Businesses Taxes: A Pernicious Sham

In the last 18 months, at least five new business taxes have been proposed to replace Michigan’s Single Business Tax, which is scheduled to sunset at the end of 2007. Two of these proposals were made by Gov. Jennifer Granholm, and one each has come from the Michigan Chamber of Commerce, the Detroit Regional Chamber of Commerce and the Grand Rapids Chamber of Commerce. Other less specific proposals would expand the sales tax to services, or impose different kinds of Value Added Taxes.

Each plan has been offered in good faith, and with each the initial reaction was enthusiastic. Without exception, this enthusiasm turned into dismay as each plan’s features became better understood, because they all were found to contain various combinations of perverse incentives and unfortunate outcomes. In effect, the different proposals were all squeezing the same balloon, but in different places.

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Observing this process suggests that business taxes, per se, are uniquely problematic, and it’s a sucker’s game to try to create one that is not. You often hear, "Businesses don’t pay taxes; they pass them on to customers." It’s true that some customers are willing to pay more for a product or service when prices are raised due to taxes, but others are not willing, and their business is lost when prices are higher. If the higher price just goes to pay a business tax, then a firm gains nothing from those willing to pay it, while the firm loses the earnings that would have come from potential customers not willing to pay more.

It turns out that while business taxes are "passed on" as higher prices, in the aggregate the real burden doesn’t fall on customers after all. Instead, it falls on investors and entrepreneurs — the owners of the company. Every business subject to the tax is made less profitable by it. The result is that less will be invested in businesses that are subject to the tax. This means fewer of them will exist in the future than would have been the case without the tax, and fewer people will get the jobs those new businesses would have created.

This is not an argument against all taxes, although every particular tax has some unique economy-dampening characteristics. Sales taxes come closest to the specific depressing effect of business taxes, but at least in theory they apply to every seller in the world who sends a product into the jurisdiction of the tax, and in fact they apply only to the final retail sale, rather than to every supplier along the chain. What is unique about state business taxes is the manner in which they target a narrow and highly desirable group — persons willing to invest in the state. And don’t forget, not only do investors already pay individual income tax on all the profits they may earn; the business operation itself already pays many other taxes, such as Social Security taxes, other employment taxes, property taxes and so forth.

Surprisingly, economists of all stripes understand that business taxes are really a tax on investors — even those who prefer more government spending don’t disagree. So why do we have business taxes? Some say that businesses should pay their "fair share." But as shown above, in the real world this just means that investors and entrepreneurs should pay more. Class warriors will fulminate, "Someone has to pay for government, and you just want tax cuts for the rich!" Not so. There’s nothing here that prevents the state from imposing on individuals some particular opinion about what is a "fair” tax policy. But any tax system should be honest and transparent, which means acknowledging that "businesses" don’t pay business taxes, investors do — whether they are rich or poor.

It has already been shown that the SBT can be replaced with nothing. In the end, business taxes are just another way for politicians to hide the magnitude of government’s exactions — which to paraphrase the late Sen. Russell Long of Louisiana, means, "Don’t tax thee, don’t tax me, tax the investor behind the tree."


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.