Michigan lawmakers are likely to keep taxing pensions

Despite campaign pledges to repeal the pension tax, Michigan legislators are likely to keep taxing pensions next year. Michiganders should instead expect an increase in state tax preferences to seniors.

A basic reason why lawmakers will not repeal the pension tax is that there is no pension tax. There is a state personal income tax that applies to the incomes of senior citizens, and in 2011 legislators changed the tax preferences for senior income. Calling this a “pension tax” is a simpler and more pointed way to put it than calling it a change in the tax preferences offered to seniors, so that’s why it gets called the pension tax.

In 2011 the pensions of government employees were exempt from the state income tax, and private sector pensions received generous exemptions. Policymakers changed this to a lower but still generous deduction for seniors that applied to all types of income — earnings from interest, wages, lottery winnings or anything.

Even with rules that exempted older people from a change, a lot of people were collecting more in pensions than the deduction amount and would therefore pay more in taxes. According to data from the Senate Fiscal Agency, 376,000 tax returns listed retirement income above the new deduction levels.

That’s a lot of people. And legislators also found that people got mad when they changed the tax rules for those who were already collecting pensions. Hence the political desire to go back.

Bill have been introduced each session to return to exemptions for pensions but not other types of retirement income. The bills haven’t gone anywhere.

A return to exemptions for pensions, but not other types of income, would be unpopular. Legislators would face the same problem they faced in 2011: A lot of retired people would pay more in taxes. People who retired on their 401(k), for instance, would pay more in income taxes if lawmakers moved from general deductions to pension exemptions.

That’s why the likely change is to simply increase the senior deduction. The state would still tax pensions when people collect more than the deduction.

Indeed, legislators passed a bill that would have made this change. Gov. Gretchen Whitmer vetoed it. In her veto message, Whitmer called the bill a stunt, marred by constitutional defects.

“Because this bill would be subject to a similarly strong legal challenge, signing it would sow uncertainty about the legality of much of the tax code,” Whitmer wrote to lawmakers. “Therefore, I am returning House Bill 4568 to you without my signature.”

The concern about who would get to take credit for an increase in the senior deduction was likely what kept the law from changing during Whitmer’s first term.

This changes with incoming Democratic majorities in the Legislature. Elected officials are likely to increase the senior deduction. Expect to hear them say they “repealed the pension tax,” even when the law still taxes pensions.

James M. Hohman is director of fiscal policy at the Mackinac Center. Email him at hohman@mackinac.org.