Michigan Republicans are taking swift action at the start of this year’s legislative session to gradually phase out Michigan’s income tax.
With populist overtones and promises to retain and attract more residents, lawmakers’ proposals would eliminate the state’s 4.25 percent tax on income that goes toward the General Fund and essential public services like roads and schools. The proposed processes could take as little as five years or as long as decades.
The expected Senate plan, led by state Sen. Jack Brandenburg, R-Harrison Township, would eliminate the income tax in five years. State Rep. Lee Chatfield, R-Levering, is sponsoring a more gradual approach that reduces the rate to 3.9 percent in 2018 and reduces it by .1 percent a year over the next 40 years.
Chatfield’s bill was introduced on the first day of the session this month, a symbolic gesture reflecting the new Legislature’s priorities. However, neither plan comes with definitive answers about how to make up for the roughly $9.4 billion a year in revenue the income tax generates. That will be the vital question and subject of much debate over the coming months, even as Michigan’s budget is projected to tighten.
Critics are skeptical that such plans would equitably restructure Michigan’s tax code, and say the proposals further jeopardize public services funding in the context of the Flint water crisis and cuts to higher education funding that have led to tuition increases, for example.
While the state’s leading business advocacy group says the plans are short on details at this point, they note the bills are an encouraging sign.
“For House and Senate members to, right out of the gate, put bills in to make Michigan more competitive in this area sends a great message,” said Tricia Kinley, the Michigan Chamber of Commerce’s senior director of tax and regulatory reform. “It’s a great message to send to taxpayers.”
She declined to further comment on “something of this magnitude” without knowing “all the pieces of the puzzle.”
Brandenburg tells MiBiz that his plan is to convene a working group to further study how other states make do without an income tax and how — or whether — Michigan could replace such a vital source of revenue. He said it was sparked by reports of Michigan’s relatively slow population growth compared to other states.
“I think Michigan needs a game-changer,” he said. “I do not think there’s anything more that gets people’s attention than when you leave money in their pocket rather than take it. That in itself will keep people here and help bring people here.”
His working group first met on Jan. 11 to start looking at the revenue question. He hopes to start taking committee testimony in five to six weeks.
“First and foremost, let’s have some good old-fashioned spending cuts and put a freeze on the budget so we don’t increase the budget like we have been doing,” he said. “I hate to say this, but maybe a sales tax increase, too. Put it this way: The consensus from the working group is that everything is on the table.”
Any increase in the sales tax would require a constitutional amendment, as the state is currently maxed out at its 6-percent cap. Brandenburg discounted the idea of raising the corporate income tax, which was lowered significantly under Gov. Rick Snyder, because “special interests would shoot that down.”
Chatfield believes his proposal gives the state an opportunity each year to review the revenue situation, and noted recent reports of budget surpluses.
Kinley said broadly “there’s always room to find efficiencies and improve how government operates.”
“Could the state weather a $9 billion reduction tomorrow? Probably not. But we’re really optimistic that legislators are trying to send the right message about making Michigan competitive,” Kinley said.
WHO WOULD BENEFIT?
According to Chatfield and Brandenburg, the debate goes back to the Granholm administration, when the income tax was increased to 4.35 percent with a sunset clause in 2015 to bring it back to 3.9 percent. In 2011, Snyder froze the current 4.25 percent rate in place. Chatfield says his plan “delivers on promises made in 2007” to bring the rate back down to 3.9 percent.
“Let me be very candid: If the governor had not frozen the rate in 2011, I don’t think we’d be having this conversation,” Brandenburg said. “But he did, and there just seems to be a negative feeling on the administration’s part — they don’t view it in a positive way of tax relief for working-class families.”
Snyder spokesperson Anna Heaton said in a statement to MiBiz that there would need to be “concrete data” showing there is adequate revenue besides the income tax to ensure infrastructure funding isn’t negatively affected.
