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Home News  Snyder's budget plan: Fairer and more efficient taxation — just not enough of it
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Wednesday, March 16,2011

Snyder's budget plan: Fairer and more efficient taxation — just not enough of it

by Charles L. Ballard

On my way to a meeting in February, I got stuck in the snow. It was fully 24 hours after the President’s Day snowstorm, but the street (in an affluent Ann Arbor neighborhood) had not been touched by a snow plow. Some folks might say, “It’s great that taxes in Michigan are so low that we don’t have enough money to plow the streets.” But I don’t.


For many years, public discussion in Michigan has been dominated by this mantra: If we just cut taxes enough — if we just lay off enough teachers and police officers and firefighters — if we just let enough roads and bridges and schools and state parks crumble, then businesses will flood into Michigan, and our economy will boom. How’s that working for you?


When Gov. Rick Snyder took office, he faced a $1.8 billion budget deficit for the 2012 fiscal year. Thus he had to propose a budget with some very substantial changes. I like some of Governor Snyder’s proposals very much. The common theme of my favorites is that they will move us toward a more level playing field in our tax system. These proposals will reduce the tax system’s discrimination among different sectors of the economy.


They would allow us to collect tax revenues more efficiently than we do now.


But the proposed overall level of taxes, and thus the overall level of public services, is much lower than I think it should be.




Where Did the Deficits Come From? Michigan’s Incredible Shrinking Tax System


Before we look at the specifics of Governor Snyder’s budget, it’s important to begin by understanding where the deficits came from in the first place. A budget deficit can arise from increased spending or decreased tax collections. Michigan’s deficits are overwhelmingly due to tax reductions.


Of course, the Michigan economy has performed very poorly in the last 10 years, and we would expect a shrinking economy to provide less tax revenue. But taxes have fallen much faster than the economy as a whole. If we adjust for inflation, the Michigan economy is a few percent smaller than it was in 2000, but the state’s General Fund revenues are down by more than 40 percent!


The percentage of the economy going into the state’s coffers was lower in 2010 than in 2000, by the equivalent of about $9 billion per year!


This helps to put the $1.8 billion deficit into perspective. If we had avoided even a small fraction of the tax reductions of the last 10 years, we would not have any budget deficit at all. We have slashed spending again and again, but we have cut taxes by even more. That’s why we have a deficit for 2012.


I believe we have reduced taxes too far. Tax cuts are popular politically, but tax cuts by themselves are not an effective economic strategy. If reduced taxes were the key to prosperity, Michigan’s economy would be booming.


No one enjoys paying taxes, but taxes are the price we pay for a civilized society.


I want the roads to be paved in the summer, and plowed in the winter, even if it is necessary to pay taxes. And I want good schools, because education is the key to Michigan’s economic future. By focusing so exclusively on tax reductions, we have greatly impaired our ability to invest in a brighter economic future.




Some Key Features of Governor Snyder’s Budget Proposals


• Cut K-12 schools by $470 per student, and more in some districts.


• Cut funding for universities by 15 percent.


• Eliminate the Earned Income Tax Credit.


• Reduce revenue sharing for local governments.


• Reduce compensation for state employees.


• Tax some forms of retirement income.


• Reduce some of the special tax breaks that have been given to businesses in the past.


• Eliminate the Michigan Business Tax, and replace part of the revenue with a 6 percent corporation income tax. On net, this proposal would result in a large reduction in business taxes.


I like some of Governor Snyder’s proposals very much. The common theme of my favorites is that they will move us toward a more level playing field in our tax system. These proposals will reduce the tax system’s discrimination among different sectors of the economy.


They would allow us to collect tax revenues more efficiently than we do now.


But the proposed overall level of taxes, and thus the overall level of public services, is much lower than I think it should be.




Cuts to Education


In the 1970s, average incomes in Michigan were about the same as average incomes in Massachusetts. Since then, incomes in Massachusetts have increased far more than incomes in Michigan. This has a simple explanation: Massachusetts has the most highly educated workforce in the country, while Michigan lags behind in many areas of educational attainment.


One of the biggest stories in the U.S. economy in the last 35 years has been the phenomenal increase in the payoff to a college degree. Michigan hasn’t benefited from this trend as much as some other states, because we are below the national average in college attainment. But it’s not just about college. Michigan is under-invested in education from pre-school to Ph.D. In fact, developing skills in early childhood is the most important investment of all. For more on that, I highly recommend the new book, “Investing in Kids,” by Timothy Bartik of the Upjohn Institute in Kalamazoo.


