Michigan tax facts, part 6: How much do taxes matter for business location?

Editor’s Note: To help voters make sense of ubiquitous political arguments in this fall’s elections in Michigan, Bridge’s 10-part special report explains Michigan taxing and spending issues. Today we present parts five and six. Read each five-minute primer published so far:
Part 1: Are Michigan taxes too high, too low or just right?
Part 2: Who wants what in the long war over Michigan taxes?
Part 3: Who pays the taxes in Michigan?
Part 4: What do you taxes pay for in Michigan?
Part 5: Who gets tax breaks in Michigan?

It’s a mantra among tax-cut advocates that low taxes are key to attracting and retaining business. Research and real world events suggest it’s not nearly that simple.

In 2003, when Electrolux AB threatened to close its refrigerator plant north of Grand Rapids, state and local officials put on the table $120 million in tax sweeteners they could think of to stop the move, including:

  • $83 million in tax credits over 20 years through the Michigan Economic Growth Authority
  • $31 million over 15 years for a tax-free Renaissance Zone and forgiveness of the Single Business Tax
  • Up to $2 million in a block grant for public works for a new factory site
  • $3.9 million over 15 years in school tax reductions
  • $790,000 over 12 years in local property tax reductions
  • $500,000 for employee retraining

It didn't matter. In January 2004, the company announced it was closing the plant in Greenville and shipping operations to Mexico and another plant in South Carolina. Nearly 2,700 jobs were lost.

The deciding factor in this case was wages, not taxes. Greenville's workers were paid about $15 an hour compared with about half that in South Carolina. In Mexico, workers would be paid about $1.57 an hour. A company official said competition from rivals with manufacturing plants in Mexico put the firm at a “large cost disadvantage.”

Some studies dismiss taxes

Analysis by the University of Vermont found that taxes are often low among factors weighed by both manufacturing and white-collar businesses in deciding where to locate. It cited a 1997 study published in the New England Economic Review of company location decisions for manufacturing plants and offices tracked over a five-year period. For manufacturing plants, labor rated 36 on a scale of 1 to 100 as a cost factor, followed by transportation at 35, utilities at 17 and taxes at 4. For offices, labor rated 72, with utilities rated at 8 and taxes 5. The author of the study concluded that “site selection data do not suggest any correlation between low taxes and positive economic growth, or between high taxes and slow growth.”

In 2007, pharmaceutical giant Pfizer Inc. announced it would close research facilities in Ann Arbor and Kalamazoo and cut 2,400 jobs by the end of 2008. Looking to trim costs by $2 billion a year, the firm planned to relocate Michigan research projects to sites in Connecticut, Missouri, California and England. A company official said tax incentives would have made no difference.

The Missouri Budget Project, a nonprofit public policy organization, found that state and local taxes “comprise a very small portion of the cost of doing business” and are much less important than factors like a skilled workforce and efficient transportation. It cited a 2012 survey by Area Development Magazine that ranked the top five location factors as highway accessibility, labor costs, proximity to major markets, availability of skilled labor and available land. The corporate tax rate did not rank in the top 10.

Tax cut advocates are not convinced. In a 2012 review of literature on tax rates and economic growth, the Tax Foundation concluded that the evidence showed that high taxes are “a drag on the economy.” It added that cuts in corporate and personal income taxes lead to “more investment, more employment, higher wages, and a higher standard of living.”

Birgit Klohs is president and CEO of The Right Place, Inc., a West Michigan economic development organization, said there is no one-size-fits-all answer on the importance of tax rates for business retention and expansion.

“It depends. Generally speaking, the talent of the work force is the number driver of economic development,” Klohs said.

Klohs said the decision by Booking.com to open a national call center in suburban Grand Rapids had little to do with taxes. The center employs more than 500 workers.

“They never asked once about taxes. They asked how many college students do you have and how many languages are there in West Michigan.”

Critics: taxes drive expansion

But for some high-tech manufacturers, Klohs said, questions about tax rates are “at the top.”

David Rhoa, president of Lake Michigan Mailers Inc., a Kalamazoo-based direct mail and document processing center, said tax rates can be a deal killer for small business. He is past president of the Small Business Association of Michigan.

