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By Jason Mast
The U.S. has been among a small number of developed countries for most of the last century in resisting an academically revered economic policy—the value-added tax. Michigan’s failed VAT may help explain why.
All John King, owner and founder of John K. King Used and Rare Books, remembers of the tax was that it was “evil.”
Regressive. Irritating. Contrived. That’s how other business owners described it to Bloomberg BNA.
They called it the Single Business Tax (SBT), highlighting its supposed simplicity, but really it was a modified value-added tax.
Michigan did twice what no other state would. Both times desperate for stable revenue, America’s manufacturing mecca instituted from 1953 to 1967 and from 1976 to 2006 the only value-added taxes in U.S. history. They were meant to be the steady motor driving the government behind the Motor City—and they were, feeding a steady stream of state income in good times and bad.
But what happened to the tax—deductions, exemptions, culminating in a decisive small business revolt led by a notorious conservative county executive—suggests why the U.S. and no other state has instituted what 160 nations have adopted.
It may also point to why House Speaker Paul D. Ryan (R-Wis.) proposed a complicated innovation over a simple VAT for his tax overhaul—and why even that version died in July.
“Somewhere in its last decade in life, it became a monstrous multi-headed creature,” Patrick Anderson, the economist who wrote the bill that repealed the SBT in 2006, told Bloomberg BNA. “It was almost no longer recognizable.”
In 1979, House Ways and Means Chairman Al Ullman (D-Ore.) proposed an invoice-credit, destination-based VAT along with a series of tax reforms. According to “The Rise of the Value-Added Tax” by Kathryn James, “Ullman ultimately paid a heavy and unexpected political price for his championing of VAT reform when he lost his safe seat in the election landslide of 1980.”
Former U.S. Treasury Secretary Larry Summers said in 1988 that the U.S. hasn’t adopted a VAT because “liberals think it’s regressive, and conservatives think it’s a money machine.”
Ryan, though, needed more than $1 trillion to make his recent corporate tax-cutting reform proposal deficit-neutral and passable through reconciliation.
For a while, there was as “a general hum” of a VAT, Rep. Kenny Marchant (R-Texas) told Bloomberg BNA in late June. Federal lawmakers settled on a destination-based cash-flow tax, a tax that University of California Berkeley and British economists devised to solve Summers’ riddle and make the recipe economists have advocated for decades politically palatable.
“It has the exact same economic impacts as a VAT,” House Ways and Means Chairman Kevin Brady (R-Texas) told Bloomberg BNA. It had the most pro-growth element—full write-offs of investments. And people couldn’t say it taxed labor or unprofitable businesses.
“It really is a tax on foreign labor and capital rather than U.S. labor and capital,” said Brady, adding that it was simple because businesses already keep track of imports and exports. There was little administrative burden.
Ultimately the tax fell victim to a multimillion-dollar lobbying assault from retailers and the Koch brothers. Furthermore, six Republican leaders wrote in a July 27 joint statement that “there are many unknowns associated with it.”
Six months into Donald Trump’s presidency, the only thing Republican leaders had agreed to on tax reform was that there wouldn’t be any form of a VAT.
“I wouldn’t recommend it nationally unless there was a hell of an education effort first,” said Howard Heideman, one of the architects of Michigan’s SBT, an economist and administrator of Michigan’s tax analysis division. He added that they would need a “behind-the-scenes” effort to get business on board.
Among the biggest obstacles to states adopting VATs is dealing with cross-border trade, but New York University tax professor Daniel Shaviro said with the rise of e-commerce, it may soon be difficult to tell which goods come from which country, diminishing the value of a value-added tax.
And the U.S. isn’t likely to adopt it before then.
“I wouldn’t quite say it would never happen,” Shaviro said. “I would say it has vast obstacles and it happening is not foreseeable.”
Overall, economists have called the federal attempt at a VAT too unwieldy and difficult to explain, much like Michigan’s tax 40 years ago.
Another political roadblock for the U.S. and others without a VAT: many governments that implemented the tax were quickly voted out of office. Canada is a prime example. The Progressive Conservative government of Prime Minister Brian Mulroney worked to pass the national goods and services sales tax in 1991, but retained only two seats in an electoral landslide in the 1993 elections. The Progressive Conservative Party never recovered and dissolved in 2003.