“The governor is always open to new ideas on revising the tax code,” Heaton said. “At this time, with the clear need to invest more in Michigan’s infrastructure, it might not be the time to create that budget hole.”
In 2015, the Michigan League for Public Policy said that bringing the rate back down to 3.9 percent would “flow to Michigan’s wealthiest taxpayers,” and that nearly 25 percent of Michigan households wouldn’t receive a tax cut at all. The group also said that $3 of every $5 in tax cuts would go those who earn $89,000 a year or more.
HOW OTHER STATES DO IT
If approved, Michigan would become the eighth state without a statewide income tax, joining Florida, Nevada, Washington, South Dakota, Alaska, Wyoming and Texas. Two others — Tennessee and New Hampshire — tax interest and dividend income.
Jared Walczak, tax policy analyst with the Washington, D.C.-based Tax Foundation, said states without income taxes take a variety of approaches with their tax code. While states like South Dakota, Wyoming and Alaska raise significant revenue through taxes on oil and gas extraction, Florida does so through taxes on retirees and tourism spending, he said.
“Some states have made a determination that they can be more competitive by foregoing income taxes,” Walczak said. “It can be a competitive move by some states, and some states have succeeded greatly.”
He added that there is evidence of higher migration levels to states that forego an income tax, although people also consider quality of life, educational opportunities, an adequate workforce and what a state’s given industry make-up is when considering a move.
“Taxes are one of the considerations in determining locations,” Walczak said.
ATTRACTIVE OR REGRESSIVE?
Brandenburg maintains that not only will his plan provide tax relief for “working-class families,” but also it will attract new residents and visitors to the state, and thus, more tax revenue.
“If we do this, it attracts people back to the state, and I really think businesses would take a very positive look at that,” Brandenburg said. “If more businesses come back, people start working again, everyone stands to reason they’ll spend more and pay more in taxes.”
Michigan State University economist Charles Ballard is critical of that approach, saying Michigan already is underfunding critical infrastructure and public education needs. Any gains in population because of the change would likely be “modest,” he added.
“I think it’s a really bad idea,” Ballard said. “In my view, it’s really easy politically to reduce taxes — it’s much harder to replace the revenue that you lose. That’s just going down the road we’ve been going down in Michigan for 40 years with declines in the fraction of our economy we devote to state and local revenue, declines in the quality of our roads and a decrease in state support for higher education means skyrocketing tuition — not to mention children drinking poisonous water in Flint.”
Ballard is also chairman of the board for the Michigan League for Public Policy.
“What we’ve done with reducing tax revenues is that we have huge gaps in the social safety net and just basic public infrastructure. It would be really unfortunate if we were to do any further tax cuts,” he said.
Moreover, the state’s income tax includes exemptions for lower-income residents, which would likely be eliminated by depending more on a sales tax, Ballard said.
“If we replace (the income tax) with sales tax, we make our tax system significantly more regressive,” he said “For me, that’s a bad way to go.”
Brandenburg and Chatfield each said they “don’t buy” the argument that raising the sales tax to counter decreases in income tax revenue disproportionately affects low-income residents, an issue that also surfaced during the road-funding debate in 2015.
Walczak said regressivity can be a concern “depending on how the sales tax is structured. Sales taxes generally fall on most goods but very few services. Certain goods are staples of life when we think about food, clothing and basic purchases individuals make. Those consume a higher percentage of income by lower-income people, and the sales tax burden would be higher.”
States can avoid this with tax exemptions on certain categories, he added.
“It’s more an argument for having a more broad-based sales tax that includes services, as services by contrast are consumed by higher-income individuals,” Walczak said.
He also said lowering income taxes is a growing trend, pointing out that 18 states have reduced individual income tax rates since 2008.
“The move toward repeal is certainly on the agenda in a number of states, but that’s a much heavier lift that not a lot of states have made significant progress on in recent years,” Walczak said.
Brandenburg also appears to be making a calculated political move, though it’s likely to revive heated discussions over generating revenue versus making budget cuts.