- Michigan’s status as a high tax state has changed over the past 17 years.
- The funding structure for Michigan local government — state revenue sharing, few local-options taxes — was developed with the assumption that state revenues would be adequate to support a broad range of services.
- With the evolution to a low tax state, state policymakers need to tend to the balance to ensure revenues are adequate to provide services residents expect.
Tax policy is all about balancing the goal of raising adequate revenues to provide services with maintaining rates low enough to maintain competitiveness.
Michigan’s recent history illustrates why this balance must be tended to continuously.
For many years, a strong state economy allowed Michigan to levy taxes at fairly low rates and still yield adequate revenues to fund services. For several decades, up until the turn of the century, Michigan consistently hovered around 15th highest in the country in total state and local government tax revenue per capita, about 4 percent above the U.S. average.
Resources were finite during these years, but the state generally had enough to fund both state departments and external entities, such as universities, health departments, and state revenue sharing.
The adequacy of state revenues led to policies based on assumptions that the strength of Michigan’s economy would continue indefinitely. Local-option taxes, such as income and sales taxes, were preempted in exchange for revenue sharing. The 1978 Headlee Amendment limited growth of state and local tax revenue and created a fiscal balance between the state and local governments. Proposal A of 1994 further limited the growth of the property tax base.
Changing economic conditions over the past two decades caused Michigan’s ranking to change. The national population has grown 35 percent faster than Michigan’s since 1979. Per-capita personal income grew at a rate almost 60 percent slower than the national rate.
By the advent of the Great Recession in 2009, we had fallen to 32nd in per-capita tax revenues, 14 percent below the U.S. average. By 2015, Michigan had fallen to 34th, 22 percent below the U.S. average. As a result, our population and economic growth are no longer able to compensate for state policies focused on tax competitiveness.
Tax policy has not changed to reflect these circumstances and tax adequacy has suffered.
State revenues have declined from about 9.5 percent of state income in 2000 to about 7.2 percent in 2018. From FY2000 to 2010, the state’s General Fund revenues declined from $10.7 billion to $7.7 billion. It has only just returned to 2000 levels. This decline in tax revenues significantly reduced available resources for both state services and for programs such as state revenue sharing, universities, roads, and school aid.
So where does that leave the state?
The rates Michigan levies for most of its state taxes rank fairly low among the states.
Michigan’s 4.25 percent flat-rate income tax ranks 37th highest for medium and high income households among the 41 states with conventional income taxes. Low-income taxpayers feel a bigger pinch because other states levy more progressive taxes and Michigan has a relatively small earned income tax credit. A small portion of the population may pay more if they live or work in one of the 24 cities with a local tax.
Our 6 percent corporate income tax is tied with five other states for the 29th highest rate among the 44 states that levy such a tax. This competitive tax rate is applied to a tax base that is much smaller than the Single Business and Michigan Business taxes that preceded it.
Michigan’s 6 percent state sales and use taxes are tied for 16th highest. But Michigan does not authorize local-option sales taxes, as are found in 37 states. When accounting for local taxes, Michigan has the 38th highest tax rate among the 46 states that levy sales taxes.
What about property taxes, primarily levied by local governments? Michigan’s property tax rates are among the highest in the nation. Detroit’s tax rate ranks among three highest large cities depending on the type of property used for comparison (residential, commercial, or industrial).
Even in comparisons of smaller cities, Michigan’s property tax rate ranked in the top 10 depending on the type and value of the property subject to taxation.
The changes to the tax base caused by Proposal A of 1994 help with tax competitiveness, but many local governments are harmed by its effect on adequacy. Prop A created the taxable value measure that limits the value of individual parcels to inflationary growth. This is good for property owners, but means that property tax revenues in many communities will take many years to recover from declines during the Great Recession.
So what does all of this mean?
For the sake of tax competitiveness, Michigan has maintained a regiment of state taxes that are levied at relatively low rates. The failure of Michigan’s economy to grow at the pace of the rest of the nation has left the state with challenges to fund its own services and little to share with local governments.
Michigan local governments remain beholden to the property tax as the primary source of local revenue. Relatively high rates are common in Michigan and there will be pressure to increase tax rates to compensate for taxable-value growth limits and the declines in property value in many parts of the state caused by the Great Recession.
When revenue sharing programs were instituted many years ago, local governments tacitly surrendered the ability to levy local-option taxes as are common in other states. Now local governments are receiving only part of what the revenue sharing statutorily promised and they do not have the ability to levy taxes common in other states.
Tax competitiveness is important, for attracting both people to our magnificent state and businesses to employ them. But when tax revenues no longer prove to be adequate, state policymakers need to reevaluate the balance. The circumstances suggest it is time to do so.