, and business movable property).
- Abolish enterprise zones and prohibit the use of targeted tax incentives to recruit companies to the state.
The Ohio Commission recommended paying for these changes by raising other tax rates and broadening the tax base so that the overall revenue is unaffected. Its proposal shifts tax burdens to individuals and away from businesses without giving out targeted business tax breaks.
Michigan should take note of the Ohio report. Over the long run, rather than granting millions of dollars in tax breaks under MEGA, the state should consider phasing out the tax on business personal property. This type of reform should benefit small firms and large firms across all industries. Furthermore, a phase-out would reduce administrative costs to the government and private sector and avoid questions of favoritism and corruption that can occur with more targeted programs.
Governor Engler says Michigan needs MEGA because 44 other states have similar programs and the state should not “unilaterally disarm” itself in the interstate war of economic development. As a response to the competition, MEGA is short-sighted, too narrowly targeted, and expensive. It will provide a large benefit to a small group of firms while not assuring that those firms will locate in the areas that most need the jobs. The 20-year eligibility period is more generous than any existing state program and will cost the state millions of dollars in foregone tax revenues.
Over the long run, the state should concentrate on broad-based improvements to the business climate. Phasing out the personal property tax on machines and equipment would benefit all of the large manufacturers targeted by MEGA and many other small and medium-sized businesses.