Tax Hike Chronicle - Final Entry

(Note: When the first straws in the wind appeared last December indicating a major tax hike push in 2007, Mackinac Center Senior Legislative Analyst Jack McHugh began a chronicle of events he called "Anatomy of a Tax Hike Campaign." McHugh’s impulse was prescient, and the record he assembled turns out to be a valuable historical record.

Below is the chronicle’s "final entry" – which isn’t really, because further additions will detail the actual appropriation bills to be adopted this month, with post scripts as events dictate. This much-longer-than typical entry is a description and characterization of the huge state tax increase and budget deal from a free-market point of view.

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Readers are invited to peruse the entire "Anatomy of a Tax Hike." In the spirit of its namesake — the famous Michigan-based "Anatomy of a Murder" novel and motion picture — it makes for a fascinating read, even when the title gives away the outcome!)

Sept. 30 – Oct. 1: The Final Act; Reflections
In the final hours before a shutdown of state government, to avoid cutting spending in the fiscal 2007-2008 Michigan budget, the Legislature votes to increase the income tax from 3.9 percent to 4.35 percent and expands the 6 percent sales tax on a wide variety of services. The income tax will take an additional $765 million out of the private economy, and the service tax $751 million in its first full year. This combined $1.5 billion tax hike is accompanied by a package of reforms that correct some outright fiscal malpractice, but are not transformational for the state. (A defined contribution pension system for school employees would have been transformational, but wasn’t even on the table.)

The reform package includes bills to do the following: Limit the ability of school employees to retire early with a full pension and health insurance; make it easier for school districts to seek competitive bids on employee health insurance; limit "double dipping" by retired state employees who return to work as a "contractor" collecting both a salary and a pension; and repeal a prohibition on contracting out mental health services in state prisons.

Other measures in the reform package are all but "cosmetic" in comparison to the magnitude of what is needed: One bill potentially requires Medicaid recipients to adopt "wellness" measures, but does nothing to address the skewed incentives implicit in that system. Another addresses an issue of prison labor competing with private firms, four bills set up "government efficiency" panels, and one requires school districts within an Intermediate School District to adopt the same calendar. That’s all the "reform" Michigan got for $1.5 billion in new higher taxes.

There are no substantive spending cuts associated with the deal. Instead, there will be a little "watering the soup" in department budgets, but no agencies or substantial programs will be eliminated or subjected to major restructuring/downsizing. School and university budgets will go up by 1.0 percent.

Michigan’s economic malaise will only be worsened by imposing $1.5 billion in increased taxes, especially taxes of the most economically destructive sort. While the silly sounding items covered by the service tax measure — things like astrology services and baby-shoe bronzing — will get the most media attention, the truly ugly job killers are new taxes on business services, including a $230 million tax on business consultant services, $98 million on "office administration" services, and $50 million on janitorial services, to name just a few. More than half the new tax revenue will come from taxing business services, which creates a tremendous disincentive for many firms to remain or locate here, and is particularly harmful to small businesses.

The growth-inhibiting impact of income tax hikes is well documented; this tax falls most heavily on the investors and entrepreneurs who are the engines of economic growth.

This budget problem was a "crisis" only for those whose livelihoods depend on state government, not for the people of Michigan as a whole. Not even the Lansing spinmeisters believe that the outcome will do anything to reverse the state’s economic decline, or that we won’t be right back in the same place in one or two years.

This time, the political class surrendered to the special interests who benefit from the status quo in state government and let slip an opportunity to embrace transformational change. Given the economic trend lines, it’s likely that a real crisis will strike the state within the next decade, where unemployment rates skyrocket well into double-digit territory, the "last person out turn off the lights" signs acquire real meaning, and the option to reach deeper into taxpayer pockets is not available. It’s not too late to adopt budget, regulatory, labor law and tax policies that would avert that, but time is running out.


Jack McHugh is senior legislative analyst at the Mackinac Center for Public Policy, a research and education institute headquartered in Midland, Mich. Permission to reprint in part or in whole is hereby granted, provided that the author and the Center are properly cited.

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