Several reporters have recently asked for my opinion on the business tax cuts recently enacted in Michigan. These business tax cuts lower the main state business tax in Michigan by about $1.7 billion annually. Will these tax cuts succeed in creating jobs?
My response is that the effects of these business tax cuts on Michigan job creation are likely to be disappointing, for several reasons.
First, across-the-board business tax cuts are less cost-effective in creating jobs than more targeted business tax cuts. Across-the-board business tax cuts include non-export-base businesses as well as export-base businesses. Export-base businesses sell to consumers and businesses in other states. These export-base businesses thereby bring new dollars into the state, which recirculate and create multiplier jobs in local suppliers and retailers.
Non-export-base businesses by definition sell to consumers and businesses in the state. Therefore, the economic activity of non-export base businesses is due more to disposable income in the state than it is to the business taxes that are paid. Including non-export-base businesses in a business tax cut decreases the likely job effects per dollar of the tax cut.
Across-the-board business tax cuts also include businesses that are not even considering creating jobs. Business tax cuts that are conditional on job creation provide incentives for job creation that have a lower cost per job created than if we also give tax cuts to businesses that are not creating jobs.
Second, in Michigan’s case, the main state business tax already had much lower rates for many export-base businesses. This is due in part to the state’s use of 100% sales factor apportionment. I explained this important but obscure tax provision in a previous blog post. In addition, many of these businesses already received MEGA tax credits for new investments. Because many export-base businesses already paid low tax rates in the main state business tax, cutting the tax further would not have major effects on their behavior.
Third, in the overall budget package, these business tax cuts are being paid for, depending upon one’s perspective, either by higher personal taxes or lower spending on K-12 education and other programs. In the short-run, reduced spending or higher personal taxes will tend to decrease disposable income and jobs in the state. This demand-side impact will offset or even outweigh the short-run positive impacts of lower business taxes.
I think that Michigan’s business tax cuts have more to do with perceived tax fairness than economic development. Many locally-oriented Michigan businesses resent that the current tax structure leads to these businesses paying higher taxes than export-base Michigan businesses. Whether this favoritism towards export-base businesses is fair is debatable. However, favoring export-base businesses does make sense in terms of promoting Michigan job creation in a cost-effective manner.
However, even if the true effects of the Michigan business tax cuts are disappointing, I think it likely that these business tax cuts will be perceived to be successful. U.S. manufacturing is doing better. The Detroit 3 are doing better. This improvement in Michigan-based manufacturing is already increasing the relative performance of Michigan’s economy, and is likely to continue to do so.
In the long-run, whether Michigan’s business tax cuts have a positive impact on the economy is likely to depend on how they are financed. (This financing is not a settled issue yet, because it depends upon decisions make not just this budget year, but in subsequent budget years.) If the tax cuts are financed by lowering the quality of K-12 education, then the effects of business tax cuts are likely to on net be negative. On the other hand, if the state tax cuts, and other state budget policies, allow the business tax cuts to be combined with increased investment in high-productivity educational programs, such as early childhood programs and selected K-12 programs, then the net long-run impact on Michigan job creation is more likely to be positive.