Pension Tax Affected 8 Percent Of All Taxpayers

There have been bills introduced to repeal the state’s so-called pension tax ever since it was first enacted in 2011. Revisiting and possible repealing it is viewed as a potential area of bipartisan agreement. It’s unsurprising since a lot of people were affected by the tax.

Actually, the 2011 reforms did not create a new direct tax on pensions but rather changed the tax preferences for retirement income. Public pensions had been exempt from state income taxes, and private sector pensions received a generous exemption. People who were retired and lived off income from savings, on the other hand, did not receive this kind of advantage.

Lawmakers changed this preference for pensions to a blanket exemption for all retirement income. They structured the change so that older retirees wouldn’t see much of a difference. The pension tax fell on people then younger than 66 who earned more than $20,000 per year in pensions (for single-earner households) or $40,000 (for married, joint-filing households).

There is plenty to discuss about the fairness of taxing pensions, and it’s worth a discussion. In 2011, it would have been worth knowing how many people would be affected by the change, but that information was unavailable. Legislative fiscal analysts expected it to raise $343 million, which could increase state revenues by 1.3 percent. Y­­ou don’t raise that much revenue without affecting a lot of people.

According to an analysis by the Senate Fiscal Agency, 1.2 million tax returns in Michigan list some retirement income, out of the 4.7 million returns filed. About a third of them — 376,000 taxpayers — report income above the $20,000 and $40,000 exemption.

But that might not be the total number of people paying pension taxes. A lot of factors could make the actual number higher or lower, as there are more tax credits, exemptions and deductions than just the pension tax. All those factors could affect the number of people who would be subject to the pension tax.

Two main factors would lower the figure, and one would increase it. The first one is the age distribution of people receiving pensions. Older retirees are unaffected by the tax, as people born before 1946 — 66 at the time of the reform — faced no changes when it was enacted. So if most people receiving pensions were over 66 in 2011, that fact would lower the number of people paying the pension tax. Another factor that could lower the figure is the number of people who received survivor benefits in 2011. A widow or widower who continues to collect a spouse’s pension paid taxes on that pension even before 2011. This would lower the number of people paying the pension tax.

One factor that could increase the figure is the number of early retirees, who could miss out on any exemption for their income. People born after 1952 (60 at the time of the reform) must now pay taxes on all of their pensions until they turn 67 years old, the state's designated retirement age.

Let’s stick with the number reported by the state, which suggests that the pension tax means a higher tax payment for 376,000 taxpayers. That is around 8 percent of taxpayers subject to higher income taxes due to the change.

Even if it’s only a third of retirees, it’s still 8 percent of taxpayers. That’s a lot of people, and it explains the interest in revisiting the issue from the new governor and legislators in both parties.