The Michigan governors in power when both value-added taxes were enacted won re-election, but for years repealing or changing the SBT became a common—and effective—campaign rallying cry, the tax’s creators said.
The value-added tax’s slow global takeover began in the ashes of post-war Japan.
General Douglas MacArthur, leader of the occupied country, believed nations’ fates often rested with their tax systems. In 1949, he assembled a team of America’s top tax economists led by Columbia University’s Carl Shoup to rewrite the island’s levies. MacArthur gave Shoup one instruction—don’t make Japan a “guinea pig.”
In a report devised mostly within the partially-destroyed Imperial Hotel, the economists introduced a tax on “value added"—only discussed in theory until that time.
It’s not clear that Michigan legislators knew of the Shoup Commission as they faced a $90 million deficit in June 1953 ($822 million in 2017 dollars). But amid a “bitter and prolonged” fight over a corporate income tax, business leaders proposed a business activities tax—a VAT, according to 1955 testimony from Michigan Department of Revenue Deputy Commissioner Clarence W. Lock.
It was adopted “with blitzkrieg celerity” before the whole Legislature had read it.
“It was not the result of any deliberate attempt on the part of Michigan to experiment or pioneer in a new field of state taxation,” Lock said.
However, Japanese small businesses argued the VAT imposed administrative burdens and consumers worried retailers would raise prices. Unions argued it promoted machines by taxing employment.
Japan delayed and ultimately repealed the tax without implementing it, making Michigan arguably the first place to try the VAT.
Originally given a two-year window, Michigan’s business receipts tax—ultimately called the Business Activities Tax—became a fixture that survived repeated Democratic cries for a corporate income tax and contributed to a $18 million surplus in 1955.
But as state expenditures grew, Midwestern states adopted personal income and corporate income taxes.
Michigan Gov. George Romney (R) signed a 1967 package imposing a 5.6 percent corporate income tax and abolished the world’s first value-added tax. Romney’s signing-day comments echoed the main criticisms of the VAT as a regressive tax on unprofitable business.
“The state’s tax program will be more just as far as low income families are concerned” and “more equitable for low-profit businesses,” he said at the time.
A year later, the result was an unprecedented number of tax filings.
“Every hallway was stacked to the gills with dishpans of individual and business returns,” Douglas Drake, one of several young graduates hired to handle the filings, told Bloomberg BNA. “And no one knew what was in each dishpan.”
It worked for the state, though. General Motors profit rose 20 percent in 1968. Revenue came in $13 million ahead of projections the next year, contributing to education and social service spending and a several-million-dollar surplus in 1969-70.
Then Egypt and Syria invaded Israel.
The U.S. supported Israel in the 1973 war, and in retaliation the Organization of Petroleum Exporting Countries started the Arab Oil Embargo. The country entered a recession, and the Michigan-based auto industry floundered.
National gross domestic product from auto manufacturing fell 24 percent. Michigan’s share of national GDP fell from 4.64 percent to 4.28 percent.
“When the economy goes badly, car companies really get hit,” James Hines, a University of Michigan economics and law professor, told Bloomberg BNA.
The economy was cyclical, leading to spending on services in one year and harsh cuts the next, Drake said.
Michigan corporate tax revenue fell by about $50 million in 1974, and GM’s profits, steady through the months of the embargo, fell by over $1.5 billion in 1975. State officials were desperate for a stable tax that could weather the boom-and-bust.
“Our highs were higher and our lows were lower,” Eric Lupher, president of the Citizens Research Council of Michigan, told Bloomberg BNA. “When the nation got the cold, Michigan had the flu.”
Robert K. Kleine, director of the Michigan Office of Revenue and Tax Analysis, and budget director Jerry Miller huddled in East Lansing to find a solution.
They went with an idea that Kleine had heard at a recent conference in Chicago, one Michigan already knew—the value-added tax. By this time, much of Europe and major South American countries had adopted a VAT regime.
“I thought it was more fair, more stable,” Kleine told Bloomberg BNA.