Rhoa said his firm was considering expanding operations in either Michigan or Indiana when the idea of expanding the state's 6 percent sales to a variety of services – including that of his business – came up for discussion in 2007. The $725 million tax hike eventually was passed as part of a deal reached at 4 a.m., then repealed before it could take effect because of public backlash.

“It forced us to exclude Michigan as a possible area of expansion,” he said.

With Michigan out, the firm decided to open a processing center in South Bend, Ind.

Rhoa approves of repeal of the Personal Property Tax – approved by voters in August – and of Gov. Rick Snyder's push to eliminate the Michigan Business Tax and replace it with a 6 percent corporate tax. That cut business taxes in the state by about $1.6 billion.

“I think Michigan is sending a message to the rest of the country that we are getting it together,” he said.

The relationship between taxes and business growth continues to spark fierce debate across the nation. New York and Washington are among those state offering aggressive tax incentive deals to companies that can deliver jobs. Other states, like Idaho, are less transparent than others about where the credits and exemptions go.

In Kansas, GOP Gov. Sam Brownback presided over a 25 percent income tax cut in 2012 and another cut in 2013. But promised jobs growth has not yet materialized, as income tax collections plunged from $3.3 billion to $2.6 billion and revenues fell $338 million short of projections for fiscal 2014. The Kansas economy lagged in comparison to five nearby states in nearly a dozen key measures associated with employment and business expansion, according to analysis by the Kansas Economic Progress Council, a nonpartisan coalition of business owners and organizations. In August, Standard & Poor's Ratings dropped the state's credit rating out of concern for the state's ability to balance its budget.

