Beware of Following Michigan's Steps Down the Road to Serfdom

     Consider Michigan.

     Michigan has been mired for several years in an economic slump. Its unemployment rate is the highest in the nation, 60 percent above the national average. Forbes magazine has ranked Michigan 46th  in the Best States for Business. It’s the only state in the country whose state GDP actually fell according to the latest data.

     The United Van Lines Migration Study had Michigan tied for first in outbound migration. It ranks 48th in population growth. It’s among the worst states for home foreclosures; the poverty rate is above the national average; and the list goes on.

     The economic malaise has predictably led to a budget crisis. Faced with a budget deficit of some $1.7 billion, the Democratic governor said she would veto any continuation spending bill unless it was accompanied by major tax increases. Negotiations continued until nearly 4 a.m. on October 1, when two tax bills and a 30-day continuation budget were passed.

     Thanks to the tax increase mandates, individuals’ income tax bills across the state will increase by approximately $765 million annually. A new 6-percent tax on services is estimated to raise taxes by another $750 million.

     Though the United States as a whole enjoys low unemployment and four straight years of positive job growth, policymakers and voters must pay attention to Michigan’s case. There are plenty of congressmen who argue that the nation needs higher taxes. Watch Michigan to see if the tax hikes improve the economy.

Higher Taxes Don’t Help

     First, there is substantial evidence that high taxes result in poor economic growth. The seminal study of this was done by Harris Bank economists in 1978, but since then a number of studies have shown similar results for states and national governments.

     The most prolific author in this area is Professor Richard Vedder of Ohio University, whose research has clearly shown the negative effect of state taxes on state personal income growth, population growth and other economic indicators. A September 2007 report by The Parthenon Group entitled “Fiscal Realities for the States: Economic Causes and Effects” is but one of the latest papers to document negative effects of state taxes on employment and state economic activity.

State Budget Has Fundamental Problems

     Second, the major spending categories for Michigan, and the ones causing the most problems for the budget, are Corrections, K-12 education spending, and Medicaid. Each of these categories has substantial structural problems that result in little value for additional spending.

     Michigan incarcerates a much larger proportion of its population than its surrounding states, with little or nothing to show in the way of reduced crime for its efforts. Elementary economics shows that one should spend another dollar on something only if the marginal benefit is in excess of the marginal cost. The Corrections budget is weighed down by incarcerating people with drug and mental health problems. Imprisonment is very expensive relative to other methods of treatment.

     There is an enormous amount of research showing additional spending on K-12 education does not produce additional educational achievement. Finally, Medicaid is fraught with problems, not the least of which are the incentives built into a third-party payment structure.

     It would be very difficult to show that additional funding in these areas, given the current structure, would reduce the cost of doing business in Michigan.

Gov’t Workers’ Salaries Among Highest in the Nation

     Third, there is evidence that Michigan’s budget is in some ways concerned with retaining a state work force that is paid more than the private sector. According to the National Education Association, Michigan teachers’ salaries are behind only those of California and Connecticut, and are the highest in the nation when corrected for cost of living.

     Research by the Mackinac Center for Public Policy found the average salary and benefits package of Michigan state employees is $75,000, while the comparable figure for private-sector workers is about $58,000. The national median household income is about $48,200.

Arbitrary New Tax Punishes Michigan Businesses

     Finally, the new use tax is levied on what appears to be a laundry list of services with no rhyme or reason. For example, if one gets a haircut and coloring, the coloring is taxed but the haircut is not. Ski lift tickets are taxed, but golf green fees are not.

     The tax is levied on business-to-business sales – in fact, about three-fourths of the revenue is expected to come from business. That creates a problem for already-troubled Michigan firms relative to firms in other states. For example, a management consulting firm in Michigan will now have to charge its clients a 6-percent tax, while an Ohio firm will not.

     This is not going to improve the competitiveness of Michigan’s service industry. The compliance costs will also fall heavily on small businesses, which will be faced with a myriad of rules and regulations on what types of services are taxable, who is exempt, when to file, etc.

     Michigan’s tax increases will create even more misery for its citizens. The economic harm caused by the taxes will lead to further budget problems in the very near future.

     Consider Michigan a warning – if legislators can pass tax increases where a state is already in economic disrepair, how much more likely are national politicians to try when the nation’s economic health is good?