The question is easier for individual taxation, since there are only a few possible alternatives: a flat rate income tax or a graduated income tax; more reliance on income taxes or consumption taxes; a tax system that attempts to shelter the most vulnerable in society or a tax system aimed at stimulating profitability and economic growth, .... For individuals, the fundamental principle is clear: each individual should pay a share of the costs of government based on income, perhaps moderated by a graduated rate.
But with businesses the issues don't seem as clear. Businesses in a state have a clear economic interest in the services provided by government, from fire and police protection, to preservation of the environment, to provision of a skilled and well-educated workforce. Business should pay its fair share in supporting the necessary costs of the state; but what is a fair share? And what is "necessary" when it comes to state services?
The situation is even more complicated when we bear in mind that business activity is itself an important source of good for citizens. More business activity means more employment and income. More jobs and wages mean more demand for services and products of all kinds -- and more income for people employed in those goods and service industries. Business disinvestment leads to significant hardship for citizens. A tax system that discourages business activity is harmful to the economic wellbeing of the state and its citizens. So business tax rates ought to be high enough to support a fair share of the costs of government, but not so high as to discourage business investment.
And the latter point in turn requires comparison with other feasible locations for business activity. If Michigan and Ohio assess business income at significantly different rates, we should expect some flow of investment from one to the other.
The state of Michigan is an interesting current example. Michigan's governor, Rick Snyder, has proposed a major change in the structure of business taxes in the state. He proposes abolishing the Michigan Business Tax, enacted only a few years ago, and replacing it with a 6% corporate income tax that applies only to the largest businesses and corporations in the state. This reform is promoted as one that is needed to simplify the tax obligations of businesses and to improve the business attractiveness of the state for future investment, and it has been welcomed with enthusiasm by the business community. (According the the Tax Foundation's State Business Tax Climate Index, Michigan ranked 17th in 2010 and 2011 in the Tax Climate Index overall and ranked 48th on the corporate tax index, based on the existing Michigan Business Tax; link.)
Often tax reforms are put forward under the banner of "revenue neutrality" -- the rules are changed and simplified, but the "before" and "after" rules collect the same amount of revenue. This reform in Michigan is distinctly not revenue-neutral. In 2009 businesses in Michigan paid $2.6 billion under the Michigan Business Tax. Sales taxes collected $8.8 billion, and personal income taxes collected $6.0 billion. (These data are presented in a 2011 report of the Citizen's Research Council in Michigan; link.) In 2013 it is projected that the flat corporate income tax, when fully implemented, will collect only $749 million -- a decline of over 1.2 billion dollars in tax revenues for the state compared to the $2.0 billion estimated under the Michigan Business Tax if applied in that year. (These estimates are provided in a February 17, 2011 report issued by the Michigan government; link.) This amounts to a greater than 60% reduction in the taxes paid by businesses in support of the general fund. And this shortfall is being addressed in the state's fiscal plan through adjustments in the structure of individual taxes: pensions would be taxed for the first time and Michigan's Earned Income Tax Credit would be abolished. In other words, a billion dollars of tax reductions for business are being paid for by sacrifices by pensioners and poor people.
So here is a question worthy of discussion: are Michigan businesses being asked to pay their fair share under the revised business tax policies? Is 6% enough? Were businesses significantly over-taxed under the Michigan Business Tax? Should the corporate income tax be applied only to the small subset of businesses in the state that qualify, or should it be applied more broadly? And is a 6% corporate tax rate competitive with other states?
Let's look at the competitiveness question. It is broadly asserted by leading business organizations in Michigan that businesses pay too much taxes for the state to be competitive, and that 6% is about as high as the rate can go without losing investment to other states. But the facts appear to be otherwise. The Tax Foundation provides annual data on corporate income rates by state (link). Here is the Tax Foundation data, ranked by the highest bracket. (A number of states have a graduated rate, so small businesses pay lower rates.)
|State corporate income tax rates (ranked by hightest bracket)|
|source: Tax Foundation|
|Note: In addition to regular income taxes, many states impose|
|other taxes on corporations such as gross receipts taxes and franchise|
|taxes. Some states also impose an alternative minimum tax.|
|(a) Michigan, Ohio, Texas, and Washington do not have a corporate|
|income tax but do have a gross receipts tax with rates not|
|strictly comparable to corporate income tax rates.|
|(c) On January 12, 2011, Illinois increased its corporate income|
|tax from 7.3% to 9.5%, retroactive to January 1, 2011. Illinois’s rate|
|includes two separate corporate income taxes, one at a 7% rate|
|and one at a 2.5% rate.|
|Source: Tax Foundation; state tax forms and instructions.|
The 6% rate proposed for Michigan falls at the bottom end of this ranking; 35 states have higher rates, extending to 12% in Iowa; four states have a 6% rate; and nine states have a lower rate. It would appear that a 7% or 7.5% rate would still leave Michigan in a competitive position when it comes to the corporate income tax. This would result in an additional $200 million in revenue -- and would permit significant dollars for the Earned Income Tax Credit. So a larger share from business would permit a better outcome for poor and working people.
But the really difficult question is the "fair share" question: how should the costs of government be allocated across individuals and businesses? What principles of equitable contribution are helpful in addressing these issues? And how would we try to judge whether Michigan's corporate tax reform plan results in a fair allocation of the costs of government across individuals and business?
(Here is an interesting post by Donald Barrett and James Steele on "Are Corporations Paying Their Fair Share of Taxes?". In a word -- no!)