Investment in early-childhood education is crucial to our future, and yet we have cut back on early-childhood education. Education through college and beyond is tremendously important, and yet we have cut back on K-12 and higher education. Governor Snyder’s budget will continue the trend of slashing education funding. That’s a mistake.


Some folks acknowledge the importance of education, but say we “can’t afford” to strengthen our educational investments. It isn’t true. If we want to support education adequately, the resources are there. All we have to do is reinstate some of the tax revenues we used to collect.


No one in Michigan can claim that we are really serious about education, as long as early-childhood programs are underfunded, as long as we don’t have full-day kindergarten for every child, and as long as many children attend school in outdated buildings. No one in Michigan can claim that we are really serious about education, as long as we have a school calendar of only 180 days. This calendar was established in the 19th century. Many competing countries have school for 200 days per year, or more. It’s no surprise that Americans score less well on math tests than students from other countries: Our kids simply spend less time doing math problems.


We should be increasing our investment in K-12 education, rather than cutting it back.


Governor Snyder’s proposed cuts to higher education are especially severe, since they come on top of the major cuts of the last eight years. Since 2003, we have reduced funding for all 15 universities by about the same percentage. But some folks have said we can’t afford to support 15 universities. So I decided to calculate how many we would have to close, to be equivalent to the real budget cuts of the last eight years. We would have to close Michigan Tech, Northern Michigan, Lake Superior State, Ferris State, Saginaw Valley State, Grand Valley State, UM-Flint, Oakland, UM-Dearborn, and Eastern Michigan, and cut Central Michigan in half. If Governor Snyder’s proposal is passed, we would finish off Central Michigan, and close Western Michigan.


As an employee of a university that is not on that list, I emphasize that I am not advocating such a draconian policy. I’m just trying to show that the cuts have been very large indeed.We cut taxes, and then say we “can’t afford” to educate our children. Instead, I believe we should move toward a different model. Under the new model, we would figure out how much we need to spend to get a first-rate educational system, and then come up with the necessary money.


Of course, we should continue to press for greater efficiency in the delivery of public education. There is still room for some school districts to save money by sharing office services with other districts, or even by consolidating. Also, no matter how much we spend, we will not get the desired results unless parents turn off the TV and get kids to do their homework. But we can’t do it properly without spending money.




Elimination of the Earned Income Tax Credit


For me, the proposal to eliminate the Earned Income Tax Credit is the biggest single disappointment in Governor Snyder’s budget.


The EITC is not an old-style welfare program. The EITC only supplements the income of low-income working families. If you don’t work, you don’t get any EITC.


President Gerald Ford signed the federal EITC into law in 1975. Since then, two dozen states (including Michigan) have passed laws to supplement the federal EITC. The federal EITC has also been expanded on three occasions. The first of these came in 1986, under President Ronald Reagan.


Reagan called the EITC “the best antipoverty, the best pro-family, the best job creation measure to come out of Congress.” Then and now, Reagan’s words were correct on all three counts: First, the EITC is one of the most effective anti-poverty programs ever devised. For the U.S. as a whole in 2009, the EITC lifted an estimated 6.6 million people out of poverty, including 3.3 million children.


Second, the EITC is pro-family, because it is targeted primarily at families with children. Third, research has shown that the EITC boosts employment, by supplementing the wages of low-income workers. It’s especially unfortunate to scrap the EITC at a time when most Michigan residents say that jobs are their top concern.




Further Reductions in Revenue Sharing


As its tax revenues have shrunk, the state government has often “dealt with” its budget deficits by passing the problem down to local units, in the form of reduced revenue sharing. As a result, local units have had to reduce police protection, fire protection, and many other services.


In addition to state aid, local governments in Michigan have traditionally relied on property-tax revenues. But these have shrunk in recent years, because of the decline in real-estate values. As a result of the double whammy of reduced state aid and reduced property-tax revenues, many local governments are experiencing severe financial stress. This is unfortunate, especially since it is completely unnecessary.


The state government could easily shore up its own revenues enough to avoid further cuts to local governments.




Reduced Compensation for State Employees


I commend Governor Snyder for avoiding the extreme anti-worker policies and rhetoric of Wisconsin’s Governor Walker. Still, Governor Snyder is looking for $180 million of additional concessions from state workers.


The total number of state workers is now only about two-thirds as large as it once was. If we exclude those who work for the Department of Corrections, the rest of the state workforce is only about half as large as it once was. Moreover, state employees have made a number of substantial concessions in pay and benefits in recent years.


