(Note: The following is an edited version of a speech
delivered by Mackinac Center policy analyst Jack McHugh before the One Day Tax
Seminar in Taylor, Mich., on April 28. Attending the seminar were the state’s
leading tax professionals, including those who manage tax issues for some of the
state’s largest corporations.)
There are two approaches that government leaders can take
to fix a broken economy. One really works, but is harder to do. The other is
politically easy, but doesn't work. Guess which one Michigan’s political
establishment has adopted?
The easy approach that doesn’t work is called "industrial
policy" in the economics literature. It involves government planners picking
certain firms to be the recipients of special tax breaks that are not available
to most other businesses or picking winners and losers. It’s unfair, and it
doesn’t work for many reasons, some of which I’ll mention in a minute.
Nevertheless, in recent years Lansing has been bingeing on
the stuff, passing scores of bills authorizing targeted tax breaks and other
"incentives." The Jobs 1 package, Jobs 2, the "53 tax cuts" Gov. Jennifer
Granholm has signed — none of which are genuine broad based tax cuts — the list
goes on, and both parties are eager participants.
Actually, they’ve been trying this for a long time. In
1947, Republican Gov. Kim Sigler created a Department of Economic Development
"to coordinate the state’s research in economic fields and utilize all of its
research facilities in economic development." In 1963, Gov. George Romney
created a Department of Economic Expansion to "encourage the expansion,
development and diversification of industry, commerce and agriculture."
In 1975, Gov. William Milliken created the Michigan
Economic Development Authority to "expand Michigan businesses and centers of
excellence in biotechnology and advanced manufacturing." Sound familiar?
In 1983, Gov. James Blanchard established a state council
to create a plan for "focusing the resources of state government on economic
development and job creation," and in 1984 he created the Michigan Strategic
Gov. John Engler created the Michigan Jobs Commission in
1995 and gave it full departmental status. It later morphed into the Michigan
Economic Development Corporation or MEDC. Gov. Engler also created renaissance
zones and MEGA, which today is called the state’s "flagship" economic
development program. MEGA selects particular firms to be the beneficiaries of
tax breaks on Michigan’s main business tax, the so-called Single Business Tax,
which I’ll have more to say about later.
MEGA credits are usually part of a raft of other tax
breaks. These packages can get pretty rich. A good example is a recently
announced 20-year, $37 million deal for a new facility in Greenville. It
includes a MEGA credit, a federal community development block grant, a local
property tax abatement, a Renaissance Zone for the site, plus training
assistance money. It amounts to $66,000 per worker if everything goes according
to plan — which Mackinac Center research shows hardly ever happens, in which
case the cost per job will be higher.
By the way, just to put that in perspective, if we paid
this amount to "save" each of the net 184,000 payroll jobs Michigan has lost in
the past six years, the total would be $12.1 billion in foregone taxes and
Building on the success of all these adventures, this
spring Gov. Granholm is launching the 21st Century Debt and Grant program. I’m
confident that it will enjoy just as much success as its predecessors in turning
Michigan’s economy around. Not much, that is.
The point of the history lesson is to show that it’s not
like we haven’t tried this sort of thing before. We’ve been doing plenty of it,
for a long time. We’re even thought to be good at it — look at the confections
regularly baked up by Site Selection magazine, and MEDC’s claims that it’s the
model that other states seek to follow.
Here’s my question, though: At what point will we finally
accept that it doesn’t work, and that only broad-based tax cuts and regulatory
reform will fix our economy?
For years, the Mackinac Center for Public Policy has
consistently presented theoretical and empirical evidence as to why the targeted
incentive approach will not work to fix Michigan’s broken economy. A year ago,
on the 10th anniversary of MEGA, we released the results of a rigorous
econometric analysis of that program’s effect. We found that it had no impact on
employment, the unemployment rate or per-capita personal income. Michigan
counties with MEGA firms fared no better than those without. For every $123,000
in MEGA tax incentives offered, only one construction job was created — and
those jobs lasted less than two years.
Maybe the closing of a Federal Mogul plant in St. Johns two
weeks ago with a loss of 420 jobs will do it, given how recently an incentive
package was trumpeted that was going to "save" that facility. Exactly two years
ago, Gov. Granholm signed targeted tax break legislation deliberately tailored
to benefit Federal Mogul. Her press release then claimed the bill "adds muscle
to Michigan’s economic development arsenal." She said, "From today onward we
will better be able to address the challenges employers face in the
fast-changing 21st-century economy, and retain more jobs for Michigan
Republican legislators echoed this. Sen. Alan Cropsey said,
"The fight for jobs at Federal Mogul is a fight we need to win — for all of
Rep. Bill Huizenga said: "This makes it crystal clear that
we will do whatever we can to help employees and manufacturers that have been
hard-hit by today’s difficult economy."
