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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 2007, the exemptions are $3400 for each exemption claimed on your federal tax return PLUS

• $2200 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

• $600 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 2007 federal Health and Human Services Department poverty guidelines:

Now lets compare exemption totals with poverty guidelines for an assortment of households:

	Exemption Total	Poverty Guideline
Single adult	$3,400	$10,210
Single adult over 65	$5,600	$10,210
Single adult getting 50% of income from UCBs	$4,000	$10,210
Two adults and 2 children	$14,800	$20,650
One adult and 5 children	$23,400	$27,610

As you can see, the income protected by our current exemptions is much less than the poverty guidelines, especially for adults under 65. 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 12 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.  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 15-18 and some of 19 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 2007 tax year: 

We also had business losses of $1,042 which reduced the taxable amount for federal tax purposes (adjusted gross income) to $47,022. Our federal tax for 2007 was $3489. Our state tax was zero. Actually, we got a $847 “refund”, which was our homestead property tax credit. Although our gross income was $59,872, 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 $678:

$47,022	adjusted gross income from federal return
-9,000	two regular exemptions @ $3,400 plus $2,200 for one senior
38,022
x .0401	the tax rate for 2007 (3.9% thru September, 4.35% Oct.- Dec.)
1,525
-847	property tax credit
$678

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.  

According to the Department of Treasury, subtractions from income totaled over $76 billion in 2005. In a Freedom of Information Act request, I asked Treasury for a breakdown by item and they said they don't have it. Over $76 billion in untaxed income, and although we report it to them item by item on our Schedule 1, they don'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 has decided to capture the data on 2007 returns, and the data should be available in about a year.

In the meantime, I was able to get some "Individual Income and Tax Data" for Michigan for 2006 from the IRS. These amounts were all reported in adjusted gross income (AGI). Amounts are in thousands of dollars:

IRA distributions	4,880,522
Pensions and annuities	17,692,199
Social Security benefits	5,958,059
Self-employment retirement plans	417,046
Total:	28,947,826

All of the above are subtracted from income for state income tax purposes. The AGI for all Michigan taxpayers in 2006 was $223.373 billion, so the above total is over 12% of AGI. Had that amount been taxed at 4.01%, the average rate for 2006, it would have generated $1.16 billion in revenue.

The following types of income were also listed on the IRS report. For the state income tax, they are subtracted only for taxpayers over age 65 and the subtracted amount is limited to a maximum of $9,128 on a single return or $18,255 on a joint return. Also, the maximum must be reduced by the amount subtracted for retirement pensions. A lot of people who receive these types of income are over 65. We can assume that a substantial portion of this $23+ billion was subtracted from income subject to the state income tax (amounts are in thousands of dollars):

Taxable interest	6,031,011
Ordinary dividends	5,306,990
Net capital gain (less loss)	11,805,643
Total:	23,143,644

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 2007 was $847. If I had not turned 65 in 2007, it would have been $508. The average property tax credit for seniors in 2005 was $735. For non-seniors, it was $493. (Source: Michigan's Individual Income Tax, page 1)

In 2005, homestead property tax credits received by seniors totaled $306,092,400. (Source: Executive Budget Appendix on Tax Credits, Deductions, and Exemptions, page 64)  Had that group not been over 65, the credit would have been 60% of that amount, or $183,655,440. The difference - the senior bonus - is $122,436,960.  

Stop favoring seniors. Seniors get a lot of tax breaks. Here are the known revenue losses (amounts are in thousands of dollars):

Exclusion of pensions, IRAs and Social Security (2006)	1,160,000
Homestead property tax credit bonus (2005)	122,437
Special exemption for senior citizens* (2005)	29,900
Total:	1,312,337

An analyst with the House Fiscal Agency tells me that each 0.1% of the personal income tax represents $166 million in revenue, so eliminating just those breaks for seniors for which the revenue losses are known would allow the rate to be reduced by nearly 8 tenths of a percent, from 4.35% to 3.55%. As yet unknown are the losses from not taxing dividends, interest and net capital gains received by taxpayers over age 65. We do know from the IRS report that the total reported by Michigan taxpayers of all ages in 2006 was over $23 billion.

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 2006 federal income tax returns from Michigan residents that reported Social Security benefits, 51% 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.

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.