However, European value-added taxes didn’t replace corporate income taxes, Hines said. They replaced high turnover taxes that resembled a VAT.
The VAT had conquered the continent as part of the euro-zone reforms, where similar tax structures were conducive to a free trade zone, economist Randall Holcombe told Bloomberg BNA.
“The motivation for the adoption of a VAT in the EU—tax harmonization—does not apply to the US,” wrote Holcombe, who has written papers opposing U.S. adoption of the value-added tax for the Koch-backed Mercatus Center. “And the inefficient taxes the VAT replaced, like turnover taxes, are not a part of the U.S. tax structure.”
To the contrary, Michigan’s VAT would eventually draw lawsuits for allegedly impeding commerce with the 49 VAT-less states.
Miller and Kleine called it the Single Business Tax—later changed to the Small Business Tax— replacing eight taxes with a single value-added tax of 2.35 percent. Thanks to an accounting trick that allowed them to collect the SBT and some of the taxes it repealed in the same year, the state projected it would bring in a budget-balancing $180 million in year one.
Economists consider VATs, like the SBT, to be the least distortionary form of taxation because they have a minimal effect on business decisions. The Michigan tax included pro-business provisions, including full write-offs of capital investments to encourage expansion into and within the state.
But it would tax businesses whether they made a profit or not. And it didn’t allow deductions for employee compensation, which coupled with the capital write-offs, opened the door to criticism that it suppressed employment.
Michigan capped the tax at 1 percent of gross receipts to solve this, but former state treasurer Douglas Roberts said he could never communicate that to complaining firms. The tax was also unique in the U.S., and businesses feared administrative costs.
“We were getting complaints from small businesses who had no idea what this thing was,” Drake said.
It also taxed passthrough entities—businesses where profits are “passed through” directly to owners who pay personal income tax. These are often small businesses, and the initial SBT proposal amounted to double taxation on the owners.
In a country where small businesses are among the most valued political currency, Kleine said the proposal was almost dead on arrival.
Ford and General Motors vocally supported it—they were highly profitable most years and the stable SBT allowed them to budget taxes as a consistent expense like any other, Drake said.
Chrysler, then the 11th largest corporation in the U.S., led the fight for small businesses. Struggling to adapt to a globalizing economy, they were $53 million in the red in 1975.
“Their lobbyist told the House Taxation Committee, ‘this newfangled thing might be okay for a big corporation like GM or Ford, but Chrysler is just a small business,’” Drake said. “What he didn’t want to say was, ‘we’re losing money hand over fist here, we don’t have to pay any taxes’” now.
Michigan Speaker of the House Bobby Crim (D) coordinated a panel of four businessmen to work with small businesses. Drake toured chambers of commerce to rally support.
After one meeting in Saginaw punctuated by a couple of yelling businessmen, Drake said a jewelry store owner and a furniture store owner waited as everyone left. Both stores, with their high-priced merchandise, stood to benefit from the fact that the SBT, like most value-added taxes, didn’t tax inventory.
They told Drake, “We really like this idea, but we can’t say anything in front of our friends.”
This was a recurring problem for 32 years, Drake said.
Eventually, the sides struck a deal. The first $34,000 in revenue would be exempt, and other businesses like rental housing and food sales got phase-in periods.
Years later, the tax’s architects would look back on these deals as the first thread in its ultimate unraveling.
“It got very complicated,” Kleine said, “which I think was always one of the arguments people made against the tax. Kind of ironic because business wanted all these things.”
For 30 years, Michigan maintained steady revenue and avoided huge cuts to services, even as much of its manufacturing economy turned on itself and some manufacturers ultimately left. Corporate tax collections over this time were almost entirely independent of the business cycle, according to Hines’ calculations.
But that didn’t make it popular.
Thirty percent to 40 percent of Michigan’s small business community supported the SBT when it passed, Drake estimates. That never grew.
Heideman chalks up the tax’s sustained unpopularity to an accounting mistake.
There are several ways to calculate a value-added tax. Most of Europe uses the subtractive method, taxing a good on each step that “value is added.”
