Brief commentaries and opinion pieces on issues of the day. Published periodically, sometimes in conjunction with Michigan Roundup.
Written by various staff members.
February 9, 1996
Michigan Income Tax: Proposed Changes
by Robert Kleine, Vice President & Senior Economist
Recently, a group of 20 Michigan Democrats called for major changes in the state’s income tax, including
lowering the rate from 4.4 percent to 3.9 percent,
- raising the personal exemption from $2,400 to $2,600,
- adding deductions for child care,
- increasing credits for college tuition, and
- eliminating income taxes for people living below the poverty line (nationally, the 1995 figure is estimated to be $12,300 for a family of three).
The changes would be phased in over several years and, when in full effect, reduce state revenue by up to $2 billion. Several questions come to mind.
Can the State Budget Afford Another Significant Tax Cut?
State taxes already have been reduced by about $1.5 billion over the past three years. My view is that given the uncertainty about the federal budget and the economy, the state cannot afford a further cut. Without welfare reform and Medicaid block grants, Michigan will be facing the need for a substantial increase in state budget dollars. There also are clear signs that the economy is slowing, among them weaker-than-expected state income and sales tax revenues in the first two months of this fiscal year.
One further point—often overlooked—is that the income tax is the fastest growing of the major state revenue sources. In view of all the recent changes in the tax system, which overall will slow the growth in state revenues and add instability, I think it would be unwise to reduce the importance of such a key revenue source.
Are Tax Cuts the Most Effective Way to Use $2 Billion in Revenue?
To help with college tuition, for example, it might make more sense to increase higher education appropriations, which would slow tuition increases, rather than provide tax credits for college tuition. I favor the appropriations approach because it has the advantage of direct accountability and legislative oversight. Tax credits, once passed, tend to assume a life of their own, regardless of whether they are achieving their intended purpose, and they are very difficult to eliminate.
Do We Really Need to Reform the Income Tax?
In answer, one should compare Michigan with other states, looking at the tax burden at various income levels. Of the 41 states that levy an income tax, Michigan is one of only five with a flat rate (a graduated rate is prohibited by the Michigan Constitution). With a flat rate, generous exemptions and/or credits are needed to relieve the tax burden on low-income individuals and families. And Michigan does have a generous personal exemption: In 1994, when the exemption was $2,100 (it will increase to $2,400 in 1997), only three states were more generous. Nevertheless, Michigan has relatively high income taxes on low-income individuals and families and low taxes on wealthier taxpayers.
The exhibit shows for Michigan and the other Great Lakes states (1) the state income tax liability of a two-wage-earner family at various income levels and (2) where the liability ranks among the 41 states that levy such a tax. For example, in Michigan a two-wage-earner family earning $15,000 pays $295, 6th highest among the 41 states, while a two-wage-earner family earning $200,000 pays $8,565, only 32d highest. At the lower income levels, the tax in Michigan is higher than in Minnesota, Wisconsin, and Ohio. At the higher levels the reverse is true: At $200,000, Michigan is well below Minnesota, Wisconsin, and Ohio but above Illinois and Indiana, which, among the 41 states, have the lowest rates.
I do not believe that either major cuts in or reforms to the state income tax are needed. Everyone wants to jump on the flat tax and tax simplification bandwagon, but Michigan already has a flat tax and the state income tax is relatively simple. The only changes that might be justified are increasing personal or family exemptions and enacting a state earned-income tax credit, which would reduce the tax burden on low-income individuals and families. Certainly, the Democrats’ goal to eliminate income taxes on people living below the poverty line is worth pursuing.
February 23, 1996
Privatizing Social Security . . . An Idea Whose Time Has Come
by Robert J. Kleine, Vice President & Senior Economist
One of the hottest topics on the campaign trail this year is Social Security. It is common knowledge that the trust fund, which is currently running a $60-70 billion surplus, will not have sufficient funds to pay benefits in about 25-30 years, when a large share of the huge “baby boom” generation begins drawing benefits. The conventional ideas for dealing with this problem include raising payroll tax rates, increasing the retirement age, or means testing benefits (reducing benefits for higher-income persons). A more radical idea being advanced by some presidential candidates is to privatize all or a portion of the Social Security system. Recently, some members of President Clinton’s Advisory Committee on Social Security indicated they would favor privatizing a portion of Social Security; the committee’s proposal is expected to be presented to the president in March.
