Business Ethos Blog

Are They Serious? Eliminate the Michigan Income Tax?

Dr. David Mielke, Retired Dean of the College of Business at EMU

There are two proposals circulating in Lansing that would eliminate the Michigan state income tax, one over 40 years, the second in 5 years.  That would eliminate a $9 billion annual revenue stream for the state budget.  There is little discussion as to how the $9 billion would be replaced. Would there be an increase in sales taxes, or property taxes, could the budget be cut by that amount or will as some advocates claim, would the state’s economic growth due to lower rates, increase state revenues to offset the income tax loss?  These proposals come at the same time the state grapples with the report that we need to spend an extra $4 billion a year on state infrastructure.  Is there a disconnect from reality with the tax cut proposals?  Will the state economy grow fast enough to replace the lost revenue?  Should the legislature cut income taxes?  What is the “Right Thing to do?”  Let’s look at some issues:

  1. One plan to cut taxes would lower rates from 4.25% to 3.9% in January 2018 and then 0.1% a year for 40 years. With the median taxable income in Michigan at about $50,000, the income taxes would fall by $175 in 2018 and then $50 each year for 39 more years.  The second plan would scrap the income tax over 5 years, or about $1,000 a year based on the $50,000 taxable income.
  2. Both plans would erase $9 billion annual revenue, which is more than one-third of the total state tax revenue.  The 40 year plan would reduce revenue about $800 million the first year and about $200 million a year thereafter.  The second 5 year plan reduces tax revenue about $1.8 billion a year.  The 2014 state budget was about $55 billion which includes both state and federal funding.  Neither proposal identifies how the lost revenues would be made up.
  3. According to the Tax Foundation, Michigan ranked 25th among the 50 states in the share of income paid in fiscal 2012 toward all state and local taxes, with 9.4% of income paid in those taxes.  That was a lower percentage than surrounding Midwest, with Indiana residents paying 9.5%, Ohio 9.8%, Minnesota 10.8% and Wisconsin and Illinois at 11%.
  4. Seven states, Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming levy no state income tax with 4 of them having higher sales tax than Michigan.
  5. If the state raises the sales tax rate, there is a concern about tax fairness.  Michigan ranked 29th of the 50 states for tax fairness.  In part, because Michigan is one of 8 states, out of the 41 with state income taxes, that has a flat income tax rate.  The other 33 have a progressive formula in which the wealthy pay a higher percentage.
  6. In sales taxes alone, those in the bottom 20% of income, pay 6.3% of their income on sales tax, about 8 times higher than the 0.8% share paid by those in the top 1% income bracket ($392,000 or more).  If Michigan tried to make up the lost revenue by increasing the sales tax, the burden on low income earners would likely increase.  Currently, Michigan gets about 25% of its tax revenue from the 6% sales tax.  The sales tax would have to be raised to 12% to make up for lost income tax revenue.
  7. Any consideration of cutting spending to cover the shortfall would come at a time some are trying to fund an extra $4 billion a year for the next 20 years to upgrade the state’s infrastructure.  Michigan was ranked 50th in 2013 in per capita state and federal spending on highways.  A 2015 study found that the major cities in Michigan had among the worst roads in the nation.
  8. In higher education, Michigan is ranked 15th lowest in 2014-2015 in funding per student for public universities.  About one-third of the income tax revenue goes to fund K-12 public schools.  One study shows that Michigan communities have lost $6 billion since 2002 because of state cuts in revenue sharing.
  9. A central tenet to the tax cut idea is that lower taxes spurs economic growth and that the higher rate of growth will make up the income tax shortfall.  Academic studies have shown a link between taxes and growth, the higher the taxes, the lower the growth.
  10. A Michigan State economist cited federal analysis showing state and local taxes as a share of personal income have already steadily fallen in Michigan from more than 13% in 1972 to 9.6% in 2011, resulting in a net revenue loss of $10 billion inflation adjusted.  He contends that economic growth is more dependent on other factors, including skill and education levels of the workforce.  He claims the most affluent states are the ones with the most highly educated populations, not the lowest income tax rates.

How would Michigan overcome the loss of income tax revenues in it’s state budget?  Could sales taxes be increased? Can the budget be reduced to compensate for the shortfall in revenues?  Will economic growth accelerate enough to generate additional revenue to fill the hole in the budget?  Do we need to eliminate the state income tax?  Do either one of the two proposals to eliminate the state income tax make sense?  What is the “Right Thing to do?”  Cutting and eliminating the state income tax may sound good, but when it comes to implementation, neither proposal faces reality with a solution to the loss in revenues.  An increase in the sales tax will cause more loss of income to the lower wage earners, a more regressive tax system with Michigan already ranked 29th in tax fairness.  Where can the budget be cut when the state badly needs to find additional revenues for infrastructure and to fix the looming problem of all municipalities to pay the expanding costs of pensions and retirement health plans?  The state is heavily dependent on the auto industry and although the industry is doing well now, the next cyclical downturn could once again cause revenues to plunge.  In what industries would the state’s economy expand at an accelerated rate to generate additional revenues as a result of an income tax cut?  The proposal to eliminate the income tax over 40 years is ludicrous.  At an average taxable income of $50,000 who will notice a $50 a year reduction?  What are the chances that reductions over 40 years would actually stay in place?  Where is the solution to find $1.8 billion every year for 5 years in revenue or budget cuts to eliminate the income tax in 5 years?  Should the legislature seriously consider either of the 2 proposals to eliminate the state income tax?  No.  Unless and until someone proposes a sound solution to cover any shortfall in revenues and finds additional revenues for infrastructure and to at least maintain the current funding for education and municipalities, the legislature is wasting its time to even consider the 2 proposals, but then it gives our politicians something to do.