The repeal of the Michigan Single Business Tax.

The Republican-led Michigan Legislature voted on August 9, 2006, to repeal Michigan's Single Business Tax (SBT), which generates approximately $1.9 billion in tax revenue for the state from business taxpayers. The vote means that the tax will sunset next year, on December 31, 2007, two years ahead of schedule of its previously approved repeal of December 31, 2009. Democratic Governor Jennifer Granholm, who opposed the early end of the tax without a revenue replacement, has argued that lawmakers should specify how they will replace the foregone revenue, but she was powerless to veto the SBT repeal, because the repeal was started through a voter-initiated petition drive.

In response, the Legislature created a bipartisan committee--the Joint Committee on Economic Growth (1)--to develop an alternative business tax. The Joint Committee is to provide its recommendations by December 1, 2006, which of course is after the November gubernatorial election.

Michigan adopted the SBT in 1975, as a replacement for several taxes--Michigan Corporate Income Tax, the Corporate Franchise Fee (which was based on corporate net worth), the Financial Institutions Income Tax, the Savings and Loan Association Privilege Fee, the Domestic Insurance Company Privilege Fee, local government property taxes on business inventories, and the State Intangibles Tax on business. Hence, the name "Single" Business Tax. At that time, the SBT was levied at a flat rate of 2.35 percent. The concept behind the SBT was to impose a form of value-added taxation permitting companies to deduct 100 percent of their investment expenditures, which in turn would encourage business investment. The SBT was also intended to provide a more stable source of revenue to the state. The levy of a Single Business Tax was a new concept in state taxation; at the time, all but five U.S. states taxed corporate income. (2) While the SBT is levied on adjusted gross receipts (which is the sum of business profits, compensation, depreciation and interest expense), it is not comparable to other corporate taxes, because its base is unique and because the State has held that the protections of Public Law No. 86-272 do not apply to it because it is a value added tax. (3) In addition, Michigan levies the SBT on all forms of business entity, including partnerships, S corporations, and limited liability companies. (4)

The passage of the original SBT was followed soon by amendments to provide targeted relief, either by reducing a taxpayer's adjusted tax base (5) or redefining the definition of "business activity." (6) In addition, relief was granted to small business entities, as Gwell as to entities deriving a large proportion of their business income from service activities; the amendments also exempted from taxation agricultural production revenues and small business revenue and limited the taxation of financial institutions. The restrictions on the SBT base were substantial. For example, the cap for small businesses quickly rose from $36,000 initially to $350,000, providing an escape from taxation for small businesses when gross receipts are under $350,000, but which levies the tax if a single dollar more is earned.

With the introduction of the Single Business Tax, the State of Michigan was pursuing four laudable goals: alleviating a budget shortfall owing to the recession of the early 1970s, providing a more stable source of tax revenue than had previously been collected, promoting economic efficiency by encouraging investment in the state, promote economic efficiency by taxing all forms of business entity, regardless of form, and easing the compliance burden by providing a single tax that was easier to administer than the seven taxes that it replaced. While the intent of the drafters was commendable, the process soon became politicized, with industries seeking exceptions, exemptions and other relief.

Discontent with the SBT quickly grew as the concept and application of the tax became more complex. The dissatisfaction took on another form in the 1990s, where the constitutionality of the SBT Capital Acquisition Deduction (CAD) was challenged. (7) The SBT had been designed to minimize the relief provided taxpayers for out-of-state investment expenditures. As a constitutional challenge to the SBT worked its way through the courts, the Michigan legislators worked to reduce the likelihood that the CAD would be held to violate the interstate commerce clause of the U.S. Constitution. Specifically, the legislature amended the SBT in 1995 (effective for years beginning after December 31, 1997) to permit favorable treatment only for assets put into place in the State of Michigan, which significantly reduced the deduction to those who invested in the State. Further legal challenges prompted the legislature to make further changes to the CAD in 1991 and, eventually, to vote in 1999 to replace the CAD (effective for years commencing January 1, 2000) with an investment tax credit. (8) Similar to the investment tax credit imposed by those states that imposed a corporate income tax, the Michigan ITC was granted for assets put in place throughout the United States. The Michigan credit, however, was a credit at less than the SBT rate, further reducing its value.

The 1999 legislation that replaced the CAD with the ITC also included, as a political compromise, a phased elimination of the SBT over 22 years. The phase-out included a reduction of the SBT rate by 0.1 percent each year until its elimination in 2021. To protect against concerns regarding the declining revenue to be collected by the state, the 1999 legislation included provisions that suspended the annual reductions in the SBT rate in any year in which the state's budget stabilization fund (known as the Michigan "Rainy Day" Fund) fell below $250 million. A suspension in the SBT rate, however, would not change its ultimate termination as of December 31, 2020. (9)

Michigan's economy continued to weaken throughout the early 2000s, and impaired tax collections put stress on the state's budget. Prompted by fears that the SBT rate would continue to fall and a desire to utilize funds in the State's Rainy Day Fund, a political compromise was reached in 2002 which would allow the Rainy Day Fund to fall below $250 million while keeping the SBT rate steady at 1.9 percent. As part of the compromise, the date at which the SBT was scheduled for elimination was accelerated to December 31, 2009. This compromise was negotiated by then-Governor John Engler.

In 2002, Michigan elected its first Democratic governor in 12 years--Jennifer Granholm. Fiscal reform was one of Candidate Granholm's top priorities, but in 2003 the Governor was unable to reach an agreement with the Republican-controlled Michigan Legislature. The legislature sent to the Governor's desk a bill that would have accelerated the SBT repeal to December 31, 2007, which the Governor vetoed, insisting that the repeal would need to be revenue neutral. Much of the Michigan economy was below the national average, and the widespread recovery from the recession of the early 2000s was not enjoyed by businesses headquartered in the state or having a significant presence in the state. The Governor threatened future vetoes, stating that it would be irresponsible to repeal the SBT tax until a replacement revenue mechanism was identified.