The proposal likely will be to give workers the option of putting two to three percentage points of their seven-percent Social Security payroll tax contribution into an individual retirement account (IRA). This could have some dramatic effects on the economy. If two percentage points of the payroll tax were diverted into privatized accounts, $60 billion more a year could flow into stocks, bonds, mutual funds, and other investments. This would increase the pool of savings available for capital investment and provide a strong stimulus to the stock market. At an annual rate of return of eight to ten percent, retirement benefits would be much higher than under the current system, which would mean higher consumer demand for goods and services (many years down the road). For most workers, the rate of return from the current system is much less; in fact, without reform, some higher-income workers will likely receive less from the system than they contributed. Also, in a country with an aging population, the number of workers per retiree declines, resulting in the working population subsidizing the retired population. This would not be the case in a privatized system, thus reducing the potential for intergenerational conflict. A final important benefit of privatization is that it could forestall some painful changes associated with the alternative proposals.
Privatization supporters point to Chile, which privatized its pension system in 1980 and has had excellent results. The average annual return on invested funds has been fourteen percent, resulting in a large number of workers retiring early. The government guarantees a minimum pension, serves as an insurer of last resort, and closely regulates the companies that invest workers’ funds.
There are some major drawbacks to privatization. First, diverting money from the payroll tax would reduce funds available for those persons retiring in the next ten to fifteen years, requiring a huge influx of new revenues to bridge the gap between the old and new systems. It is unclear where these funds would come from; adding to the deficit would clearly be unacceptable. This is a major barrier to moving to a privatized system. Some have proposed that a portion of the cost be covered by defaulting on the obligation to workers under a certain age, 30 for example. Although polls show that many younger workers do not expect to receive their Social Security benefits, this could be political dynamite. Second, if the affluent opt out of the system, as is likely, the remaining participants, who earn and contribute less, would place a further drain on the system. Third, some will object to turning a social program into a tax-sheltered savings account that would primarily benefit the middle- and upper-income classes. Fourth, there would be major differences in retirement benefits based on money-managing ability. Many people would probably choose mutual funds, which may be less risky than having individuals manage their own money, but results will still vary widely. Also, what happens to those who make bad decisions and end up with inadequate pensions? The government likely would have to guarantee a minimum pension, as is done in Chile. Although the vast majority of retirees probably would be better off under privatization, it is a riskier approach than the current system.
Our view is that partial privatization of Social Security is worth a try as long as adequate safeguards are put in place and Social Security IRA’s are tightly controlled.
March 15, 1996
PSC: “Income Tax Reform Unaffordable”
Democrats: “The Plan Is Sound”
by Robert J. Kleine, Vice President & Senior Economist
In our February 9 Periscope we voiced reservations about the plan proposed by 29 Democrats to reform the Michigan income tax. Rep. Kirk Profit, leader of the effort, expressed concern that we had not presented all the facts and thus mislead readers. Representative Profit points out that the plan is based on seven principles that he believes meet our test for good tax policy. According to a statement released by his office, “Pursuit of the goals of these seven principles will be the most broad-based, comprehensive effort to truly realize fundamental economic expansion by working with the fundamental units of the American free enterprise system.” We have agreed to print the seven principles (they have been abridged because of space), which follow.
- Eliminate applications that impede family development: Specifically. eliminate income tax burdens placed on child-care, elder-care, and health care expenses, as well as on retirement security; increase the dependent household-member exemption; and expand the opportunity for an earned income tax credit.
- Eliminate unnecessary applications of the income tax that restrict Michigan residents from being fully active in the Michigan economy: Specifically, increase the personal exemption; reduce the tax rate by the year 2000 to 3.9 percent; increase renters’ homestead exemption; and add a deduction for preschool expenses.
- Eliminate tax worries for Michigan citizens who do not have financial viability: Specifically, excuse from filing anyone with income under the poverty level.
- Simplify tax compliance by providing choice in filing: Specifically, provide a new, five-line, alternate MI1040EZ form. Those who wish to itemize may use the traditional MI1040 form, which will be expanded to reflect the new deductions.
