Taxes should be fair, which to me means they should be based on ability to pay. For that reason, my favorite Michigan tax is the personal income tax. It is a flat percentage of adjusted gross income (AGI) with personal exemptions to protect low-income people. Some people want to make the rate progressive, like the federal income tax. I want to keep it flat. But I would make some major changes.

Exemptions. For tax year 2009, the exemptions are $3600 for each exemption claimed on your federal tax return PLUS

• $2300 for each person who is over 65, deaf, blind, hemiplegic, paraplegic, quadriplegic, or totally and permanently disabled

• $600 for each child age 18 and under

• $2300 if your unemployment compensation is 50% or more of your Adjusted Gross Income

If the purpose of exemptions really is to protect the low-income people, the total of the exemptions for a household should be about the same as the poverty level for a similar household. Here are the 2010 federal Health and Human Services Department poverty guidelines:

Now let's compare exemption totals with poverty guidelines for an assortment of households:

	Michigan Exemption Total	Federal Poverty Guideline
Single adult	$3,600	$10,830
Single adult over 65 or getting 50% of income from UCBs	$5,900	$10,830
Two adults and 2 children	$15,600	$22,050
One adult and 3 children	$16,200	$22,050

As you can see, the income protected by our current exemptions is much less than the poverty guidelines. I would revise the exemptions so that family exemption totals match the poverty guidelines. I would also get rid of the special exemptions for seniors, the disabled and persons receiving UCBs.

Subtractions. The personal income tax doesn't tax all income. It starts with the adjusted gross income (AGI) from your federal tax return, but then there are "additions" and "subtractions" that are reported on MI-1040 Schedule 1. There are 13 subtractions (the numbers are the line numbers from Schedule 1:

  8.  Income from U.S. government bonds and other U.S. obligations
  9.  Military pay from U.S. Armed Forces
10.  Gains from federal column of Michigan MI-1040D and MI-4797
11.  Income attributable to another state
12.  Retirement or pension benefits
13.  Dividend/interest/capital gains deduction for senior citizens
14.  Social Security benefits
15.  Income earned while a resident of a renaissance zone
16.  Michigan state and local income tax refunds received in 2006
17.  Michigan Education Savings Program
18.  Michigan Education Trust
19.  Venture Capital Deduction
20.  Miscellaneous 

Detailed explanations of each of the subtractions are in the instructions for Schedule 1.

I have no problem with some of these subtractions. Number 11, Income attributable to another state, makes sense if that income is already being taxed by the other state. And 15-19 and some of 20 are exemptions designed for specific public purposes. I might also be OK with #10 if I understood it. But the others are just ordinary types of income that the Feds consider taxable. There is no reason to believe that people receiving these types of income would suffer hardship if taxed. Take me, for example.

My wife and I are retired and our only income is from Social Security, pensions and interest. These are our figures for the 2010 tax year: 

Our federal tax for 2010 was $4604. Our state tax was zero. Actually, we got a $691 “refund”, which was our homestead property tax credit. Although our gross income was $70,083, the state paid us. Had our pensions and Social Security been taxable to the extent they are for the federal tax, we would have paid $1,336:

$56,097	adjusted gross income from federal return
-9,500	two regular exemptions @ $3,600 plus $2,300 for one senior
46,597
x .0435	the tax rate for 2010
2,027
-691	property tax credit
$1,336

There is no reason for pensions to be exempt. They are a form of wages - a delayed payment of wages. Part of the pension comes from contributions made to the pension fund by the employee, and if those contributions were made from after-tax wages, that part should not be taxed again. The “taxable amount” is the part that has never been taxed.  

