Opinion | Tax cuts? Fine, but know that Michigan is already a low-tax state

(This is an abridged version of an article published by the Citizens Research Council of Michigan.)

The Michigan Senate and House have both reserved significant funding for tax relief in their budget plans, and it seems like tax cuts in some form will be part of the final FY2023 budget agreement.

However, Michigan is already a low-state. State tax burden has fallen significantly after a decade-long revenue slump that began in FY2000. Further, a recent analysis ranks Michigan 46th in combined state and local tax burden, according to a recent report from the Tax Foundation, a non-profit think tank

Policymakers should carefully weigh the budget tradeoffs that will be needed in implementing tax cuts, and ensure that there is a clear understanding of any budget reductions that will be necessitated by related revenue losses.

Michigan’s tax burden has fallen rather sharply since the beginning of this century. In 1994, Michigan voters approved Proposal A, which increased the rates of the state sales and use taxes from 4 percent to 6 percent and triggered other tax changes as part of broad reforms to K-12 school financing. As a result, the state tax burden shot up significantly in the mid-1990s. Since 2000, however, the state tax burden has been falling. For FY2021, state tax revenue collections equated 6.4 percent of personal income, just below the rate in FY1991 prior to Proposal A.

Like the rest of the country, Michigan is facing economic challenges related to lingering employment declines arising from the COVID-19 pandemic; the impacts of abnormally high inflation on family budgets, and economic uncertainties internationally with the war in Ukraine. Many see tax relief as a timely way to stimulate the economy and put money back into the pockets of Michigan residents.

However, on the whole, state tax cuts don’t generate any net boost to the state’s economy.  That’s because Michigan’s constitution mandates that the state enact a balanced budget that brings spending in line with available revenue.  To be sure, tax cuts increase disposable income for affected households, and at least some of that added disposable income gets spent.  That spending creates new income for others (such as workers at the local grocery store or restaurant), and the economic ripple effect of a tax cut does indeed generate new economic activity from taxpayers.

However, without any tax cut, that same revenue would still get spent. Only in this scenario, it gets spent on public services financed by the state. This spending includes payments to health care providers for Medicaid-funded services; grants to K-12 school districts, universities, and community colleges for educational activities; revenue sharing to local governments; and of course paychecks to state employees. This public sector spending brings the same economic ripple effect as the tax cuts. In short, a $1 million tax cut adds $1 million in disposable income for taxpayers but at the same time eliminates $1 million in income for persons who would otherwise have been delivering public services, whether they be state employees, school/university employees, or state contractors.  

When the Michigan Legislature approved a plan in March that would have cut state income tax revenue by $2.5 billion annually, Gov. Gretchen Whitmer vetoed the bill calling it “fiscally irresponsible.”  Our March analysis of the legislative plan illustrated her concerns. It showed that one-time revenue surpluses were sufficient to cover the resulting revenue loss in FY2023, but that the plan would require a permanent $1.3 billion cut to the state’s General Fund budget starting in FY2024. That equates to roughly 10 percent of all current General Fund spending.

As tax relief discussions are revived, budget writers – and the general public – should have a clear view of how any resulting budget shortfalls will be addressed before decisions are finalized on an amount. To be clear, state taxes should be no higher than they need to be. Our tax system should generate sufficient revenue to provide necessary public services in an efficient and effective manner. If the state is providing services that aren’t necessary, then those services can properly be eliminated allowing revenue savings to be returned to taxpayers. The challenge is that what constitutes a “necessary public service” is inherently shaped by one’s ideological and political views.

It seems highly likely that tax relief in some form will be a significant component of the final budget agreement that should be reached sometime before the July 4 holiday. Optimally, the agreement on tax relief will recognize Michigan’s recent revenue history and be transparent about budget tradeoffs that are required.