- Eliminate certain excessively unfair applications of the tax; Specifically, eliminate income tax burdens on certain sources of veterans’ and unemployed persons’ income, as well as on rewards received for information offered pursuant to a criminal justice investigation; expand and fully implement the tuition tax credit; and achieve pension equity. (Other measures are being developed.)
- Maintain fiscal responsibility by working with sound economic projections and exercising aggressive cost containment, especially in regard to the Department of Corrections.
- Prohibit raids on income tax revenue that is statutorily earmarked for local-government revenue sharing and the School Aid Fund: Specifically, propose state constitutional amendments for the 1996 ballot that will guarantee the (a) state’s 1970 promise to share income tax revenue with local government, for certain essential operations, and (b) Proposal A’s assurance of state funding for K–12 operations.
We have little disagreement with these principles, although we oppose amending the constitution to lock in income tax revenue being earmarked for local governments and school aid (principle seven); we generally oppose restricting the legislature’s ability to make funding changes as conditions change.
Our basic concern about the proposal is its cost. We had estimated the annual cost at about $2 billion when the plan is fully phased in; Representative Profit estimates it at $1.2–1.3 billion. A precise figure will not be available until the plan is final and the details are worked out. Whether the cost is $1.2 billion or $2 billion, we believe a plan of this magnitude will cause severe fiscal stress. Future budgets already are going to experience considerable pressure from declining federal aid, a slowdown in economic growth, growing school-age and crime-prone population groups, and reduced opportunities for further government downsizing. Although principle six states that fiscal responsibility will be maintained, we do not believe this is possible unless the economy grows much faster than most forecasters believe it will.
A final note: We wrongly said that the plan will increase the personal income tax exemption from $2,400 to $2,600; that increase already is slated. The Democrats’ plan does not state a specific exemption amount, but to eliminate the tax burden for people below the poverty line (principle three) will require a personal exemption of about $4,000.
March 29, 1996
And a Painted Turtle Shall Lead Them
by Martin Ackley, Consultant with Tongue in Cheek
Does Michigan really need a state reptile?
Nothing against the painted turtle. It’s cute. It’s indigenous to Michigan. It eats moss. If you’re going to have a state reptile, there are worse choices. We congratulate the school children who came up with this idea, and we’re pleased by their desire to see how the legislative process works. This was a hands-on civics lesson that had extra credit written all over it.
Of course everyone knows that the state flower is the apple blossom, the state stone is the Petoskey stone, the state tree is the white pine, the state fish is the brook trout, and the state soil is…um….oh yes, the Kalkaska Soil Series—which looks a lot like moss (I think). And now we have a state reptile.
But why stop there? For the sake of other school children, let’s offer the legislature some ideas for other new state symbols.
State vegetable—The dry bean. Michigan is the number one producer of beans in the United States, and they’re a gas.
State fruit—It’s a toss-up between the apple and the tart red cherry. But the apple blossom already has the distinction of being the state flower, so it’s only fair that tart red cherries get picked.
State beverage—Vernors. It’s gingery, and it’s ours.
State hot dog—Koegel Vienna (my personal favorite).
State toy—Lionel trains. We’d be a model for other states.
State insect—Mosquito. It’s not indigenous to Michigan, it just seems that way.
State industry— Automotive. If there is any question, take a look at Michigan’s special license plates.
State weather— Cloudy. Mostly cloudy. Partly cloudy. Take your pick.
State treasure—Lake Michigan sand dunes. (The state treasureR, of course, is Doug Roberts.)
State musical group—Da Yoopers.
Several bills have been introduced to designate a state song, but that debate has been discordant and unresolved. There are other categories of prospective state symbols, of course, but they also probably are too controversial. Take, for instance, a state sport: How can one choose among skiing and bowling, hunting and fishing, or speed skating and auto racing? The legislature’s inherent wisdom is revealed in its sticking with only noncontroversial categories, like reptile and soil.
Cost is an inhibitor, too. New state maps, on which the state symbols are proudly displayed, must be issued with every change. And state coffers must be tapped to pay for new brochures and promotional materials, to say nothing of the attorney fees necessary to determine who will have the right to market the dry bean key rings and coffee mugs.
But innocent school children should not concern themselves with such matters as contention and cost. To them, it’s a simple lesson of civics and how much mustard you can put on a state symbol.