In November 2007, I sent a Freedom of Information Act request to the Department of Treasury asking for a breakdown by item of total "subtractions from income" and they said they didn't have it. The net amount of additions and subtractions are expected to reduce income tax revenues by over $4.6 billion in 2010 (Executive Budget Appendix on Tax Credits, Deductions, and Exemptions, page 63), and although we report them item by item on our Schedule 1, Treasury didn't have totals by item. I followed up with a letter to State Treasurer Robert Kleine saying that the information would be very helpful to policy makers. I urged him to make the system changes necessary to collect the information. Jeff Guilfoyle of Treasury's Office of Revenue and Tax Analysis responded on behalf of Mr. Kleine saying that Treasury had decided to capture the data on 2007 returns, and the data should be available in about a year. (Jeffrey Guilfoyle now is president of the Citizens Research Council of Michigan.) So now we have some data. The following figures are from pages 20-21 of Treasury's analysis of the income tax for 2008:

Retirement/Pension Incl. in MI-1040	$20,934,400,000
Dividend/Interest/Capital Gain Exemption	1,088,400,000
Social Security	5,880,300,000
Total:	$27,903,100,000

The AGI for all Michigan taxpayers in 2008 was $257,476,500,000, so the total for the above "subtractions" is 9.2% of AGI. Had that amount been taxed at 4.35%, the rate for 2008, it would have generated over $1.2 billion in revenue.

Property Tax Credit. For seniors and the disabled, the homestead property tax credit is the amount by which property taxes exceed 3.5% of household income. If you are under 65, you only get 60% of that amount. No one with household income over $82,650 gets the credit.

Our property tax credit for 2010 was $691. If I wasn't over 65, it would have been $415.

In 2008, homestead property tax credits received by seniors totaled $349,200,000. (Source: Michigan's Individual Income Tax 2008, page 24)  Had that group not been over 65, the credit would have been 60% of that amount, or $209,520,000. The difference - the senior bonus - is $139,680,000.  

Stop favoring seniors. Seniors get a lot of tax breaks. Here are the known revenue losses:

Exclusion of pensions, dividends, interest, capital gains and social security (2008)	$1,200,000,000
Homestead property tax credit bonus (2008)	139,680,000
Special exemption for senior citizens* (2005)	29,900,000
Total:	$1,369,580,000

There is no reason for seniors to get a break on their state income tax. They are no worse off financially than other age groups. Of all the 2008 federal income tax returns from Michigan residents that reported Social Security benefits, 50.2% had AGI over $50,000 (source: IRS report), and when income includes Social Security and/or pensions, the gross is likely to be more than AGI. Seniors are also more likely to have medical insurance, either with their pensions or with Medicare. Anyway, an income tax by definition considers ability to pay: seniors with low incomes would pay little or no tax, just like anyone else with low incomes.

When one group does not pay its share, the burden is greater for other taxpayers. Ending tax breaks for seniors would allow the income tax rate to be decreased for all of us. As the Department of Treasury puts it in their analysis of 2008 income taxes (page 19):

The favorable treatment of pension income and interest, dividend and capital gains results in filers with similar income facing significantly different tax burden, with younger filers shouldering a heavier tax burden than older filers.

The Michigan Income Tax was enacted in 1967. Here is a history of changes to the tax that affected seniors.

Income tax breaks for seniors are not unique to Michigan. This report on the website of the National Conference of State Legislators talks about how all 50 states tax pensions and social security. Most states to some extent exempt pensions and social security from their income taxes, but some don't. California taxes pensions, but doesn't tax social security. Minnesota, Nebraska, Rhode Island and Vermont tax pensions and tax social security to the same extent the federal government does.

The following is from a story that appeared in USA Today on 9/17/2010:

Senior citizens are enjoying some of the biggest income gains in decades at a time when every other age group is losing ground in the recession, the Census Bureau reported Thursday. The 31 million households headed by people 65 and older saw their median income rise by a healthy 5.8% in 2009 after inflation and 7.1% since the recession began in December 2007. Every other age group has suffered income losses of at least 4% during the recession, the data show. Seniors got a lift last year from a $250-per-person Social Security bonus included in the federal stimulus program. That helped boost income more than any year since 1973 and led to seniors out-earning 15-to-24-year-olds for the first time.

"Retired folks are sheltered from big swings in the labor market," says Heidi Shierholz, economist at the liberal Economic Policy Institute. Deflation also helped because Social Security checks didn't decline even though prices did, she says. By contrast, the median income of working-age households has tumbled 4.6% in the recession.