INCREASE STATE PERSONAL INCOME TAX RATE

House Bill 4500

Sponsor:  Rep. George Cushingberry

Committee:  Tax Policy

Complete to 5-23-07

A SUMMARY OF HOUSE BILL 4500 AS INTRODUCED 3-21-07

The bill would amend the Income Tax Act to increase the personal income tax rate from 3.9% to 4.6% beginning January 1, 2007 and to reduce the rate back to 3.9% beginning January 1, 2012. 

In addition, the bill would set the personal exemption amount at $3,630 for the 2007 tax year and index that amount for inflation for each year thereafter.  Under current law, the personal exemption was set $2,500 for the 1997 tax year, with an annual adjustment for inflation. Currently, for the 2007 tax year the personal exemption amount is $3,400.

MCL 206.30 and 206.51e

FISCAL IMPACT:

According to the income tax model (using Tax Year 2005 data), those changes would generate about $1.1 billion on full-year basis. Because the bill would be retroactive to January 1, the revenue increase for FY2006-07 would be about $825 million.

BACKGROUND INFORMATION:

Income Tax Rates

As originally enacted, the personal income tax rate was 2.6%.  (At the time, the act also included a 5.6% tax on corporate income and 7.0% tax on the profits of financial institutions.  These taxes were later repealed following the creation of the Single Business Tax.)  Over the years, the rate has increased three times – in 1971, 1982, and 1983 – in response to projected budget shortfalls and downturns in the economy.   In addition, there have been numerous occasions where scheduled rate reductions were postponed.  This occurred, most recently, with the enactment of 2003 PA 239, which delayed by six months a scheduled reduction in the rate from 4.0% to 3.9%, to solve a projected budget deficit in the 2003-2004 fiscal year.  On other occasions, the rate was changed to reflect other changes in the state's tax policy.  In 1975, the rate increased from 3.9% to 4.6% to offset the exemption of food and prescription medication from the sales tax, and in 1994, the rate was reduced from 4.6% to 4.4% as part of Proposal A and the shift from property taxes to the sales tax in financing public schools. 

The most recent rate reductions were set in place by Governor Engler.  Following his 1999 State of the State address, the legislature passed and the governor promptly signed into law Public Acts 2-6 of 1999 (House Bills 4033 and 4034, and Senate Bills 1, 2, and 5 of 1999).  The bills reduced the income tax rate from 4.4% to 3.9% beginning in 2000.  Public Act 40 of 2000 further reduced the rate for the 2000 tax year from 4.3% to 4.2%.  The rate was to have been reduced from 4.0% to 3.9% on January 1, 2004, although Governor Granholm and the legislature agreed to delay that reduction until July 1, 2004. 

 

Effective Tax Rates

Through the proliferation of credits, exemptions, and deductions against the tax, the effective income tax rate is considerably lower than the statutory rate. 

Year	Statutory Rate	Effective Rate	Year	Statutory Rate	Effective Rate
1979	4.60%	2.74%	1992	4.60%	2.77%
1980	4.60%	2.65%	1993	4.60%	2.75%
1981	4.60%	2.55%	1994	4.47%	3.03%
1982	5.10%	2.81%	1995	4.40%	2.87%
1983	6.35%	3.88%	1996	4.40%	2.88%
1984	5.85%	3.76%	1997	4.40%	2.90%
1985	5.33%	3.50%	1998	4.40%	2.88%
1986	4.60%	3.04%	1999	4.40%	2.86%
1987	4.60%	3.01%	2000	4.20%	2.68%
1988	4.60%	2.95%	2001	4.20%	2.59%
1989	4.60%	2.88%	2002	4.10%	2.49%
1990	4.60%	2.85%	2003	4.00%	2.35%
1991	4.60%	2.74%	2004	3.95%	2.20%

Source:  Department of Treasury, Bureau of Tax and Economic Policy

Personal Exemption Amounts

As originally enacted, the personal exemption was $1,200.  Over the course of the next 30 years, the amount was increased eight times to $2,500.  Since 1997, the personal exemption has been adjusted annually for inflation.  The table below shows the history of the personal exemption amount and the inflation-adjusted amount since 1967.  The chart demonstrates that inflation has eroded much of the value of the exemption.  If the original $1,200 personal kept pace with inflation over the last 30 years, it would have a value today of $7,425. 

Source:  "Michigan's Personal Income Tax" (p.540) inMichigan at the Millennium. 

Constitutional Considerations

Article 9, Section 7 of the 1963 State Constitution states, "No income tax graduated as to rate or base shall be imposed by the state or any of its subdivisions."  This was a new provision added to the constitution with the 1961-62 Constitutional Convention, although not without a fair amount of debate among delegates as to whether an income tax, if authorized by the legislature, should have a flat or graduated rate.  In adding the prohibition against a graduated income tax, backers of the provision (included in Committee Proposal 51) stated: 

The provision makes it clear that neither the state nor any local unit of government may impose a graduated income tax.  The words 'or base' are necessary to prevent 'piggyback' taxation based on the federal tax liability.  Without such language, a tax nominally imposed at a flat rate might actually adopt all of the graduation of the federal tax.  A flat rate income tax is clearly permitted, and could, in the opinion of the committee, be imposed on a 'piggyback' basis on income computed for federal tax purposes.  The legislature could prescribe reasonable exemptions for a flat rate income tax.

