Amid record surpluses, Michigan lawmakers are looking to give relief to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. payers and enhance the state’s competitive standing. Senate Bill 786, which recently reported from committee, would reduce both the corporate and individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rates to 3.9 percent as of January 1, 2022. It would also create a tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. of $500 for each qualified dependent.
If enacted, this legislation would yield one of the nation’s most competitive tax climates. Currently, Michigan ranks 12th on our State Business Tax Climate Index, a comparison of the competitiveness of state tax structures. With corporate and individual income tax rates of 3.9 percent, Michigan’s ranking would improve to 9th, securing a spot in the top 10.
The Great Lake State currently levies a flat corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. of 6 percent, which is lower than neighboring Wisconsin (7.9 percent) but higher than both Indiana (4.9 percent) and Ohio, which does not have a typical corporate income tax. If the rate were reduced to 3.9 percent, Michigan would exceed its neighbors and claim the second-lowest rate of any state with a corporate income tax, narrowly beating Missouri and Oklahoma, which are tied at 4 percent. It would trail only North Carolina, where the rate is currently 2.5 percent and is gradually being phased out entirely.
Passage of this bill would make Michigan stand out in its individual income tax as well. The state’s current rate of 4.25 percent has historically been competitive for the region, but Ohio’s recent reduction from 4.797 to 3.99 percent makes Michigan’s rate look slightly less attractive. A reduction to 3.9 percent would bring the state just below Ohio and get much closer to Indiana’s low 3.23 percent rate, claiming the 5th lowest individual income tax rate in the nation.
While the changes outlined in SB 768 would reduce state revenues considerably, Michigan is in a good financial position to provide tax relief. The rate reductions and nonrefundable dependent credit would likely cost the state $1.7 billion in FY 2022 and roughly $2.4 billion a year in following years. Even putting aside one-time federal assistance, Michigan has seen a huge rise in revenue in recent years. Total tax collections rose by almost 20 percent between FY 2019 and 2021 (an increase of almost $5 billion), and the individual and corporate income taxes saw increases of 15 and 16 percent, respectively. These cuts, while large, represent a return of a portion of the state’s revenue growth to the taxpayer, not a reduction in the size of government.
Getting tax reform across the finish line can be difficult in a divided government. However, Gov. Gretchen Whitmer (D) has already expressed her interest in lowering taxes for Michigan residents, although she and the legislature differ in strategy. While SB 768 generally includes very broad changes, the governor has expressed interest in more targeted reform: namely, repealing Michigan’s tax on pension income and expanding the state’s Earned Income Tax Credit (EITC)The Earned Income Tax Credit (EITC) is a refundable tax credit targeted at low-income working families. The credit offsets tax liability, the total amount of tax debt owed by an individual, corporation, or other entity to a taxing authority like the Internal Revenue Service (IRS), and can even generate a refund, with earned income credit amounts calculated on the basis of income and number of children. . One feature of SB 768, the new $500 dependent credit, overlaps significantly with the governor’s goals.
Although the governor may have a different idea of what tax reform should look like, it is significant that all parties recognize the value in returning some of the excess tax collections to the taxpayers. Because rate reductions do more to increase tax competitiveness, and affect incentives to work and invest, they should be a major part of any reform.
In a time when businesses and residents are increasingly mobile, tax competition is more important than ever. Michigan lawmakers would be wise to consider lowering rates to keep the state competitive.