Rep. Jerry Kooiman, said: "This sends a strong message to
Federal Mogul and other companies that the Legislature is serious about removing
barriers that get in the way of Michigan being a friendly business and
He was wrong. The measure sent just the opposite message,
that instead of getting "serious about removing barriers to all," Lansing was
only willing to lower them for a few. While legislators and the governor chase
particular firms with targeted tax breaks, thousands of potential new business
start-ups are stillborn as a result of our punishing tax, regulatory and labor
climate. Outside of Michigan, since 2003, the U.S. economy has added more than 5
million non-farm payroll jobs, mostly in small and medium businesses, many
providing goods and services the central planners could not possibly have
predicted — one of the reasons industrial policy does not work. These firms
don’t benefit from targeted tax breaks — they pay for them.
Imagine how different things might look today if, instead
of handing out narrow "incentives" to high-profile firms or politically "sexy"
industries, the state’s bipartisan political establishment had eliminated the
obstacles that inhibit job growth here. Nothing would have prevented Michigan
from netting its share of those 5 million new jobs. The loss of 420 jobs at
Federal Mogul would be an unfortunate footnote in an otherwise booming state
economy, rather than yet more evidence of a failed policy.
Let me be even more explicit about that: The object
shouldn’t be to "save" or create jobs at a particular plant or industry. We
should focus instead on making Michigan such a good place to do business and
make money that companies rush to get in, without needing special "incentives."
Then we wouldn’t need to care whether company X or company Y comes or goes.
There will always be companies X and Y coming and going.
One of the more insidious effects of incentives is that
they remove pressure that would otherwise fall on Lansing to improve our
business climate. If General Motors and Ford had been unable to get special tax
treatment, don’t you think it’s likely the SBT and personal property taxes would
have been eliminated or drastically reduced years ago? By the way, the so-called
personal property tax is a tax on the tools that businesses use to provide goods
and services and create jobs. I call it the "stupid tax."
Whenever targeted tax breaks are criticized, public
officials, and possibly some of you, inevitably point to particular employers
who supposedly would have departed or never come "but for" such incentives. This
is intended to show the value of these, but it really only shows Michigan’s
failure to establish a favorable business climate.
Let me give an analogy. Imagine a restaurant with
second-rate food, surly waiters, slow service and high prices. When the manager
sees a customer getting restless, he rushes over and offers a 20 percent price
cut. He also stands on the sidewalk offering discounts to potential customers
who look like they might walk on by.
At the end of each day this manager sends glowing reports
to the owner of how many sales he "saved" or attracted by offering "incentives."
He spends his free time thinking up new incentives that might persuade
underwhelmed customers to buy mediocre meals.
Isn’t it obvious that this is not a viable business plan,
and that this manager should instead focus on making the food better, the
service more pleasant and the prices lower? The owner, employees and diners
would be much better off if the place were so attractive that customers stood in
line to get in, and the thought of targeted discounts never entered anyone’s
Like that restaurant manager, the extent to which state
policy makers brag about their incentive "victories," like that Federal Mogul
preening, is a function of their failure to make Michigan an attractive place to
Given all that, you probably expect that I would recommend
reducing or eliminating MEGA. You may be surprised to hear that instead, I
propose what is in effect a massive expansion.
Before I get into that, though, let me pose a question:
Does state government exist to serve the people, or is it the other way around?
Michigan’s political establishment often behaves as if the latter were true, and
this gets in the way of making the changes needed to turn things around.
Here’s exhibit number one: Government officials who say a
tax cut in one area must be "paid for" with a tax increase in another, rather
than with spending cuts. We hear this all the time in the SBT debate, so let’s
parse it out a bit. "Tax cuts must be paid for" really means that the government
is entitled to a certain amount of money that can never be reduced.
But what if we just have more government than we can
afford? Michigan doesn’t exist in a vacuum. No one has to stay here, or open a
business here, or keep one open. If high taxes and excessive regulations make
doing business here less profitable than other places or more trouble than it’s
worth, people and businesses can and will leave. There’s plenty of evidence that
this is happening already.
Now, in that context, think about what "tax cuts must be
paid for" really means: The people exist to serve the government, not the other
way around. You may think this is extreme, that no one in government really
thinks this way. Consider a place where it’s easier to imagine that they do.
The City of Detroit has 18,600 employees, or one for every
48 residents, and spends $2,859 for every man, woman and child in the city. As a
comparison, Indianapolis has just one city worker for every 203 residents and
spends just $1,103 per resident, 62 percent less.