 

The imposition of this limitation on legislative power seems desirable in order to avoid confiscatory taxation to avoid the use of a revenue measure as a device for social reform, and to prevent the entry by the state into a field largely preempted by the federal government.  A further advantage of the limitation is that with it, a legislator, who votes for an income tax will do so with the knowledge that it will fall proportionally as heavily on himself as upon others – a safeguard which a majority of the committee deems important.[1]

 

A number of delegates, however, felt that the legislature should be free to determine the structure of an income tax.  They made the following arguments:

1.                  "It freezes into the constitution unnecessary and undesirable restriction on the legislative power to levy taxes in the future.  No authority has been cited for the advisability of inserting this unique provision into a state constitution.  It does not make allowance for drastically changed circumstances beyond our present anticipation."

2.                  "The prohibition of a graduated income tax, statutory in nature, does not have the faithful sanctity of the other restrictive measures written into the constitution, such as the sales tax rate limitation, achieved through prior approval of the people at the polls."

3.                  "It freezes present and potential inequities in the Michigan tax structure by prohibiting the legislature from correcting them, should it desire to do so."

4.                  "The majority committee report implies that graduation of taxes bases is preempted by the federal government.  There is no legal authority for this presumption."

5.                  "Progressive taxation, accomplished through graduated rate structures, is not a device for social reform; on the contrary, it is a very equitable device for raising the maximum amount of revenues, without unduly burdening any individual taxpayer on the ability to pay.  Its effect does not need to be 'soak the rich' or 'pamper the poor.'  Experience actually proves these descriptions more propaganda than reality.  However, there is obviously a basic difference between the majority and minority emphasis on the equity of the Michigan tax system, particularly in terms of the impact on low income and middle income families, pensioners, and those on fixed incomes."

6.                  "Ignored in the proposal is the experience of the overwhelming majority of the state which have income taxes, all but two (33 of the 35) having adopted graduated rate structures.  Michigan would be placed in a unique category and at a potential disadvantage in relation to other state in its ability to raise revenue from income taxation."[2]

Over the years, there have been several ballot proposals, both before and after the 1963 state constitution, to enact a graduated income tax.  Between 1922 and 1936 there were four proposals, none of which passed. In the years after the enactment of the income tax, the issue of a graduated rate structure has been before, and rejected by, the voters on three occasions – in 1968 (23.3% Yes, 76.7% No), 1972 (31.3% Yes, 68.7% No), and 1976 (27.8% Yes, 72.2% No).

Interstate Comparisons

The following series of charts allow for comparisons of income tax features among the states.  The first chart shows tax rates and income brackets of the states.  The second chart shows state income taxes as a percentage of personal income and the total state and local tax burden as a percentage of personal income.  The third chart shows per capita income taxes collections and per capita total state and local tax collections. 

Tax Rates and Brackets

Source:  Federation of Tax Administrators.  Information is for the 2007 tax year, as of January 1, 2007.  (1) These states have an automatic inflation adjustment for tax brackets,(2) Georgia:  Tax brackets above are for single returns.  For joint returns brackets range from $500 to $5,000 for married, filing separately, and $1,000 to $10,000 for married, filing jointly;(3) Minnesota:  Tax brackets above are for single returns.  For married filing jointly, the rates range from 1.4% to 8.97%, with 7 tax brackets ranging from $20,000 to $500,000;(4) Nebraska:  Tax brackets above are for single returns.  For married, filing jointly, brackets range from $4,000 to $50,001;(5) New Jersey:  Tax rate and brackets above are for single returns.  For married filing jointly tax rates range from 1.4% to 8.97%, with 7 brackets ranging from $20,000 to $500,000;(6) New Mexico:  Tax brackets above are for single returns.  For married filing jointly, brackets range from $8,000 to $24,000;(7) North Carolina:  Tax brackets above are for single returns.  For married filing jointly, brackets range from $21,250 to $200,000; (8) North Dakota:  Tax brackets above are for single returns.  For married filing jointly, brackets range from $51,200 to $336,551;(9) Vermont:  Tax brackets above are for single returns.  For married filing jointly, brackets range from $51,200 to $336,551;(10) Wisconsin:  Tax brackets above are for single returns.  For married filing jointly brackets range from $12,210 to $183,221;(11) California:  An additional tax of 1% is imposed on taxable income over $1 million. 

2005 Tax Burden as a Percent of Personal Income

Source:  Census Bureau, Bureau of Economic Analysis, and Federation of Tax Administrators

2005 Per Capita Tax Collections

Source:  Census Bureau, Bureau of Economic Analysis, and Federation of Tax Administrators

Further Information

Additional information on the state income tax can be found in a July 2006 report by the Department of Treasury (http://www.michigan.gov/documents/IIT_2004_167686_7.pdf), an April 1999 report by the HFA (http://www.house.mi.gov/hfa/PDFs/inco_tax.pdf) and in the chapter on Michigan's income tax in Michigan at the Millennium (MSU Press, 2003). 

                                                                                           Legislative Analyst:   Mark Wolf

                                                                                                  Fiscal Analyst:   Rebecca Ross

                                                                                                                           Jim Stansell

■ This analysis was prepared by nonpartisan House staff for use by House members in their deliberations, and does not constitute an official statement of legislative intent.

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