Michigan Capitol | Photo illustration by Susan J. Demas
For decades, sluggish tax revenue and difficult funding decisions defined Michigan’s state government budgeting process.
Yes, total revenue went up every year. But it wasn’t nearly enough to keep up with inflation and address growing spending needs for roads, education, payments to local governments and other responsibilities of state government.
Oddly enough, the COVID pandemic changed all that. And to the surprise of many experts, healthy tax revenue growth has continued even after massive federal stimulus payments to individuals and businesses have largely ended.
Projections for combined general fund and school aid fund revenue jumped from $24.9 billion in January 2020, two months before COVID largely shuttered the economy, to an estimated $32.4 billion this year, a stunning 30% bounce.
There’s so much money flowing into the state Treasury that Michigan has an estimated $9.2 billion budget surplus.
But policymakers should use this time to craft a long-term budget strategy ensuring Michigan’s long-term fiscal health and economic vibrancy. History dictates that this unprecedented revenue growth is unlikely to last.
How did we get here?
Many feared workplace shutdowns ordered in the early days of the pandemic in 2020 would decimate state revenues. Instead, the opposite happened.
Consumers stuck at home shifted purchases away from services exempt from sales tax to taxable goods. And federal stimulus payments boosted spending power.
A 2018 Supreme Court decision that allowed states to collect sales taxes from online sellers, even if the seller had no presence in the state, also buoyed sales tax revenues as home-bound consumers shopped online.
“That changed the game,” said Jonathan Brignall, assistant professor of accounting and taxation at Grand Valley State University.
Even high unemployment in the early months of the pandemic benefitted state coffers because jobless benefits are subject to the state income tax.
“It’s pretty amazing that there is so much more revenue than we were predicting not too long ago,” said Bob Schneider, senior research associate at the Michigan Citizens Research Council in a recent analysis of Gov. Gretchen Whitmer’s proposed Fiscal Year 2024 budget. “We thought the sky was falling at the start of the pandemic.”
Unexpectedly high personal income and sales tax revenue have kept the surge going, University of Michigan economists said in a November forecast. That’s despite employment in the state still being below pre-pandemic levels.
State personal income this year of $612.9 billion is expected to be 15.2% above 2019 income of $532.2 billion, according to a Michigan State University projection.
Even the highest inflation in 40 years hasn’t stopped consumers from spending on taxable goods, translating into higher state sales tax collections.
“When prices rise on taxable consumer goods, not to mention gasoline, sales tax revenue comes along for the ride,” U of M economists wrote.
Economists expect state tax revenues to dip a bit in the current fiscal year, which ends Sept. 30. But they’re expected to rise again through at least Fiscal Year 2025 as employment recovers to pre-pandemic levels.
Despite the rosy outlook, some perspective is needed. State general fund revenue is expected to be down 17% in Fiscal Year 2025 from 2000 in inflation-adjusted dollars.
New spending programs and tax cuts will deplete the state’s $5.2 billion budget surplus over the next two years. Whitmer earlier this month signed legislation that will boost the earned income tax credit and eliminate the “retirement tax.”
While low-income workers and those with retirement-related income are expected to pocket $1 billion, the tax cuts trim a like amount of revenue from the general fund. Plus, a probable cut in the income tax from 4.25% to 4.05%, triggered by state law, would cost about $700 million.
Although the state is seeing what Schneider said is unprecedented revenue growth, some storm clouds are gathering. U of M and other economists are predicting a mild recession this year, triggered by Federal Reserve interest rate hikes to battle inflation.
And Michigan’s automakers are suddenly cutting thousands of white-collar jobs in cost-cutting moves as they boost spending to develop electric vehicles. General Motors said Thursday it was offering voluntary buyouts to nearly all its 58,000 salaried workers.
Some say economic uncertainties should prompt policymakers to consider overhauling the state’s tax structure to ensure a sound fiscal future once the current pace of revenue growth inevitably slows.
Michigan could join 30 other states by switching from a flat rate income tax to a graduated tax in which wealthier taxpayers pay a higher percentage of their income. A 2019 Michigan League for Public Policy recommendation said a graduated tax could generate more revenue than a flat-rate tax, increase fairness and result in a tax cut for most taxpayers.
Likewise, lowering the state’s 6% sales tax and spreading it across more untaxed services could also help insulate the state budget from cyclical swings in the state’s manufacturing-based economy.
Both ideas would be extremely difficult to implement. The state’s fixed-rate income tax is enshrined in the state Constitution and would require voters to change it.
And Brignall said there would likely be ferocious lobbying by business groups to prevent extending the sales tax to services.
Schneider said there’s a danger that proposed one-time expenditures in Whitmer’s budget, such as more money to attract battery plants and to replace lead water service lines, could become permanent.
If that were to happen, then the budget is “not sustainable,” Schneider said.
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