Michigan's Economic Future: A New Look

6. The Tax System in Michigan

2 173 2 The Tax System in Michigan I n the words of Supreme Court Justice Oliver Wendell Holmes Jr., “Taxes are what we pay for civilized society.” On the other hand, nobody enjoys paying taxes, and taxes can damage the workings of the economy. The tension between the benefits of public services and the costs imposed by taxes is one of the most important concerns of economics. One of the central objectives of tax policy is to choose the best possible overall level of taxes. Another objective is to choose the best possible mix of income taxes, sales taxes, property taxes, and other revenue sources. These two issues are closely related, and I will discuss both of them in this chapter. I will argue for changes in the overall level of taxes, and I will also argue for changes in the mix of taxes in Michigan. First, however, we begin with a brief tour of the tax system in Michigan.1 When I discuss the tax system, I will usually focus on the combined tax systems of the state government and the various local governments. In Michigan (as in most states), local governments and school districts receive a great deal of their funding from the state government. Therefore it usually makes sense to think of the state tax system and the local tax systems as parts of a whole rather than as separate entities. This is especially important if we want to make comparisons among the states. There is great variation in the degree to which the tax system is centralized at the state level. If we compare states 6 174 2 MICHIGAN'S ECONOMIC FUTURE by focusing only on state taxes, or only on local taxes, we can get misleading results. In fact, with the passage of Proposal A, Michigan went from having one of the more decentralized revenue systems to having one of the more centralized systems. A Brief Overview of the Michigan Tax System In many ways, the Michigan tax system is quite similar to the state and local tax systems in most states. Michigan has an individual income tax, as do fortytwo other states and the District of Columbia.2 Michigan also has a general retail sales tax, as do forty-five other states and the District of Columbia.3 Every one of the fifty states and the District of Columbia uses property taxes (which are especially important for local governments), as well as taxes on alcoholic beverages, tobacco products, and motor fuels. Table 6.1 compares the state and local tax system in Michigan with the average of the state and local tax systems in the United States in 2006–2007. These data are from the U.S. Census Bureau’s Census of Governments, which provides the highest-quality information on the finances of state and local governments .4 The downside of having data of such quality is that the Census Bureau takes a long time to release the information.5 Thus the information in Table 6.1 is three years old. Although we don’t have information that is quite as complete for more recent years, we do know a fair amount about what has been going on since 2007, especially at the level of the state government. Thus, in the remainder of this chapter, I will also discuss many of the changes since 2007. Table 6.1 shows that in 2007 property taxes accounted for a substantially higher percentage of tax revenues in Michigan than in the rest of the country. Property taxes were more than 39 percent of state and local tax revenues in Michigan but only about 30 percent for the United States as a whole. However, the percentage of the economy that goes to state and local taxes in Michigan is smaller than the national average. Thus when we take property taxes as a percentage of income (rather than as a percentage of all taxes), Michigan’s property taxes are not quite as unusual, although they are still above the national average. Michigan reduced its reliance on property taxes very substantially in 1994 with the passage of Proposal A. (We will discuss Proposal A in more detail below.) Thus if Proposal A had not passed and Michigan’s government had THE TAX SYSTEM IN MICHIGAN 2 175 not made any other changes, Michigan would be even more out of line with the rest of the country...