New Legislature Kicks Off 2023 With Major Tax Policy Changes
After two years marked by vetoes of major tax reform legislation under divided government, the newly installed Democratic majority in the Michigan Legislature made quick work of passing a sweeping tax reform bill. The core elements of Public Act 4 of 2023 reversed two major tax policy changes enacted as part of broad-based tax restructuring enacted in 2011 while both the Governor’s Office and Legislature were under Republican control.
Ironically, though, while the new Democratic legislative majorities decided to revisit tax policy history, tax policy history decided to pay a visit as well. An automatic income tax rate reduction trigger tied to a 2015 road funding law took effect when state tax coffers ballooned in the wake of the COVID-19 pandemic. As a result, the state’s income tax rate is reduced from 4.25 percent to 4.05 percent in 2023.
Public Act 4: Reversing 2011 Tax Changes
In 2011, then-Governor Rick Snyder signed legislation approved by the Republican-controlled legislature that replaced the Michigan Business Tax with a new, but more narrowly-assessed, Corporate Income Tax. But to help offset lost revenue, the legislation also made two other major tax policy changes. First, it scaled back what had been generous exemptions for certain retirement and pension income. Second, the plan reduced the state’s Earned Income Tax Credit (EITC) for low-income working households from 20 percent to six percent of the federal EITC.
Public Act 4 initiates a phased-in restoration of the more favorable treatment of retirement and pension income. Under the law, the full pre-2011 exemption will apply to retirement income for all retirees in 2026. Notably, however, the new law limits the full exemption of public pension income that existed before the 2011 tax changes to persons who retired from certain public safety-related positions. Others who receive public pension income are subject to the same exemption limit as those with private retirement income.
With regard to the EITC, the new law increases the state credit to 30 percent of the related federal credit; effectively, a 50 percent increase above its pre-2011 level. The change will result in a sizable increase in the refundable credit available to low-income households with earned income. For instance, a household with a single parent and two eligible children with an adjusted gross income of $20,000 will see their credit increase from $370 in tax year 2022 to $1,849 in tax year 2023.
Beyond these restorations, the new law also redirects between $560 million and $600 million in Corporate Income Tax revenue over three years to new funds dedicated to business attraction incentives (up to $500 million from Fiscal Year 2023 through Fiscal Year 2025), community development and housing ($50 million each year), and placemaking projects ($50 million each year). Altogether, the law is expected to reduce state General Fund revenues by around $1.4 billion annually in Fiscal Years 2024 and 2025.
A Revenue Surprise Brings an Income Tax Rate Cut
The big tax surprise of 2023, however, was the resurrection of the often-forgotten income tax trigger within the state’s Income Tax Act. Back in 2015, as the legislature worked to secure votes for road funding legislation that included a motor fuel tax increase, a compromise was reached to tie the legislation to new provisions adding an inflation-based General Fund revenue growth cap to the Income Tax Act. If General Fund/General Purpose (GF/GP) revenue grew sufficiently faster than inflation over time, a trigger mechanism would automatically reduce the income tax rate to effectively eliminate any of the “excess” revenue being collected.
For many years, it was assumed that the “trigger” would never be activated. However, new revenue projections in January 2023 found that Fiscal Year 2022 GF/GP revenue spiked by over a $1 billion above previous estimates, thus pushing revenues over the capped level. While the state’s financial books were not yet finalized, the increased revenue triggered an income tax rate reduction from 4.25 percent to 4.05 percent.
In an attempt to head off the triggered rate cut, the Whitmer administration announced a proposal in early February to issue one-time income tax rebates of $180 per tax filing household as part of Public Act 4. By using $800 million of Fiscal Year 2022 revenue to finance the rebates, the proposal would have cancelled out the triggered rate cut. However, Senate Republicans – favoring a permanent income tax rate reduction – voted “no” on granting “immediate effect” on Public Act 4. Since the act would not then take effect until after the state’s financial books were closed, the planned rebates were nullified.
In a final twist to the story, an Attorney General’s opinion was released in March 2023 finding that the relevant statutory rate trigger language only called for a one-time rate cut effective for 2023; the rate would legally return to 4.25 percent in 2024 under that legal interpretation.[1] Since an Attorney General’s opinion has the force of law without court intervention, the income tax rate cut will now be temporary barring a successful court challenge.
Other Tax Policy Highlights
While 2021 and 2022 saw few major tax policy changes, the 101st Legislature did enact significant legislation.
One significant tax law change was the creation of a Flow-Through Entity Tax (Public Act 25 of 2021) that allows eligible business entities – at their discretion – to pay the state’s 4.25 percent income tax on positive business income apportioned to Michigan and passed through to individual partners/owners.
The purpose of the new law was to help eligible business owners avoid the $10,000 federal cap on the deductibility of state and local taxes under the 2017 federal Tax Cuts and Jobs Act (TCJA). However, the TCJA capped the deduction only for individuals, not for businesses. So, by incurring tax liability at the business entity level, businesses could fully deduct all state and local taxes paid. Those tax savings would then result in higher flow-through income allocated to partners.
Other notable changes since our last update include:
- Public Acts 108 and 109 of 2021: exempts feminine hygiene products from the state’s Sales Tax and Use Tax.
- Public Act 150 of 2021: raises the small taxpayer exemption for eligible industrial and commercial personal property from $80,000 to $180,000 in true cash value.
- Public Act 5 of 2022: authorizes new income tax deductions for funds deposited into a Michigan First-Time Homebuyer’s Savings account.
This 38th edition of the Outline of the Michigan Tax System incorporates all these changes and many more since our last May 2021 update. The Tax Outline serves as an important ready reference for those interested in Michigan’s public finances. Policymakers, researchers, and citizens alike draw on this comprehensive yet accessible reference guide to navigate Michigan’s often complicated tax structure. Summary descriptions outline the base, tax rate, and revenue disposition for major taxes assessed at both the state and local levels. These are supplemented by historical information on long-run revenue trends. For easy reference, archived versions of previous updates dating back to 1997 are available at https://crcmich.org/publications/outline-of-the-michigan-tax-system-archives.