To support this spending, Detroit homeowners pay more than
twice as much property tax as many other Michigan communities, plus a city
income tax. Detroit business owners must also deal with burdensome regulations
and a heavy-handed, unresponsive bureaucracy.
Except they don’t, really. Like Michigan, Detroit doesn’t
exist in a vacuum. Residents and businesses can always leave. They’ve done so,
cutting the city’s population in half, and it continues to drop.
Let’s suspend disbelief for a moment and pretend that every
one of Detroit’s 18,600 employees serves a vital purpose and does so as
efficiently as possible: It doesn't matter if they do, because unless the city
cuts its expenses drastically and gives the savings back as huge tax cuts, the
population and job declines will continue, and there will be even less ability
to support the city workforce. Detroit just has more government than it can
The same applies at the state level. For years Michigan has
lagged behind other states in economic and population growth. We may be at the
tipping point of going from poor relative performance to absolute decline in
Let’s be clear about what this means: Michigan is on the
verge of becoming a state characterized by declining incomes, homes that every
year are worth less than they were the previous year, and lonely parents whose
children and grandchildren had to go elsewhere to find careers. It’s not a
If policy is dictated by a "tax cuts must be paid for"
mindset, then the things that need to change to avoid this depressing scenario
will not change. Here are two of those: We have perhaps the highest business tax
in the nation, and also levy property taxes on business tools and equipment.
These two taxes raise around $3 billion a year.
Let’s suspend disbelief again and pretend that every
program that money pays for is valuable and is done as efficiently as possible.
It doesn’t matter, because, like Detroit, we just can’t afford it anymore.
Without major improvements in our business climate, jobs and people will
continue to leave, and eventually the entire state will look like Detroit’s
Alright, let’s stop suspending disbelief now, because we
all know that state government does not operate as efficiently as possible.
Also, we now have a broad consensus that the SBT is too complex and harms our
economy. The non-partisan Tax Foundation recently estimated that the SBT rate is
15 percent. That may be a bit on the high side, but not by much. Add that to the
35 percent U.S. corporate tax rate, plus taxes on dividends, and you start to
understand management-guru Peter Drucker's definition
of profit as "whatever government lets a company keep."
You also start to understand why Michigan’s economy is in
such deep trouble. As I say, we now have consensus that the SBT is bad, but in
Lansing, this recognition is usually followed up with, "It’s impossible to not
replace the SBT with a different business tax, because there’s no way to cut the
$1.85 billion it takes in."
That’s not true. I’m hardly the foremost budget expert in
this state, although I am one of a minority who want the budget to go down,
rather than up. Nevertheless, without much effort I came up with a list of
reforms that could save $1.85 billion. This would allow us to replace the SBT
with — nothing. Or, to put it a different way, to give every business in the
state a permanent 100 percent MEGA credit.
Most of these proposals aren’t even cuts, really — they’re
just doing things in smarter ways, injecting competition into government
operations or rationalizing government employee fringe benefits. Those that are
cuts eliminate non-core functions. There are no starving widows and orphans
created by this plan.
I say plan, but it’s really intended not as a precise
roadmap, but as an indication of what’s possible. Some of the projected savings
are speculative, but I think you’ll agree they’re all plausible and make sense.
Here's the list:
Higher Education. Currently, Michigan's 15 four-year
universities get state operations grants each year that are essentially
determined by legislative mud-wrestling. Each college sends its lobbyist
into the appropriations pit, and tries to increase its piece of the pie. The
school gets its money whether it has more students or less. After decades of
this the result is a bizarre range of grants per resident student ranging
from $3,887 at Saginaw Valley to $15,369 at UM-Ann Arbor. Worse, the system
provides only weak incentives for colleges to contain costs.
To fix this, the system should be
overhauled so that each university gets the same amount per student, and the
money follows the student, not the most effective lobbyist.. This would mean
that every kid applying to a state university would do so knowing he or she came
with a $6,300 annual grant to the school. If colleges were forced to compete for
students to get state money, they would "sharpen their pencils," rein in costs,
and eliminate the kinds of inefficiencies highlighted in recent audit reports.
If the effect was that costs fell by just 5 percent the savings would be $70
Here’s another item: The next time you see a State
Police trooper ticketing a speeder, ask yourself this: Why is a routine
traffic safety enforcement action being performed by a state trooper, when
the same job could be done just as well for much less by a county sheriff
deputy? When you include benefits and mandated employer costs, we pay more
than $90,000 to keep a state trooper on the payroll for a year. In contrast,
the average cost statewide to employ a county sheriff deputy is
approximately 77 percent of that amount. The state could give county sheriff
departments 77 percent of the amount spent for state police road patrols,
and pocket the difference. The effect on public safety would be zero. The
savings would be $65 million.
