Commentary: Fairness Arguments on the Pension Tax

For all the ballyhoo on the pension tax, there wasn’t a substantial change in how the state treats pension income. Tempers flared to the point where Senate Minority Leader Gretchen Whitmer proclaimed, “You can lie to yourself, but don't lie to me. Don't lie to the people of our state.”

The discussion in the Senate over the proposed tax plan centered around the most politically toxic piece of the package: the exemptions placed on pension income in Michigan.

Both sides argued that it was a matter of fairness: One side said that it was unfair to give preferential treatment to this kind of income; the other that it was unfair to raise taxes that change the rules on pensioners after they’ve retired. Both sides are right and the pension tax that they passed partially addressed these concerns.

In fact, outside of changing the current system to receive more tax revenue from pensioners, the proposals do not fundamentally change Michigan tax policy. Currently, pension income of up to $90,240 is exempt. Government-employee pensions, which rarely go above that level, are fully exempt.

The bill makes no changes on the incomes of residents who are currently older than 65. For those five years younger, it would lower the exemptions by a little more than half. For all others, it would apply an exemption of up to $40,000 for seniors, which applies to all types of income, not just pension income.

These provisions keep many current retirees from having their rules changed midstream. They also take out some of the tax bias toward pension systems over independent retirement accounts. These were not momentous shifts in the way the state taxes pensions. It was more of a change in the margins of the state’s tax policy instead of a radical departure.

The fundamental change is the revenue expected.

The state expects $224.9 million more in pension income in the next fiscal year than in the previous one, and $343.4 million afterward, according to the Senate Fiscal Agency. This is was a game of margins, not one of principles.

In relation to the rest of the states on this issue, Michigan is still in the middle of the pack. The state has an income tax that covers retirement income, thus ranking below nine states that do not. Michigan does not exempt pension income, so it also ranks below an additional five states that do exempt pension income.

Conversely, Michigan does not fully tax pension income, so it ranks above five states that do.

Michigan is one of the 31 states making decisions about how much preference it would like to extend to this source of income.

Ultimately, this change in policy is unneeded because there is still money to be saved in state government. But it leaves Michigan in the middle of the pack amongst the states regarding the treatment of pension income in the tax code.

Furthermore, the new changes also address some of the arguments on both sides about fairness.