Michigan’s pension tax to likely vanish, but questions on broader tax cut

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LANSING—There appears to be bipartisan support in Lansing for repealing Michigan’s unpopular retirement tax. But some economists urge caution in enacting broader-based tax cuts, which they contend are not the solution to sustaining a stable state economy. 

Gov. Gretchen Whitmer proposed eliminating the state’s tax on pensions at Wednesday’s State of the State address. The tax went into effect 11 years ago under then-Gov. Rick Snyder as part of a broad tax reform package. Republicans in support of its repeal say they are looking forward to working with Gov. Whitmer on the retirement tax as well as cutting income taxes across the board. But some economists believe the eagerness to use state surplus revenue to fill the gaps left by such cuts is short-sighted. 

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Whitmer’s proposal would save half a million households receiving pensions an average of $1,000 a year by exempting public pensions and restoring deductions for private retirement income, including private-sector pensions, withdrawals from individual retirement accounts (IRAs), and the portion of a 401k account that is subject to an employer match.

Robert Leddy, a Whitmer spokesperson, said the governor wants to repeal the 4.25 percent tax on pensions because she believes people “should be able to retire and keep their hard-earned dollars.” Leddy said the governor will have more information on how the gap created by repealing the retirement tax will be filled when she introduces her budget recommendations in February.

“Due to smart fiscal management and federal funding, the state has billions of surplus dollars that can be used to provide financial relief to repeal this unfair tax on retirements and provide relief for Michiganders,” Leddy said.

Republican Sen. Tom Barrett introduced Senate Bill 24, which would repeal the retirement tax, because of its impact on his constituents who planned their retirement based upon the tax laws that were in effect before 2011. 

“Those tax laws changed after they had retired and it was a detriment to them,” Barrett said. “It’s hard to go back and replan your retirement after you've left your employment and to have that tax liability fall on them. When the rules changed halfway through the game, I felt it was unfair.”

Before 2011, Michigan was one of 14 states that did not tax retirees on their pensions. The state’s so-called pension tax was part of a major rewrite of Michigan’s state tax code in 2011 under Snyder. The rewrite also replaced the Michigan Business Tax with the Corporate Income Tax and reduced various credits. When Snyder took office, the revenue earned from a pension tax would fill a $930 million gap in the state’s budget, in part created by other enacted cuts.

The 2011 tax changes were based on when a retiree was born. The oldest retirees, those born before 1946, are unaffected. Retirees born between 1946 and 1952 can deduct the first $20,000 of retirement income for single taxpayers and $40,000 for married couples filing jointly prior to age 67; when they turn 67, they are able to claim those exemptions against all income, regardless of the source.

The youngest retirees, those born after 1952, cannot deduct any retirement income until they turn 67 when they can also claim more limited $20,000- and $40,000-income tax exemptions. 

Whitmer promised to repeal the pension tax during her 2018 campaign and had opposed it since her days as the Senate Minority Leader in 2011. Support for repealing the pension tax has gained steam from both parties, who believe it burdens seniors who were forced to shoulder more of the state’s income tax in 2011 to help pay for a more than $1 billion tax cut for businesses.

The amount of annual revenue earned from the retirement fund is uncertain because there is not a line item in the state budget for it. However, Whitmer and Barrett’s offices offered estimates between $350 million and $500 million. 

According to Barrett, the state has the bandwidth to fill the gap left by repealing the retirement tax because it is in a fortunate position due significant revenue increases. Michigan has generated $5.8 billion more revenue and received nearly $15 billion in federal aid for pandemic relief and infrastructure improvements, according to a report by Bridge. 

“We can more than cover the expense of the pension tax, and do the right thing by these seniors who made these decisions on when and how to retire based upon the laws that were in effect when they made that decision,” Barrett said. 

Retirees in Michigan were elated by Whitmer’s announcement, according to Melissa Seifert, AARP’s associate state director for Advocacy. Seifert said those who endorsed the retirement tax in 2011 tried to be fair by implementing the tiered system based on age. But for retirees on a fixed income, getting taxed was unexpected and problematic.

“I’m very eager to see if (repealing the retirement tax) not only changes whether retirees stay in Michigan, or if it is going to create more talent development with younger generations that see that they're not going to get a tax on their pension,” Seifert said. 

Most states, 36, tax retirement payments just as they do other income. GOP legislators contend that repealing the state’s retirement tax could lead to cuts for all forms of income. Republican Senate Majority Mike Shirkey said the tax on retirement income repeal does not go far enough. 

“The governor’s proposal simply isn’t as broad as Senate Republicans would prefer,” Shirkey said in a statement. “In these tough economic times, Michigan families need broad relief to help cover the gaps created by President Biden’s disastrous economic policy.”

On Wednesday, Michigan’s Republican-led Senate Finance Committee voted to reduce the state income tax from 4.25 percent to 3.9 percent and reduce the state’s corporate tax rate from 6 percent to 3.9 percent. 

Republican Sen. Jim Runestad said taking hold of the opportunity to cut taxes would help residents pay the higher prices on goods and services caused by inflation. The gap created by reducing the tax rates would be paid using the state’s revenue surplus, according to Runestad.

“Michigan has one of the highest inflation rates, 7.5 percent,” Runestad said. “When you cut taxes, you are helping people deal with this because you're putting more money in their pocket.”

But some economists, as well as the Senate Fiscal Agency, noted that such cuts would blow a hole in the state’s budget for years, with no new revenue to replace it. Mitch Bean, who served as director of the nonpartisan House Fiscal Agency from 1999 to 2011, said the state’s tax system is generally inequitable. 

“The taxpayer rate for very wealthy people have a lower tax rate than somebody making the average income of the state,” Bean said. “Rich people don’t pay as much taxes as you think they should. So the idea of fairness in the tax code is in the eye of the beholder.”

Bean said state policymakers should remain focused on making reliable investments in sectors such as infrastructure, noting that highways and bridges still earn income decades after they are built. Tax cuts are also hard to repeal after going into effect, which Bean called them a short-sighted solution that does not address long-term economic growth.