by Robert Kleine, Vice President and Senior Consultant
|This report is the fourth in a series examining the fiscal effects of the two proposals on individual and business taxpayers and on the state budget.|
In late December the legislature completed work on school finance reform with some of the most important legislation in Michigan history. This may not be the revolution that some expected or hoped for, but the package includes more than 20 public acts that will affect everyone and nearly every institution in Michigan: school districts, taxpayers, businesses, state departments and programs, and the economy.
On March 15 the public will decide between a statutory proposal that will raise the income tax to 6 percent or a ballot proposal that will increase the sales tax to 6 percent (and reduce the income tax to 4.4 percent). Both proposals provide the same fiscal support to the schools, but each has a considerably different effect on taxpayers. Exhibit 1 presents a summary of the major provisions of the two plans.
As shown in Exhibit 2, Public Act (P.A.) 145 of 1993 reduced school operating property taxes by about $6.9 billion, or $6.1 billion net of state homestead property tax credits. The statutory plan would increase taxes by $5.9 million, leaving a tax cut of about $200 million that would reduce federal tax deductions and increase federal income tax collections by about $62 million, leaving a net tax cut of $134 million.
The ballot plan would increase taxes by $5.65 million, providing taxpayers with a tax cut of about $400 million. However, because the sales tax is not deductible for federal tax purposes and property taxes are deductible (as are income taxes), the dollar value of deductions claimed by taxpayers would be lower and federal income taxes would be $294 million higher.
Consequently, the net tax reduction under the ballot plan would be only $110 million. The size of the net tax cuts under both proposals would not be significant since the error in these estimates could easily exceed the amount of the cuts.
It would be fair to characterize both proposals as being revenue neutral (i.e., the changes would yield neither gains nor losses in revenue). It should be noted, however, that there will a significant tax cut in calendar year 1994, about $1 billion, as there will be a full year of property tax relief, while the replacement taxes will only be in effect for eight months.
The share of taxes paid by business would increase under both proposals but would be slightly higher under the ballot proposal (see Exhibit 2). Business (excluding agriculture) currently pays about 34 percent of the property tax.
Because individuals lost state tax credits due to the reduction in property taxes under P.A. 145, business received 41.5 percent of the net tax reduction (before federal deductibility). Business would pay about 46 percent of the increased taxes under the ballot proposal and about 44 percent under the statutory proposal.
Under either proposal, business would pay 24 mills of school operating millage (more in a few districts), about the same dollar amount under both proposals, and a smaller share of the larger total amount raised by the statutory plan. Although business would escape paying the SBT under the ballot proposal, it would pay an estimated 27 percent of the two-cent sales tax increase imposed by the ballot plan.
Both the statutory and the ballot plans provide a generous level of funding for K–12 education. Although the overall increase is a relatively modest 4.8 percent above FY 1993–94 (adjusted for one-time items), most districts are receiving substantially larger increases. The modest increases for richer districts hold down the overall increase. In addition, if the $300 million transitional payment made in FY 1993–94 is counted in FY 1994–95 (since the payment is an advance on 1994–95 payments), the overall increase is almost 8 percent.
Initially, there was concern that this large increase would require substantial cuts in the remainder of the state budget. Due to the rapidly improving economy, however, revenue estimates have been revised sharply upward, largely eliminating the need for budget reductions (see Exhibit 3). In fact, it appears that in FY 1994–95 there will be an excess of money in the school aid fund. This excess will occur because most of the tax increases take effect on May 1, which would generate close to $1.5 billion under the ballot plan and about $1.4 billion under the statutory plan.
Both plans would require transition expenditures of $488 million in FY 1993–94, producing a carryover surplus of nearly $1 billion under the ballot plan and about $915 million under the statutory plan. As a result, in FY 1994–95 there would be a surplus in the general and school aid funds of $706 million under the ballot plan and $948 million under the statutory plan.
State Tax Limit
A major factor in shaping the school finance proposal was the limitation on state taxes imposed by Section IX, Article 26 of the state constitution. This section restricts the amount of the revenue the state may collect in any fiscal year to 9.49 percent of Michigan personal income (i.e., personal income for the calendar year preceding that in which the state fiscal year begins). To stay under the limit, the legislature was required to restore a portion of the local property tax (under both proposals)
It appears that state revenues will fall under the tax limit in FY 1994–95 by an estimated $435 million if the statutory proposal is adopted, but only $40 million under the limit if the ballot proposal is adopted (see Exhibit 4). Little room is left to raise taxes in the future should the need arise, especially under the ballot proposal.
The need to levy hospital provider or other taxes to replace federal Medicaid funds could push the state over the constitutional limit. In addition, a one percent change in personal income on the downside would reduce the revenue limit by about $200 million. These numbers can easily change by several hundred million dollars in either direction, but the available margin leaves no room for events that would raise revenues or reduce the revenue limit, particularly under the ballot proposal.
The large surpluses generated by both school finance plans raise some interesting policy questions. What should the legislature and the governor do?
The effective dates of the taxes could be delayed past May 1 to raise less money in FY 1993–94, but this would require revisiting the tax bills, which could create opportunities for mischief. Another possibility would be to lower tax rates or drop one of the taxes, such as the property transfer tax, although this could result in a shortfall in the future and again require revisiting some of the tax bills.
Under the ballot plan, another option is to transfer money to the general fund to cover the projected deficit. In any case, it is possible to increase spending on programs such as higher education or mental health or to increase K–12 spending.
Our view is that, overall, the December legislation gives schools too much money—although clearly some districts have been underfunded. Little effort was made to encourage more cost containment or to reflect cost differences among districts. Some rural districts will receive more money than they need. One effect of this increase to the districts is likely to be pressure to increase salaries.
Under either proposal, the schools and the Michigan Education Association are the big winners, and the business community is the big loser. It remains to be seen how taxpayers will react.
Overall, the two plans are essentially revenue neutral, but a number of taxpayers will pay more taxes than they did before, while many others may be unhappy that they didn’t receive more tax relief. The largest gains will go to a relatively small number of high-income taxpayers who probably won’t send thank-you notes to Lansing.
From a political standpoint, politicians will be best off if the ballot plan passes because property taxes will be lower (6 mills vs. 12 mills), the sales tax increase will be much less noticeable than the income tax increase, and the limit on assessment increases should prove popular. Whether the voters recognize this on March 15 remains to be seen.