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Comments

Tue, 09/23/2014 - 11:52am
There is a large-scale research literature in regional economics on the effects of state and local business taxes on business location decisions. This was most comprehensively reviewed in my 1991 book, Who Benefits From State and Local Economic Development Policies? Since then, most estimates of effects of business taxes on business location have been consistent with that 1991 summary of multiple studies. What this research suggests is that holding public services constant, the elasticity of long-run business activity in a state with respect to state and local business taxes is somewhere in the range from -0.1 to -0.6, with a value close to -0.2 or -0.3 being most likely. A -0.2 elasticity means that a 10% reduction in ALL state and local business taxes in a state, holding public services constant, will in the long-run increase the state's business activity by 2%. This research finding yields mixed results that sometimes makes people on both sides of this issue unhappy. On the one hand, this indicates that business taxes do have some effect, and so this must be considered when designing state tax policy. We can't just soak business and expect no effect. In addition, these results indicate that business tax cuts that are very tightly targeted at new business investment decisions, especially in businesses that are "export-base" (regional economics jargon for selling to non-state residents) and that have high multiplier effects (e.g., growth in these businesses leads to high growth in other local businesses due to local suppliers and worker respending on local retail) and that pay high wages and hire local residents, may have a favorable benefit-cost ratio. On the other hand, these results also indicate that business tax cuts do not pay for themselves in new business activity. Furthermore, the elasticities are close enough to zero that if an across the board business tax cut is financed by cutting public services, the short-run and long-run effects of this may actually be to reduce a state's business activity. Also, the results tend to imply that more targeted business tax cuts for new investment have larger economic development effects than across-the-board business tax cuts, which doesn't always fit into the agenda of state business groups.
Duane
Tue, 09/23/2014 - 10:21pm
Tim, I would like to add a caveat to your work. I am highly skeptical that the 'politicians' (at least the vast majority) are so conscientious that they make the effort to even read research that you describe when voting on taxes. I believe the career polticians, with rare exception, don't care enough about the impact of the taxes to even consider the unintened consequences short of what timely public or lobbying efforts provide. Also the bigger the business the more likely they are to invest (hire people to understand the tax codes) so they can benefit from the different parts of the code. In reality, tax code is an effort by the 'politicians' to get more money to spend. Any efforts to manipulate employers through the tax code (creating exemptions, incentives) only distorts the decision process and prevents the best economic and business decision for the long-term sustainability of the companies. S The simpler the taxes/codes the better for the smaller employers and for the local economies, and the State in effect is a local economy. The better chance of supporting current resident businesses and drawing new businesses is focusing on the value of services provided for the taxes.
David Waymire
Tue, 09/23/2014 - 2:48pm
I always hesitate to follow Mr. Bartik, an economist I believe has an extraordinary grasp on all aspects of economic growth. I might add that we see in this story...and today's announcement by GM that it is moving its Cadillac headquarters (about 100 persons) to New York City. An underlying reason for GM's decision is the inability of metro Detroit to attract the creme de la creme of talent in a world where talent is increasingly mobile. If you are one of the top 100 young design/marketing/thought mavens in the world, and the choice is to live in New York City or Detroit, the answer is pretty easy. Michigan's public policy decisions have made Detroit a difficult sell, even as it is doing wonders in improving itself. At the same time, we have made ourselves very attractive to companies such as Lake Michigan Mailers. It's a production line business. It's based on low costs, low taxes, and its owners are ready to move to states with even lower taxes, lower per capita income, and limited government services, such as Indiana. Bottom line: We can have tax/government services policies that attract mailing companies and factories...or tax and government services policies that attract top talent. I'd rather have the 100 Cadillac jobs here than the 100 Lake Michigan Mailer jobs. And the people who build houses, work as plumbers, sell clothes, wait tables...I think they would be better off if we made Cadillac's positions a higher priority. Unfortunately, that's not the way the policies are moving these days. We are more interested in beating out Indiana for low paying jobs than beating out New York for good paying jobs.
Tue, 09/23/2014 - 5:19pm
Mr. Waymire raises a different and important question, which is the relative effects on economic development of business taxes versus "other things", such as amenities and public services. And I think it is true that there are many other policies that have higher bang for buck than untargeted business tax cuts. For example, as I have written numerous times, high-quality early childhood education programs have a very high economic development return, definitely higher than untargeted business tax cut. In addition, even if we are aiming at programs targeted narrowly at business, economic development programs such as customized job training and manufacturing extension services seem, based on some good research studies, to have a higher bang for the buck than even targeted business tax cuts for export-base investment. But the point remains that an overall state fiscal policy has to be balanced. It has to combine adequate financing for high-quality public services with an openness to new business investment. About 5 years ago, I wrote a piece on what Michigan should be doing about economic development. It argued for very targeted business tax cuts, combined with funding for various types of services with evidence for effectiveness. Such services include not only early childhood education, but also investment in such services as K-12 summer school, high school career academies and a variety of job training programs: http://research.upjohn.org/up_workingpapers/160/
Duane
Tue, 09/23/2014 - 11:07pm