Got any ideas of your own about state symbols? Email (firstname.lastname@example.org) or send them to us. Maybe we’ll print the best. Or maybe we won’t, but we’ll enjoy them.
April 26, 1996
Should the Minimum Wage Be Raised?
by Robert J. Kleine, Vide President and Senior Economist
The Republicans and the Democrats are engaged in a classic debate over the minimum wage.
The president and most Democrats are urging that the minimum be increased from the current level of $4.25 cents an hour to $5.15. Their main arguments are
- the minimum wage was last increased in 1991 and, adjusted for inflation, has declined more than 50 percent since the mid 1960s and almost 30 percent since 1980; and
- a minimum-wage job leaves most workers below the poverty level, which is roughly $7,800 for a single person and $12,000 for a family of three.
The Republicans counter that
- increasing the minimum wage will reduce the number of jobs and hurt the very people that the increase is designed to help; and
- minimum-wage jobs are stepping stones to better-paying jobs, and they help workers learn job skills.
Data from the Industrial and Labor Relations Review show that within one year of employment, about two-thirds of minimum-wage workers receive raises or are working for salaries. Some studies estimate that each 10-percent increase in the minimum wage reduces entry level jobs by 1–2 percent. One estimate of the president’s $5.15-per-hour proposal is that it will cost 400,000 jobs. Most economists agree that raising the minimum wage is likely to reduce employment, although the effect is likely to be small, as only about 10 percent of the work force will be affected.
Historically, the majority of minimum-wage jobs have been held by teenagers, but the Bureau of Labor Statistics says this is changing: more minimum-wage workers are older than 25, and more are married men or divorced women. (See the exhibit for characteristics of low-wage workers compared to all workers.) In 1985 about 40 percent of the minimum-wage jobs were held by people over age 25; in 1995 the figure was almost 46 percent. This statistic is of major concern to those who believe the wage should be raised. It is one thing for a teenager to make $4.25 an hour for an after-school or weekend job but quite another for an adult trying to support a family and probably with no medical insurance (most minimum-wage jobs provide few, if any, benefits). There have been proposals to raise the minimum age for older workers only, but this likely would lead to some older workers being replaced by teenagers; a two-tier minimum wage probably will not work.
My view is that the minimum wage should be raised to $4.50 an hour and indexed for future inflation. This modest adjustment is unlikely to have much effect on employment, but I fear it will not have much effect on poverty, either.
I believe that the best way to bring workers above the poverty level is to expand the federal earned-income tax credit. Currently, a family of three can receive a refundable credit of as much as $2,038. If this family has one wage earner at the minimum wage (working 40 hours a week), his/her earnings are $8,840 a year, about $3,200 below the poverty level. The earned-income tax credit would have to be increased about $1,200 to bring this family up to the poverty level. Raising the earned-income tax credit by an average of $1,200 for families with children would cost an estimated $14 billion (the cost could be reduced considerably if the credit were tied to the poverty level), a large amount, particularly in view of efforts to balance the budget by 2002. However, I think that this is a higher priority than many other federal programs, and it could be financed with budget cuts and the closure of tax loopholes. The Republican proposal to reduce the earned-income tax credit is the wrong way to go.
May 3, 1996
Does State Economic-Development Spending Really “Grow” Jobs?
by Robert Kleine, Vice President and Senior Economist
My view has been that spending by state economic development agencies has little influence on economic growth (although I do think that state expenditures on infrastructure and financing assistance are much more effective than spending on tax incentives), but a new study on this topic is worth a look.1 The authors offer some evidence that spending by state economic development agencies has a positive influence on manufacturing employment. They also find that well-targeted economic development programs have more effect on the economy than does lowering tax rates.
de Bartolome and Spiegel compared 1990 per capita spending by state economic development agencies with the 1990–93 percentage change in manufacturing employment. The model developed for the analysis controlled for other factors that independently influence employment growth: (1) measures of the basic condition of the state economy, e.g., personal income and infrastructure spending, (2) demographics, e.g., size of the industrial labor force and ethnic composition, (3) labor force conditions, e.g., education expenditures per worker and percent of work force unionized; and (4) state policy, e.g., state income and sales tax per worker and the state corporate tax rate.