Nevertheless, if state workers were “overpaid” (i.e., compensated a lot more than comparable workers in the private sector), then we might be able to reduce the compensation of state workers further, without sacrificing much in terms of the quality of their work. Thus it’s important to have a sense of how state-employee compensation compares with private-sector compensation.


If we just take a simple average, without making any adjustments, the average state employee has higher compensation than the average private-sector worker in Michigan. But unadjusted averages can be very deceiving.


The most important adjustment has to do with education. More than one-half of state employees have a college degree, compared with only about one-fourth of private-sector workers in Michigan. The state workforce has relatively large numbers of attorneys, doctors, engineers, social workers, and others whose jobs require a high level of education.


It’s difficult to make a complete comparison of public- and private-sector compensation, because pay and benefits are influenced by so many things. On balance, my sense is that state workers with lower levels of education and skill are compensated pretty well, when compared with their counterparts in the private sector. However, many state workers at higher skill levels receive substantially less compensation than they could get in the private sector.


If someone can earn more in the private sector, why work for state government? Many state employees are motivated, at least in part, by a sense of mission and public service. But a sense of mission doesn’t pay the bills. If we further reduce compensation for state employees, it will become more and more difficult to attract and retain qualified workers, especially for the most highly skilled positions.


When compared with their private-sector counterparts, many state workers have lower pay, but more generous benefits. It makes sense to move toward a better balance


between pay and benefits. But if we make big cuts to public-sector benefits, without any offsetting increases in pay, we will increasingly run the risk of being unable to find qualified workers.




Taxation of Retirement Income


Michigan exempts Social Security payments and all public pensions from the state income tax. We also exempt private pensions, up to a limit of more than $90,000 per year for a married couple. And we give senior citizens an exemption for interest, dividends, and capital gains, up to a limit that exceeds $20,000 for a married couple.


These provisions make Michigan one of the most generous states in the country toward retirement income. More than 90 percent of Michigan senior citizens pay no income tax. Also, seniors are eligible for an enhanced Homestead Property Tax Credit. This means that Michigan’s senior citizens make net payments of less than zero in the state income tax.


The revenue loss from these exclusions is pushing toward $1 billion per year. As our population gets older, the revenue losses get larger every year.


I expect to retire at some point in the next 10 or 15 years. Under current Michigan law, my income taxes will then go to zero, or nearly zero. And yet, I will still want the roads to be paved, even after I retire. I will still want Michigan to have state parks, even after I retire. I believe I should continue to pay income taxes, even after I retire.


I applaud Governor Snyder’s courageous proposal to tax some forms of retirement income. It’s courageous because the politics are difficult. But it’s a slam dunk from an economic standpoint. Michigan’s current tax treatment of retirement income is unfair and inefficient, a n d i t erodes the integrity of the tax system.


Various arguments have been put forth against Governor Snyder’s proposal. The most frequent criticism stems from special concern for low-income senior citizens. I am also very concerned about the plight of the low-income elderly (although I’m also concerned for younger low-income people, especially if they are raising children). If we want to provide some special protections for low-income seniors, we can do it, and I have no objection to that.


However, a very large part of the tax benefits of the current system are received by middle- and upper-income seniors. If we adjust Governor Snyder’s proposal to provide more protection for low-income senior citizens, the net result will still be a much-improved tax system. But if we scrap his proposal completely, we will have lost a major opportunity. Upper-middle-income retirees (such as myself in a few years) should pay income taxes.




Reductions in Some Special Tax Breaks


The proposal to tax some retirement income will move us toward a more level playing field between retirement income and income from working. In the same vein, Governor Snyder has proposed to limit some of the special tax breaks that have been handed out to businesses. This is a good idea, because it will move us toward a more level playing field between different sectors of the economy. The current system of high taxes on some businesses and subsidies for others is unfair and inefficient.


I want to comment specifically on Governor Snyder’s proposal to reduce the tax credit for the film industry, since it has generated the most controversy. It’s true that we have “brought jobs to Michigan” with the film tax credits. But the film credit covers 42 percent of a film crew’s operating costs! With a subsidy that generous, we can bring anything to Michigan.


If we cover 42 percent of the operating costs, we could have a thriving citrus-fruit industry in Michigan. And then politicians would point to the giant greenhouses, kept warm all winter long at taxpayer expense, and they would crow about the “jobs created” in the Michigan grapefruit industry. But it wouldn’t be a wise use of our resources. I applaud Governor Snyder’s proposal to scale back many of these tax credits.




