Anderson Economic Group, assisted the Michigan Retailers Association in advising the legislature and governor on this issue, resulting in the enactment of three new laws. The laws, which took effect January 1999, will save Michigan retailers and consumers over $6 million per year, according to the Anderson analysis.
Since 1993, Michigan law has required large retailers to “pre-fund” their sales tax collections, by submitting an estimate of each month’s collections in the middle of the month. Previously, retailers collected tax throughout the month, and submitted the tax collections early in the following month. The impetus for the change was to assist the State government in their cash-flow management needs.
Since that time, employers, legislators, and economists have questioned the wisdom of this approach. Does requiring retailers to, in effect, loan money to the state encourage business expansion, or discourage it? Do the benefits to the state–reduced borrowing costs–exceed the costs to the retailers and their customers, investors, and employees?
Anderson Economic Group was commissioned by the Michigan Retailers Association to independently evaluate the costs and benefits of the pre-funding law, when compared with the traditional approach of collecting taxes after the month in which sales have occurred. In conducting the study, AEG reviewed financial statements for the State Government, met with state officials, interviewed key officers of affected businesses, and surveyed affected retailers. AEG prepared a detailed cost-benefit model, weighing the costs and benefits of sales tax pre-funding on both the business and government side.
The study was conducted by Patrick L. Anderson, president of AEG and a former deputy state budget director and chief of staff for the Michigan Department of State. Kelly Beeman, Research Director for AEG, assisted in developing the report.
Pre-funding does not directly provide the state any greater revenue. Pre-funding affects the timing of the payments, and increases administrative costs for both the government and the retailers. Under the Generally Accepted Accounting Principles followed by the State during recent years, and by express provision of the Sales Tax Act, simply changing the timing of payments will not affect the revenue earned by the state during a given fiscal year.
Pre-funding does indeed save the state borrowing costs. Department of Treasury data confirm 1996 pre-funded sales tax revenue of over $1.56 billion. In 1997, based on recent interest rates and revenue growth, the interest on the advanced sales tax payments will be worth approximately $5.7 million to the State in reduced borrowing costs.
At the same time, pre-funding costs the state’s employers a considerably larger amount in higher interest payments. The accelerated payments, which constitute approximately twelve short-term loans to the State, will cost businesses approximately $11.9 million in additional borrowing and capital costs.
Both the state and the private sector incur significant administrative costs as a result of the pre-funding requirement. Pre-funding requires two additional steps each month for the retailer: an estimate of the current month’s sales collections, and a reconciliation with the previous month’s overpayment or underpayment. The pre-funding also requires additional auditing at the state level, as well as intervention in the cases of overpayment or changing business conditions. The costs of the additional administrative work were estimated at approximately $850,000, most of which is incurred by businesses. This represents a “dead weight loss” to the citizens of the state.
The state’s short-term borrowing costs are significantly lower than the retailers’ cost of funds: 9.5% to 4.5%. This is due to three factors: tax-exempt borrowing of the state government, the requirement that private businesses maintain equity investments to partially cover their liabilities, and the state’s power to tax, which reduces the risk of default on its debt and hence the interest rate demanded by lenders.
Although this study did not review the legal or normative standing of pre-funding, many business executives expressed indignation at being forced to send money that they had not yet received to Lansing. The constitutional basis for pre-funding was also questioned, as Article IX section 8 authorizes a sales tax on retailers of “gross taxable sales,” which does not appear to include future sales.
The State has made policy decisions to pre-fund other obligations, notably payments to educational institutions. Such decisions, which represent an interest subsidy to those enterprises, are not costless to taxpayers, and force the Treasury to increase their intra-year borrowings. The pre-funding requirement for large retailers helps finance these interest subsidies, but at a considerable cost.
The total annual costs to business of the pre-funding requirement, including both costs of funds and additional administrative costs, exceed $12.6 million. This amount is more than double the net benefits to the State of $5.5 million. In effect, retailers in the state–and through them consumers, workers, and investors–pay $2.28 to save the State $1.00.
Executive Summary Table One details the cost-benefit analysis.
The net benefits of the pre-funding flow indirectly to the taxpayers, through lower costs of state government. The net costs are borne by consumers in the state, who pay higher prices at stores; workers in those stores, who receive lower earnings; and investors, whose retirement and other savings make lower earnings. The vast majority of these consumers and workers, and a large share of the investors, are also taxpayers in this State. Thus, the pre-funding requirement forces costs on mostly the same group that it benefits, although the costs are over double the benefits.
The pre-funding requirement fails the cost-benefit test by a 2-to-1 ratio. It is clear that it inflicts economic harm on the state, as the implicit savings to the state’s taxpayers (through reduced borrowing costs, and presumably a lower tax burden) are far outweighed by the higher costs borne by the retailers. These higher costs must be passed on to citizens in the form of higher prices, lower returns for investors, and reduced employee earnings. While some of those costs are spread beyond the state’s borders, it makes little sense for state law to require local businesses to pay $2 to save the state $1.
The state can achieve the goal of improved cash-flow management through a number of methods that would cost far less than requiring retailers to pre-fund the sales tax. These options include: adjusting payment schedules for recipients of state funds to eliminate the implicit subsidy to those recipients; using the state’s borrowing power to assist other units of government with their cash-flow needs. A final option is to simply return to the pre-1993 law, and eliminate the additional burden on retailers, their customers, investors, and employees.