In response to the Governor's veto, a petition drive was launched to place the elimination of the SBT on the November 2006 ballot, without specifying a replacement tax. The petition drive was led by L. Brooks Patterson, Oakland County Executive, in a well-established leader in the Michigan Republican party. Three hundred thousand signatures were required to put the initiative on the ballot, and over 360,000 signatures were obtained and validated by the Board of State Canvassers. Upon validation by the Board of State Canvassers, the petition was sent to the Legislature, which had the option of enacting the ballot initiative as a law or not taking action, in which case the proposal would be placed on the general election ballot. By enacting the ballot initiative as law, the general election vote by Michigan voters was obviated. Because the Governor may not veto a voter-led initiative, the law is final.

Michigan's SBT is unique in that it collects a large amount of revenue relative to state income. Michigan's tax collections under the SBT do not necessarily follow the economic cycle in the State and, in fact, provide significant revenue to the state in years in which the state government has the most need for such revenue. This is obviously a "taxing" burden on Michigan's businesses, which are taxed more heavily with the SBT in lean years than they would be if the state levied an income tax on profits. Amplifying this situation is the select exposure businesses have to the SBT. In reality, only a handful of Michigan businesses shoulder the major burden of the tax with approximately .02 percent of businesses paying 30 percent of the tax. (10) In addition, the SBT structure has become increasingly complex over time, imposing significant compliance and administrative costs both for taxpayers and for the state.

The repeal of the SBT can be linked to its complex tax structure, its high administrative and compliance costs, continued criticism over the perceived inequities of tax, and the continual need for amending legislation to encourage new business growth within the state, all coinciding with a gubernatorial election year and the ability to lead a voter-initiative ballot petition by a county executive who had a strong leadership following. The result is the elimination of a tax that no longer met the principles of equity, that favored certain economic activities over others, and that was paid by a limited group of taxpayers.

The Joint Committee on Economic Growth, with a deadline of December 1, 2006, to submit its recommendations on a replacement tax to the legislature has indicated that it will also review the structure and costs of Michigan's personal property taxes, which places a significant burden on the many manufacturing entities located in the state. (11) (Recently, the other midwestern states of Ohio and Indiana have eliminated or reduced their personal property tax businesses.) In addition to the Joint Committee, other policymaking groups within the state are looking at which business tax structure is best for Michigan. Several replacement tax structures are under review, including the return to a corporate net income tax, the levy of a business license fee, or the imposition of a broad-based gross receipts tax, or a combination of several options. Legislatures are also looking at the recent tax reforms in Ohio and Texas for guidance on which business tax structure may be best for the state, and additional proposals include extending the sale tax to most goods and services.

Senator Nancy Cassis, co-chair of the Joint Select Committee on Economic Growth, has said the Committee will also review the exemption, credit, and incentive structure currently in place. It will be important to ensure that the state retains enticement tools regardless of the form of the replacement tax in order for Michigan to remain competitive with the incentives offered by other states. Because the replacement tax is expected to be less burdensome in terms of administration and compliance, as well as perhaps spreading the tax burden among a larger base, there may be a need for fewer incentives to be enacted under the replacement tax. Anticipating a slowing or halt of economic development within the state while the state grapples with the future of business taxes, the legislators have enacted legislation preserving certain SBT tax credits that may have already been granted or promised to taxpayers. (12) It is anticipated that similar legislation will be passed this fall to preserve the state's MEGA tax credits, and other SBT credits.

The winner of the gubernatorial election will have the opportunity to shape the nature of the replacement tax. Governor Jennifer Granholm's Republican challenger is Dick DeVos, whose is running on a "I'm a business person" platform and relying on his family's successful business (Amway) to prove that he has the skills needed to turn around Michigan's fiscal problems. It is anticipated that the race will be close, and it is unlikely that the Legislature will pass any proposals until after the November election (possibly during the lame duck term). In addition, the City of Detroit is facing its own financial crisis, heightening the partisan and regional (west side versus east side of the state) differences.

(1.) Members of the Joint Committee are Rep. Sheen (Co-Chair), Sen. Cassis (Co-Chair), Rep. Huizenga, Rep. Dillon, Sen. Sanborn and Sen. Thomas. The committee has met three times thus far, with no regular meeting dates.

(2.) These five are Nevada, South Dakota, Texas, Washington, and Wyoming.

(3.) See Michigan RAB 1998-1.

(4.) Most states levy their corporate income tax only on C corporations.

(5.) MCL 208.35

(6.) MCL 208.9

(7.) See Caterpillar v. Michigan Dep't of Treasury and Jefferson-Smurfit v. Michigan Dep't of Treasury, [insert citation].

(8.) MCL 208.35a

(9.) Public Act 115 of 1999.

(10.) National Bureau of Economic Research.

(11.) The Senate Fiscal Agency estimated that for fiscal year the amount of tangible personal property taxes is $1,788.4 million, all of which is paid by businesses.

(12.) PA 240 of 2006 which protects committed State Historic Credits and Brownfield SBT credits.

Lynn A. Gandhi is a principal in the Detroit office of Miller, Canfield, Paddock and Stone, P.L.C. Both an attorney and a certified public accountant who focuses on multistate tax structural and transactional planning., Ms. Gandhi received her undergraduate degree from Kalamazoo College, her law degree from Wayne State University School of Law, and her LL.M. in Taxation from New York University School of Law. A former member of Tax Executives Institute, she has worked in industry for the past 18 years, most recently at Visteon Corporation, as well as Ernst & Young. She can be reached at [e-mail].