Elimination of the Michigan Business Tax


Based on what I have written so far, some readers might expect that I am opposed to Governor Snyder’s proposal to eliminate the Michigan Business Tax. After all, ending the MBT does make the deficit worse. But the MBT has some really bad features. The worst part of the MBT is the “modified gross receipts tax.” In terms of economic efficiency, this is about as bad a tax as one could devise. It distorts the economy a great deal, and it does make it more difficult to attract businesses to Michigan. Governor Snyder’s proposal to eliminate the MBT, like several of his other proposals, would move us toward a more level playing field in our tax system. Thus I am OK with reducing the MBT, or even eliminating it, as long as we make up the revenues elsewhere.


Many of my progressive friends are more enthusiastic about the MBT than I am. This may be partly because of a disagreement about who really pays the MBT.


In the short run, the MBT is probably paid mostly by business owners. Since many business owners are affluent, this could be seen as a progressive tax. But the economy adjusts to taxes in complicated ways. Ultimately, a large part of the MBT is probably borne by consumers (in terms of higher prices) or by workers (in terms of lower wages).


Thus I am strongly in favor of eliminating the gross-receipts portion of the MBT, as well as the MBT surcharge. I’m even OK with going all the way to complete elimination of the MBT, as proposed by Governor Snyder, as long as we make up the revenues.




Other Sources of Revenue


I have repeatedly emphasized the importance of finding more revenue, so we can have solid transportation infrastructure, a topquality education system, and other vital public services. If we are to do this, we must go beyond Governor Snyder’s proposals. Where will the additional money come from? In fact, there are many possible sources of additional tax revenue in Michigan. The se include the estate tax and the taxes on beer, wine, tobacco products, and motor fuels. But the two most important potential revenue sources are the income tax and the sales tax.




The Income Tax


In the last 35 years, most of the income growth has been at the top of the income scale. Thus the ability to pay taxes is increasingly concentrated. This strengthens the case for increasing our reliance on the income tax.


Michigan is one of only seven states with a flat-rate income tax. Most states have a graduated income tax, with higher rates on those with higher incomes.


I believe we should have a graduated income tax in Michigan. However, a graduated income tax would require a constitutional amendment, so it is unlikely to occur soon.


In the meantime, we could raise the flat rate of the current income tax. Michigan’s rate is 4.35 percent. If we increase the rate to 5 percent, we would collect an additional $1 billion per year of tax revenue. Much of the additional revenue would effectively be paid by people in other states, because state income taxes are deductible from the federal income tax.




The Sales Tax


In Michigan, as in most states, the sales tax does not apply to many services and types of entertainments. Over the years, services and entertainment have grown more rapidly than the things that are taxed. As a result, the sales tax applies to an ever-shrinking part of the economy. We should extend the sales tax to services and entertainment. Governor Snyder does not propose to broaden the sales tax. However, doing so would be consistent with the theme of his other tax proposals, in that it would level the playing field.


Politically, it won’t be easy to extend the sales tax to services and entertainment. But economically, it’s a no-brainer.


The current system is unfair and inefficient, and it has greatly reduced our ability to provide key public services.




Conclusion


To eliminate the deficit, it’s necessary to find some combination of tax increases and spending reductions. Almost all tax increases and spending reductions will meet with political opposition. Thus Governor Snyder did not have the option of proposing a budget that would make everyone happy. I applaud his courage in tackling some very difficult issues.


I have made the case that several of Governor Snyder’s proposals would be good for Michigan, and I believe we can use these proposals as a good starting point. However, tax revenues have fallen dramatically over the decades, and this has crippled our ability to provide many essential public services. If we are to build the kind of Michigan that our people deserve, we will need to go beyond Governor Snyder’s proposals. We will need to shore up our tax system, so that we can once again provide adequate public services, especially in education.



Charles Ballard has been on the Economics Department faculty at Michigan State University since 1983, when he received his Ph.D. from Stanford University. In 2007, he became director of the State of the State Survey in MSU’s Institute for Public Policy and Social Research. Also in 2007, he won the Outstanding Teacher Award in MSU’s College of Social Science. In 2011, he joined the board of directors of the Michigan League for Human Services. He has served as a consultant with the U.S. departments of Agriculture, Health & Human Services, and Treasury, and with research institutes in Australia, Denmark, and Finland. His books include “Michigan at the Millennium” and “Michigan’s Economic Future.”
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