Next on the list is school employee health care. The
Hay Group report last year showed that 48 percent of Michigan school
employees had "fee for service" health insurance, which is the most
expensive kind and provides no incentive or means to economize. In
comparison, only 8 percent of government employers nationwide provide fee
for service, and only 2 percent of private sector employers. The report
found that if the current system were replaced by a single state plan
offering generous benefits through preferred provider networks with modest
co-pays the annual savings would be $422 million.
We should eliminate the Michigan State University
cooperative extension service and agriculture experiment station. Yes, that
would mean 4-H clubs and Master Gardener classes would be off the dole. For
the rest of what these programs do, let ADM and the other agribusiness firms
do it. Not only is government involvement in this area obsolete, it’s a
luxury we can no longer afford. This would save $61 million a year.
I’ve already beaten up enough on industrial policy, so
I’ll just say that the next item, repealing the "21st Century Jobs Fund"
would save $40 million in annual debt service.
Prison privatization – According to a Rio Grande
Foundation report, if 5 percent of prisoners are placed in privately run
prisons, a state saves 14 percent on overall prison spending, because
government-managed prisons respond by "sharpening their pencils." This could
save $192 million.
Next — Arts grants. The Department of History, Arts
and Libraries budget is $45 million. The "history" portion should come from
user fees and the arts portion from voluntary contributions. Cutting
spending on libraries in half and eliminating the rest would save $35
Intermediate School Districts probably have less
accountability per tax dollar than any other unit of government. A Citizens
Research Council report noted that "a number of changes have occurred over
the past decade that have reduced the need for ISDs." Let's help them catch
up by reducing ISD operations grants, for savings of $32 million.
Due to a quirk in Proposal A, certain wealthy school
districts benefit less from per-pupil state foundation grant increases than
other districts. (They still benefit, though.) The political response to
this is a thing called "20j" payments. Cut this luxury in half for $26
million in savings.
Mass transit. By eliminating protectionist regulations
that restrict alternatives, empty buses driven by public employee union
members could be replaced by private sector innovations like jitneys,
commercial van pools, "call-and-ride" services, car-sharing, and more. This
would improve service for transit users and save $112 million. By the way,
this is the only item on my list that contemplates a radically different
model. When you see the outrageous featherbedding at the Detroit Department
of Transportation, and what Senate Appropriations Committee chair Sen.
Shirley Johnson often refers to as "all those damned empty buses," it’s hard
not be radical. The only beneficiaries of keeping the current model in place
are DDOT employees — remember that "Does government exist to serve the
Next, repealing the "prevailing wage" law that
requires above-market level wages be paid on school construction projects
would save $150 million
Gov. Granholm proposes sending extra money to school
districts that are losing pupils. Here's a better idea for those districts:
Consolidate and downsize. In the private sector, this is what an enterprise
that's losing customers must do. That's a useful model: It would save $50
Reduce the Merit Award Scholarships by 50 percent.
When families face hard times the first thing they do is cut luxuries.
Non-need based college scholarships are a luxury Michigan can no longer
afford. This would save $60 million.
Medicaid and Welfare — Total spending on these two
programs is almost $15 billion. More than $6 billion of that comes from
state taxes. Medicaid in particular is a command and control monstrosity
rife with perverse incentives. Reforming it in ways that give recipients an
incentive to economize and take better care of themselves could save
hundreds of millions, and actually give recipients more freedom and choice.
If just 1.6 percent of the expense could be reduced in this way, the state
would save $240 million.
Finally, stimulating growth. Can anyone doubt that
eliminating the SBT, one of the most complex and burdensome business taxes
in the nation, would be like a shot of adrenalin for the state's economy,
especially if we replaced it with nothing? It would send a powerful message
that Michigan is open for business. The dynamic effects of such a change on
income, property and sales tax receipts would easily raise $300 million.
These items total $1.85 billion.
That's how much the Single Business Tax now takes in.
None of these items are "devastating" to the state, or to
education, "vulnerable populations," or even to any particular interest group.
Most people wouldn't even notice them.
There’s a school of thought that says government will do
the right thing, but only after every other option has been exhausted. Are we
there yet? I think we're getting close.
Jack McHugh is a legislative analyst for the Mackinac
Center for Public Policy, a research and educational institute headquartered in
Midland, Mich. Permission to reprint in whole or in part is hereby granted,
provided that the author and the Center are properly cited.