Average state-development-agency spending per worker in 1990 was $10.67, ranging from $.52 in Florida to $34.78 in Arkansas. Michigan was about $16, higher than all but 10 of the 46 states for which data were available. Among the Great Lakes states studied, Michigan outspent Ohio and Illinois and about matched Wisconsin. The only major industrial state spending more than Michigan was Pennsylvania.
The study does not imply that state development agencies provide good value for the money but rather that their efforts appear to have at least some positive influence on the number of manufacturing jobs. How much influence? According to the model, if a state development agency increases its annual expenditures per worker by $10 (about double the state mean expenditure of $10.67), manufacturing jobs in the state increase about 1 1/6 percent a year. In Michigan’s case, this would be about 11,000 jobs. An additional $10 per worker in Michigan comes out to about $40 million, meaning that each additional job costs only $3,600, a real bargain if these numbers are to be believed.
I am skeptical about this study, given the short time period examined and the numerous factors that can affect manufacturing employment, particularly in such a period as 1990–93, when jobs in many states were declining, due in part to structural changes in the national economy. The results do, however, give ammunition to Governor Engler, who credits his economic development policies with the upswing in the Michigan economy during his tenure. On the other hand, the study seems to discredit his claim that tax reductions have been a contributor to the improved economic growth.
|1Charles, A.M. de Bartolome, and Mark M. Spiegel, Does State Economic Development Spending Increase Manufacturing Employment, San Francisco Federal Reserve Bank, April 1995.|
June 28, 1996
The Second War between the States
by Robert Kleine, Vice President and Senior Economist
The controversial Michigan Economic Growth Authority (MEGA), which has operated since April 1995, again is a topic of discussion in the legislature, in part because the authorizing legislation will sunset on December 31. The MEGA provides single business tax credits to firms that are expanding their existing facilities or building new facilities in the state. Since its inception, the authority has issued 20 contracts, which have “created” an estimated 5,598 jobs, at a cost in lost state tax revenue of $116.8 million over the life of the contracts.
Opponents of MEGA argue that the state should not be in the business of picking winners and losers and that a better approach is to lower taxes across the board. Critics contend that (1) selective tax incentives limit the state’s ability to provide across-the-board tax cuts, (2) the MEGA contracts do not result in a net gain in new jobs but simply shift employment from one area of the state to another, and (3) tax credits are given to firms that would have located jobs in the state without the incentive.
Supporters of the MEGA, such as Sen. Bill Schuette (R-Midland), take the position that an economic civil war is waging in the United States and that we have to provide incentives to prevent our jobs from being pirated by other states. Supporters also claim that in the long run, MEGA tax incentives more than pay for themselves. The Michigan Jobs Commission reports that the 20 contracts issued to date will yield $665.8 million in new tax revenues over the life of the contracts (this estimate is produced using a University of Michigan economic model and includes direct and indirect jobs).
This issue not only is being debated in Michigan but is becoming a hot topic among state and local officials, tax analysts, and economists across the nation. It was examined recently in an article in State Tax Notes.1 The authors, Burstein and Rolnick, make two arguments in support of their recommendation that Congress use its power to regulate interstate commerce, granted by the Commerce Clause of the U.S. Constitution, to prohibit the states from using subsidies and preferential taxes to compete with one another for business.
- While states are spending billions of dollars competing with one another to retain and attract businesses, they must struggle to provide such public goods as schools and libraries, police and fire protection, and roads, bridges and parks, all of which are critical to the success of the community. Burstein and Rolnick argue that this is not what the framers of the Constitution had in mind in granting Congress the power to regulate interstate commerce, and they quote Supreme Court Justice Benjamin Cardozo, who in 1934 said, “The Constitution was framed upon the theory that the people of the several states must sink or swim together, and that in the long run prosperity and salvation are in union and not division.”
- Almost all economists agree that unfettered competition among private businesses has generally proved to be a very successful economic system. As Adam Smith predicted more than 200 years ago, individuals acting in their own best interest are led, as if by an invisible hand, to produce what is best for the overall economy. A comparison of the experience of market-oriented economies compared with that of centrally controlled economies shows that Smith was right. When states compete for business by granting preferential taxes to particular businesses, the overall economy suffers. From a state’s point of view, it may appear better off competing for particular businesses, but the overall economy ends up with less of both private and public goods.