Michigan used the additive method. The difference is rather than the tax appearing as a line item on an invoice, businesses added their relevant costs—their value added—and then were taxed at 2.35 percent on that.
Economic theory dictates costs will be passed to the consumer either way. The idea was transparency, Heideman said. They wanted businesses to see what they were paying and why, but Heideman said that was their biggest mistake.
It felt like an income tax rather than a sales tax, Heideman said, and psychologically that mattered.
“I think had Michigan administered its VAT using the invoice credit method, it would still be in effect,” Heideman said.
There were other problems. Proponents said the SBT would spur investment in Michigan, but VATs are rarely imposed in only one section of a country.
To avoid companies using Michigan’s full-expensing to subsidize investments in neighboring states, the Legislature enacted a different apportionment formula for business than for personal property. Caterpillar subsequently sued Michigan for impeding interstate commerce. The state Supreme Court narrowly overturned a ruling favoring Caterpillar.
Nevertheless, several states inquired, including New Hampshire, Texas, and Washington. The latter two ultimately rejected the idea.
“The word that came back was Boeing didn’t like it, so there went that,” Heideman said.
New Hampshire adopted what they called a VAT—but one levied at only 0.25 percent, on top of its regular corporate income tax and without full expensing.
Shaviro offered a second reason—the thing Michigan was sued over. “They’re worried about how to handle the cross-border stuff,” he said.
The first domino in the SBT’s fall was unrelated to taxation, its creators said. Michigan passed a constitutional amendment setting term limits on lawmakers in 1993.
Ironically, the term limits law was written by Patrick Anderson, the same economist who would pen the SBT’s repeal.
Gone were the lawmakers who built the SBT, Drake said, replaced by new legislators who heard nothing but negatives about the tax from their local chambers of commerce.
The tax slugged along until 1999, when amid the dot-com bubble Michigan passed a 22-year phaseout of the law. It would fall 0.1 percent each year until extinction.
By then the tax was a Frankenstein of its former self, Anderson said. Deductions and exemptions slowly ate their way through the SBT. There were five different formulas for businesses to calculate their liability.
Most frustrating to Anderson was a loophole that theoretically allowed businesses to fire all employees, reincorporate in Indiana, rehire everyone, and eliminate SBT liability. Enough companies took advantage of the exemptions, and Anderson’s 10- to 20-person boutique consulting firm was in the top 50 percent of SBT taxpayers.
When the bubble burst in the early 2000s, the Legislature repealed the slow repeal.
With the government recommitted to the law, Brooks L. Patterson started a petition drive, seeing the tax as anti-business and amended beyond redemption. Patterson was the Republican county executive of thriving Oakland County who once proposed turning Detroit into an “Indian reservation.”
“You keep amending things, a sleek race horse turns into a humpback camel,” Patterson told Bloomberg BNA.
Within a year and a half, he had 291,741 signatures. Under Michigan law, the Legislature had to pass it or put it on the ballot. They chose the former. The SBT was repealed, but the petition didn’t include a replacement and a state already in fiscal strife was missing a key tax.
With six months to replace $2.1 billion and avoid a shutdown, the Legislature tasked a panel of bipartisan lawmakers led by Kleine to find a solution.
Republicans wanted to tax individuals. Democrats said that was too regressive. Some ultra-conservatives said they shouldn’t replace it at all. The governor needed the revenue, but the simplest way to do that—a 15 percent corporate tax rate—would be higher than any in the country.
Kleine, who was treasurer at the time, said that eventually many concluded the SBT was better than anything they could devise. But the politics were untenable.
“They said headlines would be ‘state replaces the single business tax with the single business tax,’” Kleine said.
The committee ended up with a tax more convoluted than the final version of the SBT: 0.8 percent on gross receipts and a 4.95 percent profits tax. When the early volleys of the Great Recession came in 2007, the Legislature added a 21.99 percent surcharge.
Eventually Michigan would join most of the country with a corporate income tax. Hines said the recession would have put unprecedented pressure on the SBT and between business and state finance.
“You were having companies getting killed in ’09, they were going out of business right, left, and center,” Hines said. Under the SBT, “they still would have had tax obligations, so it would have been an extreme version of what they confronted before.”
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