Impact on Michigan Seniors from the Governor’s Tax Reform Proposal

The proposal to tax pensions in Michigan embedded in Governor Snyder’s February 17 Tax and Budget Proposal is getting much attention. I will attempt to shed some light on the subject, in the midst of much heat being emitted from affected folks.

1. Let’s start with the pertinent changes being proposed:

“Gov. Rick Snyder’s $1.8 billion plan to eliminate the Michigan Business Tax and replace it with a new tax on corporation profits would be financed through an equal level of change in Michigan’s income tax code.

Rate: Currently 4.35 percent under present law, scheduled to drop to 3.9 percent by 2015. Proposal would lower it to 4.25 percent and freeze it.

Retirement exemptions: Current law exempts all Social Security, public pension payments, IRA, annuity and employer-contributed 401(k) withdrawals from income tax. Private pensions up to $45,120 for single filers and $90,240 for joint filers are also exempt. Under proposed law, all retirement income, except for Social Security, would be taxed at a 4.25-percent rate. Eliminates exemption, $20,115 for joint filers, for dividend, interest and capital gains income receive by seniors.

Homestead Property Tax Credit: Current law provides refundable credit on property tax bills that exceed 3.5 percent of household income, up to a maximum of $1,200. Non-seniors get a 60-percent credit; seniors, 100 percent. Credit is fully phased out when household income exceeds $82,650. Proposed law would provide an 80-percent credit to all filers, keep the maximum at $1,200 and lowers the income threshold to $70,000.

Michigan Earned Income Tax Credit: Three-year-old law provides an average of $432 annually to some 800,000 low-income wage earners. It equals 20 percent of the federal EITC. Proposed law would eliminate it.

Exemptions: The $2,300 senior exemption, the $600 dependent children exemption and the $3,700 personal exemption for single filers over $75,000 and joint-filers over $150,000 would be eliminated.

Credits: Tax breaks for city income tax payments and donations to universities, public broadcasting, food banks, community foundations, libraries, museums and historic preservation projects would be eliminated.

Source: House Fiscal Agency” As reported in “Snyder tax plan would be costly for thousands of Michigan residents, including many seniors”, by Peter Luke, accessed at http://annarbor.com/news/snyder-tax-plan-would-be-costly-for-thousands-of-michigan-residents-including-many-seniors/

2. Next, let’s clear up a misconception of any “threshold” exemption:

The Governor’s Office has said that, in general, a retired married couple would need to have over $40,000 before their income would be taxed. The statement regarding the $40,000 has created some misunderstanding, as there is no threshold proposed for exemption, but rather the generality is based upon analyses done by tax experts in the Michigan Department of Treasury, whose conclusions are published in, “How Snyder’s income tax plan impacts YOU”, by John Bebow, February 24, 2011, accessed at http://www.thecenterformichigan.net/how-snyders-income-tax-plan-impacts-you/

Bebow concluded, “Under five different Treasury Department scenarios above, retirees with total pension and other income of $42,000 or less would pay no state income tax under Snyder’s tax plan.

Snyder’s tax plan may be many things, but according to the Treasury Department analysis it is NOT a tax on destitute grandmothers or other retirees with low fixed incomes.”

Nonetheless, the calculations were based on 16 different scenarios, with differing sources of income, with taxpayers owning homes of average value at average millage rates, etc. which might vary significantly from some actual, non-hypothetical taxpayer. In other words, there will likely be some seniors with total income less than $40,000 that may still incur a state income tax liability. The possibility of an online calculator into which you could input your specific information to see how the proposal would affect you is being worked on. Stay tuned!

3. Next, let’s compare the treatment of retirement income in Michigan versus other states:

In a recent news release published in several news media, I made an incorrect statement: “Michigan is the only state with an income tax that does not tax pension income.” I apologize for that inaccuracy.

This week in our House Tax Policy Committee, the House Fiscal Agency presented us with the following information:

· There are five broad types of pension and retirement income: (1) Social Security, (2) private, (3) state and local, (4) federal, and (5) military.

· Eight states (California, Minnesota, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, and Vermont) fully tax all forms of pension income.

· Four states (Mississippi, New Hampshire, Pennsylvania, and Tennessee) explicitly exempt all retirement and pension income.

· Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not impose an income tax and therefore implicitly exempt pension and retirement income.

· The remaining 31 states exempt some pension income either by providing credits or exempting specific portions.

If Governor Snyder’s tax proposal would be adopted, Michigan would be in this latter group by exempting only Social Security.

