Why Tax Rate Cuts Matter More Than Increasing Credits and Exemptions

With more tax money coming into the state treasury than the state expects to spend, politicians are considering proposals to reduce taxes.

One plan would lower the tax rate over time and the other would increase some credits and exemptions. In evaluating the proposals, politicians should care primarily about the influence the proposals will have on state economic growth.

The tax policies that influence long-term economic growth are the ones that improve decision-making on the margin. All things being equal, there are some ideas that don't make sense when they're taxed at 29.25 percent (current rates for a middle tax bracket when federal and state income taxes are applied) than they are at 28.9 percent (rates after implementation of the proposed reduction in state income tax rates).

The difference might not sound like much, but they can affect the thousands of hiring and firing decisions that are made daily. Michigan's economy added 217,038 private sector jobs and lost 200,728 private sector jobs in the second quarter of 2013. It is a change in tax rates that can make more of those decisions to add workers feasible and less of a reason to lower employment.

The other tax proposal does not lower tax rates at all. It adjusts tax policies that encourage home ownership and the treatment of retirement income. These policies can influence the decision to buy a home or rent one and decisions about where to retire. But their impact on long run growth is less clear.

Some businesspeople — like real estate agents and home builders — will appreciate increases in these credits and exemptions. Yet this is only a small portion of the economy. And pensioners may spend more if they are allowed to keep more of their income. But the decisions on whether to expand or contract will only be indirectly affected by these changes in tax policy.

Changing these credits and exemptions can have other influences as well. Crediting home owners for paying property taxes has an ancillary consequence of making it easier to raise property taxes. When local governments, school districts and other property taxing authorities can raise taxes and their constituents pay a portion of it, they are more likely to request these rate increases.

Some state politicians, however, don't care as much about those effects as they do about who will receive the abatements. Pensioners and home owners vote and politicians may feel necessary to show voters that they are letting them keep more of their money than would otherwise be the case.

Improving the factors in the decision-making that businesses go through when adding or losing jobs improves the state economy. A more prosperous state is one that can better meet the needs of the people in the state.

This is better served by broad-based drop in the tax rates than in changing credits and exemptions.

Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.