Tim, Before we will get the services such as the early education we first have to have a public that values it personally not just because they hear about it from others. We hear all the time about the value of education in general, but it only has true value when it becomes personal and immediate. Where does each person have that contact with educational value? As best I can tell it is the teachers and yet all we hear about is the battle over compensation so the message isn't about value. We see it athletics, but that is more about the campuses and path way to a higher level of sports. Think about the local schools that are successful and then look at the attitude toward education in those communities, I suspect you will find it is the public driving the schools not the schools driving the public. To your point of early education, whether the school provide it or not it is whether the families value it or not will determine if it is successful. If you want a program to be successful you need to create an accountability for the program, metrics that everyone can understand (relate to) and apply. I say this because it is how people make things personal and immediate. As I have mentioned I do have the knowledge in economics, but I have learn more about how I function and it seems those around me respond. It is attitude and attention that will achieve what you are interested in and it has to be personal and immediate to get attention and develop attitude. I think Cadillac is missing an opportunity of collaboration by out sourcing their people to NYNY, so few drive cars there how will they grasp the interests of those who they expect to buy the Cadillacs to. I would like to see our government define their purpose, agency by agency, and create metrics for the results they expect to deliver. That would have more impact on the quality of the business envrionment and the quality of life for residence than all the tax code manipulations.
Duane
Tue, 09/23/2014 - 11:21pm
Tim, Before we will get the services such as the early education we first have to have a public that values it personally not just because they hear about it from others. We hear all the time about the value of education in general, but it only has true value when it becomes personal and immediate. Where does each person have that contact with educational value? As best I can tell it is the teachers and yet all we hear about is the battle over compensation so the message isn't about value of an education. We see it in athletics, but that is more about the campuses and as a path way to a higher level of sports. Think about the local schools that are successful and then look at the attitude toward education in those communities, I suspect you will find it is the public driving the schools not the schools driving the public. To your point of early education, whether the school provides it or not it is whether the families value it or not will determine if it is successful. If you want a program to be successful you need to create an accountability for the program, metrics that everyone can understand (relate to) and apply. I say this because it is how people make things personal and immediate. As I have mentioned I do have the knowledge in economics, but I have learn more about how I function and it seems those around me respond. It is attitude and attention that will achieve what you are interested in and it has to be personal and immediate to get attention and develop attitude. I think Cadillac is missing an opportunity of collaboration by out sourcing their people to NYNY, so few drive cars there how will they grasp the interests of those who they expect to buy the Cadillacs to.
Duane
Tue, 09/23/2014 - 10:43pm
David, It is only when you are truly knowledgeable that you have trepidation being in the same discussion with others. Since I accept my limitation I have little knowledge on the subject I will barge ahead. The GM is one of corporate ego over real effort. NY may have the hype, but I suspect the Ann Arbor zone can be appeally to any number of the top designers. Current technology simply allows the GM execs to indulge themselves in having a presence (company appartments and regular visits) in the Big Apple. Even in Detroit's heyday it was always a family town and not one for the sporty singles, so it would never compete for those that want the glamour and the glitz (and high cost of living). We would be better off it the state saw themselves as a partner with business and tried to figure out what and how the state services could help businesses be more competitive. If we as a state and as local communities want employment for our residents then we need to work with businesses to make our environments competetive and facilitating employers to be competitive on a world scale. As an example, the infa structure we should be talking about is the digital one that allows our state to communicate faster and with more information then any other. Why should we be investing fast trains to Chicago when by the time they are built the cars will do the driving and the passagers will be working while they ride between Detroit and Chicago. If Govenor Snyder we truly looking to the future he would be looking at making it easier to drive between Detroit and Chicago by making I-94 three lanes all the way their and even researching an imbedded track for battery powered cars to charge themselves while driving. We have no policies for the future because we lack a diversity of prespective in our Legislators. Mr. Power 's commentary about politicians is an example of barriers to drawing in people who are working on the future in their jobs.
Rob Burgess
Fri, 09/26/2014 - 7:22am
Not being an economist, I'll skip Tim's jargon about "elasticity". Sorry, Tim. As a retired past president of Michigan School Business Officials, I admire your work especially when it comes to issues like pre-school funding. That being said, do taxes matter? The former school district that I was employed by did business with Mr. Rhoa and Lake Michigan Mailers (good company, good service), I suspect it does matter to a company which thrives on high volume and low margin. However, for other companies, professions it may not make such a difference. Take two thriving communities in West Michigan: East Grand Rapids and Forest Hills/Ada. Both have median household incomes over $100,000 and more than double the state-wide average. Average homes in these communities are more likely to be in the $200,000-$400,000 range (or above) than lower. Both arguably have thriving shopping areas, low crime rates, excellent schools, etc. Forest Hills, home of Amway, has significantly lower property taxes than East Grand Rapids, home of many professionals. (I once visited East Grand Rapids High to examine some of their educational programs. We were told that more students take Latin in that high school than career technical education classes. They are preparing for careers in law or medicine and not to be mechanics or plumbers.) On a $300,000 home, property taxes in East Grand Rapids would be about $2,100 more per year than Forest Hills. The two communities are next door neighbors. Both are considered "desirable" communities (by many although not all, but that is a different matter) to live, raise a family, shop, etc. Apparently, at least for the professionals in East Grand Rapids, taxes are not an issue. Living in a community with Reeds Lake, excellent health care availability, safe and well maintained streets, boutique shopping, and one of the top school systems in the state is important. Seems to me that taxes are important to certain types of businesses. Not so much to others. If Michigan is ever to lower its poverty rate, strengthen the middle class, and improve the overall standard of living for all Michiganders, I personally think our tax policy (and related state spending on roads, schools, colleges, safety net, etc.) needs to be smarter and less driven by less (or more) is better. Thank-you to Bridge Michigan for raising important issues in a civil and rational manner.