4. Arguments for the proposed changes:

a. It is fundamentally unfair to tax the income of wage-earners, but not the retirement income of seniors who rely on many of the same state services as everyone else. Is there a good justification (other than raw political power) for taxing the income differently in the following scenarios?

i. A struggling, 30 year old single mother of 3

ii. An elderly couple with no pension income who must continue to work to earn enough money to survive

iii. A retired couple who draw pension income.

iv. A business owner/job creator whose income is derived from his/her personal labor in his/her business.

b. Michigan’s population is aging. In 2000, 12.3% of the state’s people were over 65. In 2010, that had grown to 12.8%, with projections for 16% in 2020 and 19.5% in 2030. This will have serious implications for state budgets due to its impact on health-care spending (especially Medicaid), pension spending and tax revenues. On the revenue side, the loss of revenue from the current exemptions for the five types of retirement income would grow and grow, making balancing the state budget a problem year after year. The elimination of four of those exemptions in the Governor’s proposal would reduce the multi-year budget problem.

c. Our number one goal in Lansing needs to be getting our economy going again, to create jobs and put people back to work. Eliminating the Michigan Business Tax is one (but only one) of the things we must do to make Michigan competitive amongst the states and to encourage our existing businesses. Given that decision, then we are left with revenue hole to fill. The 6% corporate income tax fills some of the hole, but leaves about a $1.5 billion shortage, on top of the existing projected $1.4 - 1.8 billion shortage projected for the next fiscal year.
Many programs are cut in the Governor’s Budget Proposal. State employee compensation is also targeted for reductions. Total budget “cuts” total about $1.7 billion, many in very worthy and popular areas, such as K-12 and higher education and statutory revenue sharing to local governments. Without general tax increases to fill the remaining shortfall (or even more excruciating budget cuts), the remaining option is the elimination of “tax expenditures”.

i. With the elimination of the MBT, the business tax expenditures are also eliminated.

ii. The tax expenditures in the property tax area mostly affect local revenues, so eliminating them would not help fill the state’s shortfall.

iii. Increases in consumption taxes (to eliminate the tax expenditures of the exemption of food, prescription drugs and services from the sales tax) are not favored.

iv. That leaves the tax expenditures in the state income tax area, and the ones selected by the Governor are the most logical ones, even if not the most politically popular ones to eliminate.
The result is a net reduction in taxes to be collected of about $250 million in the next fiscal year.

5. Arguments against the proposed changes:

a. The tax exempt status of retirement income was “promised”. Many people have made retirement decisions based on their expected retirement income being tax exempt. Now that expectation would be shattered.

b. Union members say that they took lower wages so that they could get the higher retirement benefits (which they calculated would be state income tax free) in their negotiated settlements over the years.

c. Seniors are a powerful voting block feared by many politicians.

6. Conclusion

Governor Snyder in his proposal obviously chose to propose the changes, as they more closely fit his goals to make the tax structure “simple, fair and efficient” and to change it in a way that would not continue to push the tax/budget structural imbalance to future years. He knows that any tax reform means that even to raise the same amount of revenue would mean that some people would pay less while others would pay more. He knew that those who would pay more would object. He has chosen to propose what he believes is best for the state, rather than what would be the most popular, this is, kicking the can down the road to future years, future law makers and future generations as has been done in years past.

The tax and budget discussion will continue for several months, during which the various tax and appropriation committees of each house will thoroughly review the proposals, consider alternatives and ultimate pass tax and budget bills to present to the Governor – hopefully before the end of May. Any addition or subtraction from the Governor’s proposal must be weighed against an accompanying addition or subtraction in another area – each change cannot be judged in isolation.

I am not taking hard positions for or against any of his proposals at this time, but will participate with my fellow legislators in making the most objective decisions I can after thorough review – keeping the big picture in mind.

For an in-depth, objective look at the state of the state’s economy and our state’s budget issues, please view the four video tapes at http://repolson.com .

Ways to Help Local Governments Control Their Costs

Governor Rick Snyder’s Budget Proposal contained many reductions to local governments (including school districts). Many local governments will have a very difficult time achieving cost reductions under current laws. Assumed reductions in compensation costs of state employees will also be problematic under current laws. We, as legislators, have a responsibility of giving the state and the local governments the tools to deal with the financial stress.

In a perfect world, the state and local governments could reach agreements with their employees for the reductions in compensation costs necessary. But from the immediate reactions of the public sector employee unions (see A letter to EMU faculty on the growing threats to collective bargaining http://markmaynard.com/?p=12359&cpage=1 and Michiganders, will you March Tuesday against Gov. Snyder? http://www.dailykos.com/story/2011/02/19/947288/-Michiganders,-will-you-March-Tuesday-against-Gov-Snyder) we know we don’t live in a perfect world. They are calling for massive protests, similar to those occurring in Wisconsin.

Now, I don’t blame the unions for their stances. After all, that is their role – to push for whatever they can get for their members, regardless of the damage to anyone else or to the general public interest. But, it is the role of us legislators to consider and pass legislation to further that general public interest.

