Fiscal Time Bomb Quietly Advances in Michigan

Years of debate over how to boost funding for Michigan’s roads may be nearing an end.  But somewhere along the way, that debate was hijacked in a way that few people seem to have fully noticed.

Earlier this week, the Michigan House passed a road funding package that would raise the gasoline tax by 3.3 cents per gallon, raise the diesel tax by 7.3 cents, boost vehicle registration fees by roughly 40 percent, and offset some of these regressive tax increases with an expansion of the state’s circuit breaker tax credit for low- and moderate-income homeowners and renters.

So far, so good.  But these changes aren’t the real story.

Buried beneath talk of those 3.3 extra pennies that motorists would pay for a gallon of gasoline is a provision that could eventually eliminate the state’s single largest, and fairest, source of revenue: the personal income tax.  Under SB 414, which has passed both the House and Senate in slightly different forms, income tax rate cuts would be triggered whenever general fund revenues grow faster than inflation.  Unlike recent triggers enacted in states such as Oklahoma, SB 414 does not specify a target income tax rate and thus rate cuts would continue until the tax vanishes entirely.  In the House version of the bill the first cuts could begin as early as 2019, while the Senate’s version would start the process in 2018.

There are a multitude of problems with this approach.  Among them:

• The cost of these triggered cuts would be enormous.  The Michigan League for Public Policy (MLPP) explains that the state’s most recent budget “falls short in key areas related to economic growth and opportunity, and many investments are not on a scale that will make Michigan a comeback state for all of its residents.”  And yet, the Michigan House Fiscal Agency (HFA) explains (PDF) that if SB 414 were in effect right now, the result in 2016 would have been roughly $700 million less to invest in public services (caused by a drop in the income tax rate from 4.25 to 3.92 percent).  That revenue loss would compound as additional rate cuts are triggered.
• Michigan already has a regressive tax system where low- and middle-income families pay 9 percent, or more, of what they earn in state and local taxes.  High-income families, meanwhile, pay just 5 percent of their incomes in tax.  As ITEP’s Who Pays? analysis shows, the state’s personal income tax is the only major tax on the books running counter to this unfairness.  Cutting or repealing the income tax would primarily benefit those wealthy individuals who already face the lowest state and local tax rates.  According to Who Pays?, four of the five states with the most regressive tax systems in the country do not to have an income tax—hardly a group that Michiganders should be eager to join.
• SB 414 is designed to appear fiscally responsible by allowing income tax rate cuts to take effect only when overall revenue growth exceeds the rate of inflation.  In this case, inflation is measured for the cost of products typically purchased by household consumers—known as the Consumer Price Index (CPI).  But the CPI is not a reliable measure of the costs that Michigan’s state government will incur in the years ahead.  As we explain in our brief outlining Colorado’s disastrous history with a somewhat similar inflation-based formula, growth in the cost of services such as medical care, education, and infrastructure has routinely outpaced growth in the CPI.  This suggests that SB 414’s inflation measure is a poor gauge of the state’s fiscal trajectory.
• Even if the CPI were a relevant measure of inflation for these purposes, the Michigan proposal’s vulnerability to the “ratchet effect” would still guarantee its fiscal irresponsibility.  If revenues plummet in one year because of an economic downturn and then partially recover in the following year, that modest recovery could trigger an income tax rate cut even if the state’s revenues remained far below their pre-recession levels.  In other words, every recession would lower the bar needed to trigger an income tax rate cut to the point that even an anemic recovery could be enough set it off. 
• While an economic recovery may be the most frequent scenario in which an unaffordable income tax rate cut would take effect, it is by no means the only scenario.  The Michigan HFA, for example, explained in its analysis (PDF) of the bill that a “one-time revenue increase” caused by unusual economic events or federal tax changes could also result “in a permanent reduction in the income tax rate.”  If that happens, Michigan will find itself trying to provide the same level of services, with a lower income tax rate, even after the temporary tax windfall that triggered the rate cut is no more than a distant memory.

Michigan Rep. Jim Townsend recently called this income tax trigger proposal “the ugly conclusion to what term limits have brought us.”  This is in reference to the fact that Michigan’s fairly strict cap on the number of years that lawmakers can hold office will mean that many—if not most—of the lawmakers voting for this trigger law will no longer be in the legislature when it comes time to deal with its full budgetary consequences.

Enacting tax cuts that will not take effect for years, and even decades, in the future under the mistaken impression that SB 414 will be able to accurately gauge their affordability is a major gamble that is unlikely to pay off.  Michigan residents would be better served if their lawmakers refocused their efforts on the issue that is supposed to be at the core of their work: finding a way to fund the state’s deteriorating transportation infrastructure.