Outline of the Michigan Tax System
Once again, tax policy discussions during 2015 were dominated by the Legislature’s efforts to come to an agreement on a long-term plan to increase revenues for Michigan’s increasingly deteriorating road system. Late in the 2013-14 legislative session, the Legislature approved a plan that traded an increase in motor fuel taxes for the elimination of the sales tax on motor fuel. However, the plan also included a 1 percent increase in the sales and use tax rates designed to avoid a revenue hit to K-12 schools and local governments that receive dedicated revenues from the sales tax. Since the sales tax rate is set in the Michigan Constitution, raising the rate required a vote of the people. In May 2015, the people spoke by resoundingly rejecting the sales tax hike contained in Proposal 15-1. As a result, the entire road funding package fell by the wayside, and the Legislature found itself back at the drawing board in search of a road funding solution.
At long last, they found success. In November, six months after the defeat of the ballot proposal, the Senate and House approved a package of seven bills that represented the first major road funding increase since 1997. Governor Snyder signed the package. The plan will eventually generate close to $1.2 billion per year in new road revenues: half from increased transportation taxes and half from the redirection of existing income tax revenue that currently goes to the state’s general fund. However, the bulk of that new revenue won’t come to fruition for several years, so Michigan drivers may need to be patient as they wait to see significant improvements in road conditions.
Transportation Taxes: Motor Fuel and Registration Tax Increases
With regard to transportation taxes, the road plan will raise both the 19-cents per gallon gasoline tax and 15-cents per gallon diesel fuel tax to 26.3-cents per gallon beginning January 1, 2017. It also applies this increased tax rate to various alternative fuels. Beginning in 2022, the motor fuel tax rates will begin to adjust automatically based on consumer inflation. Finally, the plan raises annual registration taxes on passenger vehicles and large commercial trucks by 20 percent and creates a new registration surcharge for electric-powered vehicles. This component of the package is expected to generate $460 million in new transportation revenues in FY2017 and around $620 million per year thereafter.
That’s well short of the $1.2 billion in new annual revenue that road officials indicate is minimally needed to bring Michigan’s roads back to an acceptable state and that has been the de facto goal of the Legislature’s efforts over the last several years. To get the remainder of this revenue, the Legislature looked to the state’s existing revenue stream.
Income Tax Changes: Road Allocation and Rate Reduction Trigger
To supplement the revenues from the motor fuel and registration tax increases, the road plan redirects existing revenue from the state income tax for road purposes. State and local road agencies will receive $150 million from the income tax in FY2019, $325 million in FY2020, and $600 million in each subsequent fiscal year to help address road repair needs. While that new revenue will help the roads, it means less revenue available for other state priorities that receive general fund support.
However, that was only the first of three major changes to the income tax that was part of the enacted road plan. In order to offset some of the tax burden imposed by the transportation taxes, the Legislature included enhancements to the state’s Homestead Property Tax Credit against the income tax. The credit reduces the income tax liability of low- and moderate-income home owners and renters. The legislation increases the maximum credit amount, revises criteria to enhance the credit for most eligible households, and increases the amount of income a household can earn while remaining eligible for a credit. Like the road allocation, the changes to the homestead credit’s parameters are expected to reduce revenue to the state’s general fund by around $200 million per year.
Lastly and perhaps most significantly, the Legislature added language to the Income Tax Act that could trigger an automatic reduction in the income tax rate in future years. Beginning in tax year 2023, whenever cumulative growth in state general fund/general purpose revenues exceed an inflation rate calculation included in the act, the income tax rate will be reduced in order to eliminate the general fund revenue growth in excess of inflation. The annual calculations of general fund growth and inflation that determine whether the trigger is effective for that year will use FY2021 as a base year.
Other Tax Policy Changes
While much of the focus during 2015 was on achieving a compromise on the transportation funding package, a number of other significant tax policy changes were approved. These changes include:
- New income tax exemptions of up to up to $5,000 for a single return and $10,000 for a joint return for contributions, interest earnings, and qualified withdrawals from a “Achieving a Better Life Experience” savings account designed to assist disabled individuals.
- New sales and use tax exemptions for data center equipment sold to or used by a qualified data center or co-located business.
- Earmarking a portion of sales and use tax revenue generated from the sale or use of aviation fuel for aeronautics programming.
The Legislature and Governor finally achieved a policy priority that had eluded them for several years by enacting a long-run road funding plan in November 2015.
However, as noted, that plan calls for only $460 million in new transportation revenue for FY2017 and just over $600 million in FY2018. That falls well below the $1.2 billion in new annual road revenue that has been the goal of road funding debates ever since Governor Snyder first proposed a significant increase in transportation taxes in his FY2014 budget proposal way back in February 2013. Only when the significant redirection of income tax revenue begins in FY2019 will new revenues begin to approach this goal. Even then, new revenue available for road repairs will fall slightly short of $1.2 billion in FY2021 when the income tax redirection is fully phased in. That means that significant improvements in Michigan’s road conditions will likely not be realized for many years.
Furthermore, the new road plan’s reliance on redirected general fund revenues for roads as well as the enhanced homestead property tax credit and rate reduction trigger all have the potential to create new challenges for budget writers in future fiscal years. The foregone general fund revenue tied to the plan has important implications for state programs that rely on general fund support, including high-dollar state programs such as Medicaid, higher education, and corrections.
Many of the legislators involved in putting together last November’s road funding plan will be gone due to term limits by the time these challenges come to a head in FY2021 and beyond. How a future Legislature decides to address these challenges remains to be seen.