A Policy Guide to Tax Cuts

Background

The state economy has lost more than 200,000 jobs since the COVID-19 pandemic began, the 10th worst recovery in the nation. Lawmakers can to do more to encourage economic growth and get people back to work. One of the important policy options open to them is to reduce the state’s tax burdens. This is why lawmakers ought to reduce the state’s individual income and corporate income tax rates.

Tax rates have an impact on economic growth. Business managers want to be profitable, and taxes on their profits discourage investment and job creation. Taxing income at lower rates creates long-term benefits: It encourages business managers to invest in Michigan, and this improves income and job growth. This happens not just in the year when lawmakers lower taxes, but also in the years that follow.

A business can earn more after taxes in some states than in others, so states compete over tax policy. It’s not the only thing that matters, but if a state lowers its tax rates, that gives businesses a powerful incentive to expand there.

Other states have lowered their rates recently, and Michigan is falling behind. According to the Tax Foundation, 14 states have cut their tax rates since the pandemic began. This includes Ohio, which now assesses lower taxes on income than Michigan.

Lawmakers need to act. Specifically, they ought to lower the personal income tax rate from 4.25% to 3.9% and the corporate income tax rate from 6% to 3.9%. Doing so would improve the state’s tax competitiveness and improve the state business climate. It would encourage long-term economic growth in the state, which would make Michigan more prosperous.

Some lawmakers hesitate to lower taxes out of concern that lower rates will generate less money for the state budget, and Michigan operates with a balanced budget requirement. Over the long term, a tax cut can pay for itself through encouraging greater economic growth — and therefore larger tax receipts — but lawmakers need to consider short-term effects, too. So they need to find money within the budget if they want to lower tax rates. This is easier to do right now than in years past because state revenues are up. Even though Michigan has lost jobs since the pandemic began, state tax collections have increased. The most recent state budget spends $3.6 billion more than the one from the year before COVID hit — 10.4% more. Lawmakers may have even more money than that, since more taxes are coming in than expected. Plus, lawmakers have billions in unallocated money sitting in their funds, due to strong revenue growth.

And finally, Michigan lawmakers increased the personal income tax from 3.9% to 4.35% in 2007, and the tax rate was supposed to return to 3.9% after a few years. That didn’t happen, as lawmakers made a modest cut in 2011 but never completely repealed the rate increase. Now that tax cuts are manageable, lawmakers ought to revisit the idea of what was promised to be a temporary increase.

The details of the reform:

Tax cuts are a simple but important policy; they can be implemented by approving two simple bills. One reduces the state’s personal income tax rate from 4.25% to 3.9%. Another reduces the state’s corporate income tax rate from 6% to 4.5%.