Burstein and Rolnick point to several outcomes from states competing for business. It is a fact that few businesses actually move to a new location, and one reason is because of the defensive strategies of other states, thus the first outcome is that the state from which a business is being enticed launches a competing offer, and the business stays “home.” The result is that the home state keeps the business, but with reduced tax revenue and no new jobs. Because this is a common occurrence, states have considerably less resources with which to support public programs, and the country as a whole has too few public goods. Another outcome of the competition is that a business does relocate to another state. This appears to be a gain or at least a wash for the national economy, but it really is a loss, because the revenue decline for the losing state must be greater than the gain for the winning state, otherwise the firm would not have moved. In addition, the national economy becomes less efficient, because output is lost when businesses are enticed to move from—or not move to—their optimal location. Finally, to offset the incentives they give to entice specific businesses, states may raise taxes on businesses that are not able to move. Again, this distorts economic decisions and results in a less-than-optimal production of private goods.
U.S. Labor Secretary Robert Reich also has expressed concern that state competition for business reduces resources available for education and job training. In a May speech, he said
The sum of tactical decisions by corporate managers and state and local officials—each decision rational in its own way within its own boundaries of time and space—can lead to a disastrous pattern of national under investment in our nation’s capacity to learn, innovate, and adapt.
Economists agree that the best tax is one that is uniformly applied to all businesses. Allowing states to have a discriminatory tax policy, one based on location preferences or degree of mobility, will result in the overall economy yielding fewer private and public goods.
It is obvious that states will not unilaterally disarm. To end this destructive competition, it will take action by Congress (unlikely) or the courts (less likely). Michigan can do its part by letting the MEGA legislation sunset and reaffirming its commitment to providing lower taxes for all businesses, without sacrificing a reasonable level of public services.
|1Melvin L. Burstein, and Arthur J. Rolnick, “Congress Should End the Economic War Among the States.¨ State Tax Notes, Arlington, VA, June 24, 1996.|
October 4, 1996
Education Reform: It’s Not that Simple
by Laurie A. Cummings, Senior Consultant for Economic and Education Policy
The 1996 Governor’s Education Summit on September 17 featured a speech by Robert A. Lutz, president and CEO of Chrysler Corporation. Lutz’s speech, which championed competition among schools as the best way to reform education, both enthused and inflamed the audience.
Lutz urged the educators in the audience not to fear competition and stated that it “may be the best thing that’s happened for teachers since chalk.” He admits that competition among schools may not be fair, but stated that “Fairness is irrelevant! The products speak for themselves—end of discussion.” Lutz also assumes that when a school fails, as when a businesses fails, it “will be replaced by something better,” and he believes that to be “a wholly good thing.”
Lutz’s speech was a candid presentation of the assumptions and beliefs of many market-based education-reform advocates. Competition-based reform basically means directly tying the amount of money that schools receive to the number of students they can attract. If a school cannot attract enough students to stay in operation, it closes, just as a company goes out of business if it doesn’t have enough customers.
Forcing schools to improve in order to survive sounds, in theory, like a sure-fire way to improve the education system. However, in practice it is not so simple. There are some complex questions about this approach to which we do not yet have answers.
- How do we ensure that failed schools will be replaced by better ones—that the problems of today’s public schools are not transferred to their replacements?
- How do we ensure that schools that are willing to change and improve will be able to do so successfully. Will they have the resources and know-how to improve in the face of growing competition?
- Will education become better for all students? How do we improve the schooling of students who are “left behind” by parents who do not take the time and make the effort to move their children out of failing schools?
- What about students whose parents lack the financial resources to transport them to “better” schools?
- How will parents know which are the better schools?
- What are the long- and short-term costs—financial, social, and educational—of letting schools fail? What happens to the students during failure but before closure?
- Is replacing “uncompetitive” schools with “competitive” ones more cost-effective than improving current schools?
- How will the progress of schools be monitored under a market-based system?
Policymakers must carefully consider these and other questions before jumping into a school system such as that championed by Lutz. The transition to competition-based education is not as simple as Lutz and others may believe. The plain fact is that no one knows exactly what will happen. I am not suggesting that market-based reforms cannot work, but I do believe that they should be initiated incrementally, with caution, and with the education needs of all students in mind.