March 15, 1996

PSC: “Income Tax Reform Unaffordable”
Democrats: “The Plan Is Sound”

by Robert J. Kleine, Vice President & Senior Economist

In our February 9 Periscope we voiced reservations about the plan proposed by 29 Democrats to reform the Michigan income tax. Rep. Kirk Profit, leader of the effort, expressed concern that we had not presented all the facts and thus mislead readers. Representative Profit points out that the plan is based on seven principles that he believes meet our test for good tax policy. According to a statement released by his office, "Pursuit of the goals of these seven principles will be the most broad-based, comprehensive effort to truly realize fundamental economic expansion by working with the fundamental units of the American free enterprise system." We have agreed to print the seven principles (they have been abridged because of space), which follow.

1. Eliminate applications that impede family development: Specifically. eliminate income tax burdens placed on child-care, elder-care, and health care expenses, as well as on retirement security; increase the dependent household-member exemption; and expand the opportunity for an earned income tax credit.
2. Eliminate unnecessary applications of the income tax that restrict Michigan residents from being fully active in the Michigan economy: Specifically, increase the personal exemption; reduce the tax rate by the year 2000 to 3.9 percent; increase renters’ homestead exemption; and add a deduction for preschool expenses.
3. Eliminate tax worries for Michigan citizens who do not have financial viability: Specifically, excuse from filing anyone with income under the poverty level.
4. Simplify tax compliance by providing choice in filing: Specifically, provide a new, five-line, alternate MI1040EZ form. Those who wish to itemize may use the traditional MI1040 form, which will be expanded to reflect the new deductions.
5. Eliminate certain excessively unfair applications of the tax; Specifically, eliminate income tax burdens on certain sources of veterans’ and unemployed persons’ income, as well as on rewards received for information offered pursuant to a criminal justice investigation; expand and fully implement the tuition tax credit; and achieve pension equity. (Other measures are being developed.)
6. Maintain fiscal responsibility by working with sound economic projections and exercising aggressive cost containment, especially in regard to the Department of Corrections.
7. Prohibit raids on income tax revenue that is statutorily earmarked for local-government revenue sharing and the School Aid Fund: Specifically, propose state constitutional amendments for the 1996 ballot that will guarantee the (a) state’s 1970 promise to share income tax revenue with local government, for certain essential operations, and (b) Proposal A’s assurance of state funding for K–12 operations.

We have little disagreement with these principles, although we oppose amending the constitution to lock in income tax revenue being earmarked for local governments and school aid (principle seven); we generally oppose restricting the legislature’s ability to make funding changes as conditions change.

Our basic concern about the proposal is its cost. We had estimated the annual cost at about $2 billion when the plan is fully phased in; Representative Profit estimates it at $1.2–1.3 billion. A precise figure will not be available until the plan is final and the details are worked out. Whether the cost is $1.2 billion or $2 billion, we believe a plan of this magnitude will cause severe fiscal stress. Future budgets already are going to experience considerable pressure from declining federal aid, a slowdown in economic growth, growing school-age and crime-prone population groups, and reduced opportunities for further government downsizing. Although principle six states that fiscal responsibility will be maintained, we do not believe this is possible unless the economy grows much faster than most forecasters believe it will.

A final note: We wrongly said that the plan will increase the personal income tax exemption from $2,400 to $2,600; that increase already is slated. The Democrats’ plan does not state a specific exemption amount, but to eliminate the tax burden for people below the poverty line (principle three) will require a personal exemption of about $4,000.