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What Happens to State Budgets if 4.05% Tax Rate Stays Put?

August 15, 2023

Article courtesy MIRS News for SBAM’s Lansing Watchdog e-newsletter

When asked whether the Fiscal Year (FY) 2024 budget would sustain a permanent income tax rollback, the Senate Appropriations Chair Sarah Anthony (D-Lansing) said she thinks it will be dealt with “when it comes.”

“One of the first things that I learned when I got this big job was about the income tax trigger and the potential of it happening, and we adjusted accordingly,” Anthony told MIRS on Tuesday. “I think that next year, when we’re faced with new numbers from the Consensus Revenue Estimating Conference and more data, we will adjust.”

Anthony said she hopes legislators have put enough money into Michigan’s “Rainy Day Fund” – the Budget Stabilization Fund – so that the state “could withstand whatever comes.”

Multiple Republicans in Michigan have criticized the state budget for not considering that Michigan’s income tax rate could permanently be 4.05% in upcoming years.

Near the end of March, the State Treasurer Rachael Eubanks announced that the state income tax would drop from 4.25% to 4.05% for the 2023 tax year only. The reduction was affiliated with a 2015 law approved by Republican Gov. Rick Snyder, automatically lowering the state’s income tax if the General Fund increased by more than 1.425 times the rate of inflation.

A day before Eubanks’ announcement, the Attorney General issued an opinion, stating the tax decrease would have a one-year lifespan, reading that the trigger itself is based on “temporary, impermanent, circumstances that change, and are reviewed, every year.”

With forecasts that Attorney General Dana Nessel’s opinion will face legal challenges, aiming to establish that the new 4.05% rate will be long lasting, Republican legislators argue that “a future tax hike” is baked into the budget.

“The Democrats will need the new 4.05% income tax rate to go up again to 4.25% next year in order to balance their budget. The Democrat attorney general in March disregarded the clear language, history, and legislative intent of the law and declared that the tax cut should only last for one year, an assumption Democrats used to write their massive budget,” reads a press release from House Minority Leader Matt Hall (R-Kalamazoo)’s office, following the Governor’s signing of a more than $57 billion general government omnibus budget bill.

When asked about Republicans’ negative messaging about the budget, Anthony said she believes sometimes “there’s desperation for a press hit or for relevance…but I think my Republican colleagues know that they can always set up a meeting with me and other folks who have been in the room, negotiating the budget.”

Bob Schneider, a senior research associate for the Citizens Research Council of Michigan, told MIRS that his organization has taken a “deep dive” into the 2015 law’s language, and concurred with Nessel’s opinion.

He described how, although it’s really clear that the tax decrease was intended to be permanent, the law’s plain language reads that a calculation must be performed to determine if a rollback should occur if revenues grow faster than inflation.

“What it doesn’t say is what should happen in any year where revenues don’t grow faster than inflation, and in this next year, revenues will not only not grow faster than inflation, they’re going to be negative because we did all this tax cutting,” Schneider said.

The aforementioned rollback, the expansion of the state’s Earned Income Tax Credit from 6% to 30% of the federal credit and the approved phased-in measure allowing taxpayers to have more of their retirement income deducted from the state income tax by the 2026 tax year will each impact upcoming General Fund growth, according to Schneider.

“We’re for sure not going to have revenue growing faster than inflation, and the trigger language doesn’t talk about what you’re supposed to do there. It doesn’t talk about that scenario,” he said. “I think everybody at the time who was working on (the 2015 legislation)…nonpartisan staff, everybody at fiscal agencies…were talking about this as a permanent rate cut. But if you then go back and look at the language, it’s not really what it says. I think the language wasn’t drafted very well.”

Ultimately, Schneider thinks the 2015 language “got goofed,” and claims there’s a very small chance that legal action against Nessel’s opinion will result in a long-term 4.05% rate.

Schneider forecasted that the budget to be designed next year, for FY ’25, will consist of more “normal,” inflationary spending growth, with the General Fund budget possibly rising by up to $600 million.

“If the income tax rate reduction was continued into another year, it would basically gobble up that remaining room for growth . . .Fiscal Year 2025 turns from a regular growth budget to zero growth . . . so anything, like if state employees get a payroll bump and that costs $100 million in General Fund, it’s got to come out of something else,” he said. “If you need $100 million because the Medicaid caseload happens to go up, then it’s going to have to come out of something else. Any growth is going to have to come out of something else.”

Between the general government omnibus budget, HB 4437, and SB 173 for PreK-12 education, community colleges and public universities, more than $15.19 billion in General Fund spending was appropriated. Additionally, one-time spending makes up more than 14% of the General Fund that is set to be deployed.

Also, $500 million is already committed to the state’s Strategic Outreach and Attraction Reserve Fund – which was designed to lure large-scale business projects – for FY ’25 from corporate income tax revenue.

“There’s plenty of room in the budget for cuts. I mean, just look at the myriad number of district projects that are contained within it, but you’re talking about a half of a billion dollars – they can figure that out without too much of an issue,” said James Hohman, the fiscal policy director for the Mackinac Center for Public Policy.

Hohman says it was inappropriate that legislators made a budget based on the assumption that the income tax will go up in 2024. He said while there are ways to afford lower taxes in the future, lawmakers “should have been more prudent about budgeting for this year,” to allow for courts to determine if the Attorney General improperly interpreted the 2015 law.

According to the Mackinac Center, the $500 million that will be released back into Michigan’s economy through the tax rollback equals 1.1% of the state budget for FY ’24.

Hohman said the state budget has increased by 16% from pre-COVID-19 pandemic levels, but per-capita personal income in Michigan is about 1% above inflation and Gross Domestic Product is about 5% above inflation “over this period.”

“That’s a large amount of growth that is not justified by how taxpayers are doing,” he said.


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