Is it fair to tax some Michiganders’ retirement income and not others?
Democratic Gov. Gretchen Whitmer and GOP lawmakers who control the budget process will have to contend with that question this spring as they negotiate whether Whitmer’s campaign promise to undo her Republican predecessor’s tax on some retirement income will be built into the state’s next budget.
Support for doing away with former Gov. Rick Snyder’s so-called “pension tax” is gaining steam among some legislators from both parties, who say repeal would do right by seniors who were asked to shoulder more of the state’s income tax burden in 2011 to help pay for a more than $1 billion tax cut for businesses.
But defenders of the tax, who include some Republican legislators and business groups, also cite fairness as a primary concern — namely, that all forms of retirement income should be taxed similarly. The 2011 tax change ended a 100-percent income tax break for government pensions and lowered deductions for private retirement income, including pensions and individual retirement savings, bringing more parity to public and private retirement benefits.
Those contrasting views have House and Senate lawmakers working on a legislative compromise, said Gideon D’Assandro, spokesman for House Speaker Lee Chatfield, R-Levering.
“Nobody’s wrong,” said Eric Lupher, president of the nonpartisan Citizens Research Council of Michigan. “It’s just, what’s your opinion on it?”
Budget negotiations will be further complicated by Whitmer’s desire to offset the more than $300 million in state general fund revenue that would be lost if she does away with the pension tax by increasing the income tax rate paid by some businesses — a proposal the administration calls “tax parity,” but that has angered business groups.
Senate Majority Leader Mike Shirkey, R-Clarklake, voted for the 2011 tax changes while serving in the state House and said through a spokeswoman he continues to support them.
“We made a change to treat all retirement income the same in the state of Michigan, and he believes that is the most important premise of how we tax retirees in the state. And if we’re going to do anything to change that, fairness should be the cornerstone of that change,” said Amber McCann, Shirkey’s spokeswoman. “He would be more supportive of looking at something that provided tax relief across all retirement income than he would treating one group of retirees different from another.”
Chatfield wants to give seniors tax relief, but is open to discussing what form that would take as part of a compromise, D’Assandro said.
A powerful voice for retirees is also watching closely.
“If somebody wants to propose a bill that broadens tax relief for senior citizens, AARP would be in favor, I can say that without any hesitation,” said Mark Hornbeck, a spokesman for AARP Michigan, whose members largely support repeal. “We have not been lobbying for that. We have enough to get done to get this pension tax repeal through. As you know, it’s not a slam dunk.”
How the retirement tax works
The 2011 tax changes were phased in based on a retiree’s birth year. The oldest retirees, those born before 1946, are unaffected. Those 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 can claim those exemptions against all income, regardless of the source.
The youngest retirees, born after 1952, don’t get to deduct any retirement income until they turn 67 — which will happen starting next year — when they also can claim more limited $20,000 and $40,000 income tax exemptions.
Whitmer’s administration said her proposal, beginning in the 2020 tax year, would again exempt public pensions and restore 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. For the 2019 tax year, those private-sector thresholds are $52,808 for single taxpayers and $105,615 for married couples filing jointly, according to the Michigan Department of Treasury.
The administration’s proposal also would allow Michiganders born after 1945, once they turn 67, to choose between deducting their retirement income or claiming income tax exemptions of up to $20,000 and $40,000 for filing solo or jointly, respectively, on all sources of income.
“The taxpayers who would do better with the deduction against all income have income from other sources (wages, interest, dividends, other investments, a business, or a non-qualified retirement plan) rather than retirement benefits,” Treasury spokesman Ron Leix said via email. “The one that is most common is probably a taxpayer who is continuing to work past age 66.”
The administration projects Whitmer’s repeal proposal would save close to 425,000 households $800 on average each year, and 600,000 households would pay no state income tax on their retirement income. It would cost the state an estimated $259 million in the 2020 fiscal year, which starts Oct. 1, and $355 million in 2021, according to Treasury.
While the administration’s proposal would entirely exempt public pensions and not private retirement income, said Jeff Guilfoyle, the state’s chief deputy treasurer, deductions for private-sector retirement income would be generous enough that the majority of retirees wouldn’t pay state income tax on the amount they receive each year.
