Gov. Rick Snyder says the new federal tax law may have inadvertently caused the state to eliminate its personal exemptions, which exempt from the state income tax $4,000 per taxpayer and for every dependent in the household. There is a bipartisan consensus between Michigan legislators and the governor to quickly amend state law, if necessary, to avoid this.
But Snyder proposes to go further and increase the state personal exemption to $4,500. This is a change from a year ago, when the governor helped kill a state income tax rate cut by persuading 12 House Republicans to vote against it.
A Senate fiscal office analysis of the proposal to increase the tax exemption estimates that Snyder’s version would let Michigan families keep $150 million more of what they earn each year. Even with that hit, state revenue would be expected rise by $750 million next year.
But if the state can now afford to let residents keep more of their own money, there is a better way than raising personal exemptions.
Not everything that reduces state government revenue is a tax cut. The billions of dollars that lawmakers hand out to a select handful of companies in the form of refundable tax credits, for instance, are not tax cuts but a form of spending that benefits a few favored special interests.
The personal exemption that Snyder wants to increase does not change state government’s authority to take 4.25 percent of every dollar you earn. It instead exempts households from their first $170 of taxes, and more for every child in the household. Outside of making the system a little more progressive, it may create a slight incentive to have more kids, though it is a stretch to claim it has a meaningful effect on a person’s decision to do so.
The better option is to lower the income tax rate itself. Doing this lets people keep more of what they earn and makes Michigan more competitive with other states. Both Indiana and Illinois still tax income at a lower rate than Michigan.
A rate cut can also increase job security for workers. Michigan’s dynamic economy, like the nation’s, constantly experiences tremendous job churn. Every three months, around one out of 20 Michigan jobs disappears, and when times are good, it is replaced by a new job, or slightly more than one new job.
When the state takes less of what you earn — say, 4 percent instead of the current 4.25 percent — this encourages businesses to hire more people and shed fewer jobs. It also helps grow the state economy by encouraging more people to move here.
Importantly, job growth is associated with income tax rate cuts and not with increases in the personal exemption. While exemptions do let some people keep more of their money, it is not as clear that they have growth-inducing effects on the overall economy. Legislative discussions will show whether growth matters when lawmakers talk about taxes.
James M. Hohman is director of fiscal policy at the Mackinac Center for Public Policy.