by Robert J. Kleine,Vice President and Senior Economist & Laurie A. Cummings, Economist
|With the March 15 ballot election approaching, it is important to take a final look at the competing school finance plans. This final school finance reform analysis will briefly summarize the two plans and discuss how the plans will affect different taxpayers.|
Summary of the Two Plans
Exhibit 1 compares the different provisions of each plan. The major difference between the two is that one would raise the income tax while the other would raise the sales tax. The statutory proposal raises the income tax to 6 percent but makes no change in the sales tax rate. In contrast, the ballot proposal raises the sales tax from 4 percent to 6 percent and reduces the income tax rate from 4.6 percent to 4.4 percent. Other major differences are outlined below. The ballot plan levies 6 mills on homesteads, raises the cigarette tax 50 cents, and limits assessment increases on every parcel of property to 5 percent or the rate of inflation, whichever is lower.
The statutory plan levies 12 mills on homesteads, raises the cigarette tax 15 cents, increases the SBT from 2.35 percent to 2.75 percent, and increases the personal income tax exemption from $2,100 to $3,000.
Both plans levy 24 mills on nonhomestead property (for example, businesses and second homes) and increase the state property tax credit for renters from 17 percent to 20 percent. Both also levy a real estate transfer tax of 0.75 percent on the sale value of a home. School funding and educational reform are the same under both proposals.
Which is the Better Plan?
Which plan is best depends entirely on one’s economic circumstances. Exhibit 2 shows how different groups of taxpayers would fare under each plan. In general, the ballot proposal is better for high‐income taxpayers, and the statutory proposal is better for low‐ and middle‐income taxpayers, regardless of whether they own their home or rent.
Individual spending and income situations should be taken into account when reading the exhibit—the data are based on averages and will not hold true for all taxpayers. For example, the chart shows that a low‐ or middle‐income taxpayer would fare best under the statutory plan; however, a low‐ or medium‐income taxpayer who owns a business might fare better under the ballot proposal.
An annual income of $30,000 is the break‐even amount between the two plans, meaning that based on income alone, both plans are equally favorable at this income level. If income only is considered, the statutory proposal is best for people earning less than $30,000 and the ballot proposal is best for people earning more than $30,000.
Effect on Homeowners
School property taxes are six mills lower under the ballot plan than the statutory plan, which makes it more attractive based on property taxes alone. Income also is a factor, however, because the higher sales tax under the ballot proposal may cancel out the benefits of lower property taxes. In general, the ballot proposal favors high‐income people living in high‐millage areas, and the statutory proposal favors low‐ and middle‐income people living in high millage areas.
For example, a taxpayer in a $150,000 home in an average millage district (58 mills total/37 mills schools) and earning $100,000 a year will receive a tax cut of $1,085 under the ballot plan and $403 under the statutory plan. A taxpayer in the same district living in a $50,000 home and earning $25,000 a year will receive a tax cut of $130 under the ballot plan and $173 under the statutory plan.
The main reason that low‐ and middle‐income homeowners’ would have lower savings under the ballot plan than high‐income owners is that low‐ and middle‐income owners pay a larger share of their income toward the sales taxes tax than the high‐income group does. High‐income homeowners, in contrast, pay much more under the statutory plan because the income tax will be higher. Under both plans, taxpayers earning more than $83,000 do not qualify for the state property tax credit and receive a larger net benefit because they have no credit to lose
In general, renters will receive no direct tax relief and will pay higher income or sales taxes. Even if their taxes are reduced, landlords are unlikely to lower rents. Some renters, however, will benefit from the increase in the state tax credit from 17 percent to 20 percent. For example, a nonsenior renter earning $25,000 and paying $500 a month in rent will receive an additional credit of $108, and a senior citizen will receive an additional credit of $180. As with homeowners, low‐ to middle‐income renters will do better under the statutory proposal, and high‐income renters will do better under the ballot proposal.
Most seniors will do better under the statutory proposal because much of their income is exempt from the income tax. Most seniors, however, will receive little net property tax relief because they lose a dollar of tax credit for every dollar of reduction in property taxes. Only those seniors who reach the $1,200 limit on the property tax credit will see any net property tax relief.