State Treasurer Rachael Eubanks said one factor to consider in the debate over fairness is that government employees often earn less pay than they could make in the private sector, anticipating that they will receive more-generous retirement benefits.
Whitmer’s proposal comes after Republicans in the House and Senate introduced legislation this term to reverse the tiered retirement tax changes from 2011. A House committee recently voted to send a bill introduced by state Rep. Joseph Bellino, R-Monroe, to a second committee for consideration before it heads to the House floor. The nonpartisan House Fiscal Agency estimated Bellino’s bill will lower state personal income tax revenue by $330 million, increasing by roughly $15 million each year as more people retire.
The state changed the game on seniors in 2011, Bellino testified in a hearing in late February, shorting younger retirees who have to pay taxes on their fixed retirement income while also budgeting to afford necessities such as car insurance and heat.
“I hope we can work together to bring relief to the seniors who have worked their entire lives to retire peacefully, only to have their livelihood threatened,” Bellino testified; he could not be reached for additional comment. “It’s time to stop balancing the budget on the backs of seniors and work to bring them relief that they have earned. Plain and simple, it’s always a good time to have good tax policy, and this is good tax policy.”
Bellino’s bill differs from Whitmer’s proposal in part because it would not continue the $20,000 and $40,000 tax deductions on all income for seniors 67 and older. The state Treasury said Bellino’s bill would increase taxes by an average of $650 on an estimated 38,000 households as a result of ending those deductions.
“When a tax like this affects a lot of people, there is going to be a desire to look at it and reconsider some type of exemption for pension income,” said James Hohman, fiscal policy director for the Midland-based Mackinac Center for Public Policy, a free-market think tank. “This is a new legislative environment. I can’t tell you how likely it’s going to be.”
Fewer private-sector companies are offering defined-benefit retirement plans, what are traditionally considered employer-promised pensions. More are opting instead for defined-contribution, 401k-style savings accounts, to which employees contribute money and employers can match.
The public sector has been slower to make that change, said Lupher, of the Citizens Research Council. Many local governments struggle to set aside enough money to cover their full pension obligation, which they’re constitutionally required to pay out to retirees.
And Michiganders are getting older. In May 2008, the Citizens Research Council issued a report on the state’s fiscal future that noted that tax-exempt retirement income will limit state income tax growth as more residents retire.
“We’ve gone all in on these IRA-type plans, these self-investment type plans, for your retirement, and people aren’t investing enough,” Lupher said. “At some point, we’re going to have a lot of poor retirees, people working beyond retirement age, because they can’t afford to retire. And so levying a tax on top of that is, at some point, going to be kicking people while they’re down. But I think (policymakers are) trying to worry about: How are we going to fix the roads and how are we going to fund schools?”
Business groups that support keeping the tax in place, including the Detroit Regional Chamber and the Michigan Chamber of Commerce, say the decision eight years ago to tax more retirement income addressed the fairness issue.
“Everybody’s utilizing government services,” said Dan Papineau, director of tax policy and regulatory affairs for the Michigan Chamber. “I think it struck a balance between all seniors, in whatever financial situation they’re in.”
House Democratic Leader Christine Greig, of Farmington Hills, disagrees, saying that Snyder’s approach asked residents to pay more so business could pay less.
“He implemented the pension tax at the same time he slashed corporate taxes, so the shift of the tax burden to individuals was tremendous under his administration,” Greig said. Whitmer’s proposal “starts to swing that pendulum back a bit.”
D’Assandro, Chatfield’s spokesman, said one possible alternative could be to lower income tax rates on both public and private retirement income, rather than exempting it from taxes.
Another could be to link the amount of income tax paid to a retiree’s ability to pay — if it can be done without violating Michigan’s constitutional prohibitions against a graduated income tax, said Robert Kleine, a partner with Great Lakes Economic Consulting and a former state treasurer in Democratic Gov. Jennifer Granholm’s administration.
The original version of the law passed in 2011 attempted to do that, but the Michigan Supreme Court, in an advisory opinion issued at Snyder’s request, said that approach was akin to a graduated income tax and could not be enforced.
“It might be unconstitutional, but I think that would probably be fairer,” Kleine said, adding that there may be other ways to offset the burden for low-income seniors.