Public Union Reform Is Where the Money Is http://www.michigancapitolconfidential.com/article.aspx?ID=14586 by the Mackinac Center analyzes the situation keenly. One way to reach the state employees’ compensation is to eliminate the Civil Service Commission’s role in setting state employees’ compensation. But, that requires a Michigan Constitution amendment, which if approved by 2/3 of both houses of the legislature and approved by the voters in November, could not take effect until sometime during the 2012 fiscal year, rather than be in effect for the entire fiscal year.

Another approach would be to negotiate in good faith until it is clear that no agreement can be reached, then impose a contract upon the unions as provided for in Michigan law (which procedure I outlined in my paper Taking Back the Ship – A Strategic Approach to Better Bargaining http://k12schoolfinance.net/Negotiations%20Strategy.doc that I presented at the 2006 Michigan School Business Officials Annual Meeting). Unfortunately, this process takes about 18 months if all of the hoops are jumped through, and that again would push the resolution well past October 1, 2011, the beginning of the 2012 fiscal year.

The Mackinac Center suggests the way out of this dilemma is to repeal PERA (the Public Employee Relations Act). While the National Labor Relations Act gives the private unions the right to collectively bargain, the public sector employee unions do not have that right, unless authorized by state legislation such as PERA. The repeal of other states’ enabling acts are currently being considered – in Wisconsin and Ohio, and perhaps also in Indiana. The proposed repealing legislation is being strenuously resisted by the unions, as expected.

Local governments would be able to achieve the cost savings they need to remain solvent in the absence of PERA. The compensation cost reductions assumed by the Governor in his budget proposal could be obtained if the state did not need to collectively bargain.

I am not proposing (nor would I support) that the entire budget balancing be done “on the backs of the public employees” (dang, I hate that mantra), but even a reasonable amount will not be voluntarily achieved without the repeal of PERA. We might as well face that fact. And, we might as well face the fact that any legislator who votes for even reasonable reductions in public sector employee compensation will not garner the support of those unions in the 2012 elections. We might as well deal with the underlying problem once and for all, and truly reinvent Michigan.

Without reasonable reductions in public sector employee compensation, as I laid out in the Economic Presentation accessed online at http://repolson.com, even more of the remaining three options would need to be done:

• Cutting programs,

• Reducing or eliminating “Tax Expenditures” (primarily involving those applied to income taxes – credits, exemptions, and deductions – remember, those in the MBT will be gone with the repeal of the MBT), and

• Increasing taxes

Public sector employees must do their share of balancing the budget – not because we don’t like the police officers, fire fighters, teachers and other public employees, because we do like them – but because we can no longer afford what they demand.

Governor Snyder’s Tax and Budget Proposals Create “Winners and Losers” – Resulting Tax Structure Does Not

Governor Snyder’s budget message yesterday was awaited with great anticipation, and in some cases, trepidation. Everyone familiar with the state of the state’s economy and the state and local governments’ fiscal condition knew the choices would not be easy, and that any proposal would gore many oxen. The Governor’s message yesterday did not disappoint in that regard, as many “real people” (as the Governor likes to refer to them/us) will bear the “shared sacrifice” he promised - to the extent his proposals are adopted by the legislature.

The Governor’s task was to simultaneously achieve three goals: (1) create a better climate to encourage job growth to cure our basic economic problem of high unemployment, (2) achieve a balanced budget as required by the state’s constitution and (3) put in place a revised tax and budget structure that would solve the long term “structural” budget problem, in contrast to the year-by-year band-aid budgeting approach of years past.

The first goal required a revised tax structure, leading to his proposal to dump the Michigan Business Tax and its hated 22% surcharge and recommend a replacement 6% corporate income tax which he deems “simple, fair and efficient. Numerous “tax expenditures” (tax credits, exemptions, preferences in business and income taxes) would be reduced or eliminated. Any tax reform naturally results in some people or entities paying lower taxes while others may pay more taxes.

The result is a projected net reduction in tax collections of about a quarter billion dollars – meeting the “no net tax increase” criteria for even those candidates who signed a “Taxpayer Protection Pledge”. Another result is a tax structure that does not favor one industry or business over another, and together with the proposed revisions to the Michigan Economic Development Corporations, does not pick winners and losers in the marketplace.

On the budget side, Governor Snyder has proposed a combination of wage and benefit reductions for public employees and program reductions. Here too, real people are affected.

Public clamor against some of the elements of the Governor’s proposal was expected and instantaneous. The elimination of the exemption of retiree’s pension income from the personal income tax is drawing fire. The Governor’s reasoning he shared was as follows. Why should the following income earned by neighbors living side by side be taxed differently?