If only the cigarette tax is considered, smokers will prefer the statutory proposal because the increase in the cigarette tax is smaller. The 15‐cent tax increase will mean that a person smoking two packs a day will pay $109 more for cigarettes annually than they pay now. The 50‐cent increase under the ballot plan will cost them $266 more per year. Of course, tax increases of this size will encourage some people to smoke less or give up smoking.
The business community does not like either package because both will bring a tax increase to this group. In some areas businesses could end up paying higher property taxes than they currently pay, because nonhomestead property is taxed at a higher rate than homestead property. On balance, business will prefer the ballot plan because, unlike the statutory plan, the ballot plan limits assessment increases, contains more favorable provisions for industrial property tax abatements, and does not increase the SBT.
The statutory plan offers some advantages to local governments over the ballot plan, and there are two important differences between the two plans. First, the statutory proposal guarantees that Tax Increment Financing Authority (TIFA) monies lost due to lower property tax rates will be replaced by the state for projects planned before March 1, 1994. This plan also will allow limited capture of new state and local taxes in the future. In addition, the statutory proposal does not limit assessment increases, while the ballot plan includes a limit on every parcel of land. While this is good news for property owners, it means a loss of revenue for local governments.
The State Budget
Under either plan K – 12 expenditures will be about $10.5 billion, $600 million more than in the current fiscal year. A one‐time budget surplus due to school finance reform and an improving economy, however, mean that budget cuts will not be needed in the near future for the extra education funds. The surplus stems from the fact that many of the proposed tax increases take effect May 1, 1994. As a result, about $1.4 billion will be collected in FY 1993 – 94, but only about $500 million of this will be spent. The remaining $900 million will be allocated to the school aid fund, resulting in a surplus.
This surplus combined with an improving economy means that only minor cuts in the state budget will be required in the near future to pay for the higher education expenditures. With the recent reduction of the property transfer tax to 0.75 percent, however, a shortfall in revenues is likely in two or three years, particularly under the ballot proposal. Such a shortfall would mean cuts in the state budget, reduced support for K – 12 education, or increased taxes.
Both proposals will push the state close to the constitutional limit on taxes. Under the statutory proposal taxes in FY 1994 – 95 will be about $435 million below the limit, and under the ballot proposal taxes will be only $40 million below the limit. Coming so close to the limit leaves little room for future tax increases to pay for new programs or to increase funding for old ones as needs change.
The two plans also require different amounts of general fund/general purpose (GF/GP) money. The ballot plan takes $600 million of GF/GP funds, while the statutory plan takes $350 million, which means that there will be $250 million less for lawmakers to work with under the ballot plan than under the statutory plan. These state budget numbers will be changed by the reduction in the property transfer tax (to 0.75 percent for both plans), which reduces total revenues in FY 1994 – 95 by about $50 million under the statutory plan and $240 million under the ballot plan.
The Michigan Economy
Neither plan will have much effect on the economy. The statutory plan reduces taxes by about $250 – 300 million, and the ballot plan reduces taxes by about $345 million (out of $7 billion cut in property taxes). The sales tax increase in the ballot plan, however, is not deductible for federal tax purposes, whereas property and income taxes are deductible — this will affect only those taxpayers who itemize, about 35 percent. This loss of federal deductibility under the ballot plan will cause federal income taxes paid by Michigan taxpayers to increase by about $300 million, offsetting the tax reduction. Since the statutory plan will still allow taxpayers to deduct their income taxes, it appears to be slightly better for the economy.
In general, the ballot plan is best for the following groups:
- most taxpayers earning more than $30,000 annually — homeowners or renters — because the income tax is lower under the ballot plan; the higher income tax under the statutory plan will affect this high‐income group more than lower income groups and
- business, because this plan limits property assessment increases, is more favorable toward industrial property tax abatements, and does not increase the SBT.
In general, the statutory plan is best for the following groups:
- people earning under $30,000 — homeowners or renters — because members of the low‐ and middle‐income group pay a larger share of their income toward the sales taxes tax than the high‐income group does; in addition, the higher income tax rate is less burdensome at lower income levels;
- senior citizens, because much of their income will be exempt from the higher income tax rate;
- smokers, because the per‐pack cigarette tax is 35 cents lower under the statutory plan;
- local government, because this plan is more favorable to TIFAs and does not limit property assessments; and
- the state budget, because taxes will be farther below the constitutional limit on tax, because this plan requires a smaller GF contribution, and because the risk of budget shortfalls is smaller.