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.
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 .