• A business owner/job creator organized as a sole proprietor, partnership, or limited liability company whose income for federal income tax purposes is not taxed at the business level but flows through to the individual’s tax return, while under the current state tax structure is taxed at both the business level through the MBT AND at the individual level on the individual income tax return.

• An elderly couple with no pension income who must continue to work to earn enough money to survive.

• A retired couple who draw pension income.

The Governor has concluded that income is income and people should not be taxed differently based on the differences in the source of that income. (Exceptions he retained are Social Security payments and the pay of active duty military servicemen and women.)

Regardless of the reasoning, real people will be affected by his proposals. Local governments would be affected by the proposed reductions in statutory revenue sharing. School districts will be affected by the reductions in the student foundation grants that the districts rely on.

All of these proposals will be rigorously scrutinized in the months ahead by the various legislative tax policy and appropriations committees and the legislature as a whole. I expect a respectful consideration of the Governor’s proposals, but no rubber stamp by the legislature. Each element of the proposal will be considered in light of the big picture – how the pieces all fit together to achieve the three goals that the legislature shares with the Governor.

Whether we agree 100% with the Governor or not, we must all applaud the Governor for his comprehensive, courageous proposals which address our long-term problems head-on, and which do not simply “kick the can down the road” to the future. Based on his business background and campaign promises, we expected no less, and he has delivered. Now it is our turn as legislators to do what we promised in our campaigns.

Emergency Financial Managers' Powers to Be Clarified and Strengthened

About 40 Michigan Cities are close to bankruptcy. Hamtramck is just one example. About 40 Michigan public school districts have negative fund balances, requiring them to file two year deficit elimination plans. Detroit is only one of many, with an emergency financial manager (Robert Bobb) running the district’s finances. With declining property values causing local property tax collections to decline and the loss of revenue sharing from the state, many fear the worst is yet to come.

PA 72 (i.e., the current Local Government Fiscal Responsibility Act) currently provides for the declaration of a financial emergency and the appointment of an emergency financial manager (“EFM”). Unfortunately, there are flaws in the process that delay state intervention and make it hard for the EFM to do his or her job well:

• The current system limits the steps the state and local governments can take before reaching emergency status, which overlooks several relatively painless options along the way. Appointing an EM could take months, and by then much more damage could be done.
• If an EFM is appointed, options are restrained by his or her limited authority. The manager cannot negate certain agreements, including minimum staffing requirements and union contracts. If those deals are keeping a city or school from solvency, they have no choice but to pursue bankruptcy, which has negative implications on credit ratings for the city and the state.
• It is clear that EFMs have authority over finances, but the statute is unclear on whether they have the authority to make changes to the way an organization operates. Often, many of the things an EFM could do to save a school district money, like consolidating buildings or restructuring academic schedules, are blocked by the governing school boards because they may affect academics. Local government officials sometimes have incentives to block sweeping but necessary changes and insist on retaining control. The current example is Detroit Public Schools, with several lawsuits between the EFM and the school board concerning control over many actions.
• The existing law allows for EMs to be appointed, but does not provide details on an exit strategy. This ambiguity puts the local government at further risk of recurrence when the manager returns control.

The Proposals: The package of bills we expect to be introduced this week:

• Allows local governments to work with the Department of Treasury (or the Superintendent of Public Instruction in the case of school districts) to proactively address financial issues earlier and hopefully avoid the EFM process entirely. The bills will emphasize early detection and give local authorities a roadmap to finding their own success without resorting to more extreme steps, including receivership with an EFM, or worse yet, bankruptcy. Local control will be retained, to the extent that that local control is exercised responsibly.

Incentives for local government officials to take the prospect of the state placing the local government into receivership and an EFM being appointed include:

o The salary, benefits and other compensation of the governing board and chief administrative officer are suspended.
o Any elected officer or member in office at the time of receivership is declared will be prohibited from running for public office in that local government for a period of ten years.
• If it becomes clear to the state treasurer, state superintendent or governor that a local government or school district cannot act to correct their financial situation, then the state will place the local government into receivership and a trained EFM will be appointed.
• The EFM will be given the freedom to innovate and create the best solution possible. One power that will face opposition will be the power to break labor contracts. The most crippling costs faced by local governments and school districts are their unmanageable labor and legacy costs, which often are 85% of the total expenditures of the municipality. We must give the EFM the authority to get those costs under control if there is any hope of turning the local governments and school districts around. We must do the right thing, even if it is difficult. The taxpayers must be protected.
• The 2 year budget and collective bargaining agreements made by the EFM cannot be undone by the local officials for a year after control is returned to the local governing board.
• Only as a last resort will bankruptcy be an option.

The changes proposed are greatly needed.