As Michigan Passes Pension Tax, Maine Considers Repealing One

By: - September 19, 2011 12:00 am

Office of Governor Rick Snyder, Office of Governor Paul LePage
Michigan Governor Rick Snyder (left) and Maine Governor Paul LePage are on opposite sides of the pension tax question.

Republican governors Rick Snyder of Michigan and Paul LePage of Maine were both elected in 2010 on a wave of anti-tax sentiment. But on one important tax question — what to do about pension income — they have taken dramatically different positions.  

Both governors face similar challenges attracting and keeping people. Michigan was the only state to lose population during the last decade and Maine was one of the slowest growing, according to the latest census .

LePage is preparing a plan that he says would lure new residents by eliminating the state tax on public and private pension income. Snyder has already signed legislation to impose taxes on retirement income. His lawyers are defending it before the state Supreme Court.

Whose approach is right? Why such different views from Republican governors whose states are both in a jam? The answer lies partly in the distinctive financial difficulties facing each state.

But it also reflects contrasting political philosophies. LePage, who was elected last fall with the backing of the anti-tax Tea Party, signed the largest tax cuts in state history in June and recently called for a new round of up to million in spending cuts. Snyder, a former computer entrepreneur, has been more of a centrist, mixing spending cuts and corporate tax breaks with the pension tax increase.

Predictably, seniors have applauded LePage; 75,000 Maine retirees would see their taxes lowered under his plan. Meanwhile, Snyder has taken considerable heat from seniors who say their already-shrinking retirement income would be slashed if the court upholds his legislation.

Pursuing rich retirees

Taxing pension income

Seven states do not tax any personal income, including pension income. They are
Alaska , Florida , Nevada , South Dakota , Texas , Washington and Wyoming . Two states — New Hampshire and Tennessee — levy personal income taxes only on interest and dividend income. Of the states that do tax personal income, nine do not tax most federal, state and local government pension income, with limited exceptions. They are Alabama , Hawaii , Illinois , Kansas , Louisiana , Massachusetts , Michigan , Mississippi and New York . Pennsylvania taxes personal income but excludes all pension income, according to the National Conference of State Legislatures.

LePage says he will propose removing the pension income tax before lawmakers return for their next session January 4. He wants to target not only current retirees living on fixed incomes but also wealthy people who have moved their legal residence from Maine to states without income taxes yet return to Maine for part of the year.

“They move their wealth away from Maine, but they come back and spend summers here,” LePage said at a town meeting in August. “We need to stop that. We need the capital they have to help invest.”

The catch is that eliminating the pension tax would cost the state treasury up to million a year, money that would have to be made up in deeper spending cuts.  Lawmakers already approved a two-year budget in June that included million in tax relief, including a reduction in the top income tax rate that could end tax payments for 70,000 low-income residents. The budget also contains a million shortfall for the fiscal year beginning next July 1 that lawmakers have promised to close in the coming session. On top of that, LePage says the deficit-reduction law approved by Congress in August could cost Maine up to million.

LePage’s press secretary, Adrienne A. Bennett, acknowledges that the state budget will have to be balanced despite the pension tax proposal, the existing budget hole and the cut in federal dollars. “The bottom line is we don’t want people leaving our state,” she says. “If we can attract other retirees to make Maine their home — even better. But when Mainers retire they must be able to afford to continue to continue living here.”

A break for the young

Snyder has a significantly bigger task than LePage in attempting to turn around Michigan’s economy, one of the nation’s weakest. A decade-long loss of jobs, people and tax revenue means that more Michigan residents need government services while the state has less money to pay for them. But Snyder is more interested in retaining young people than he is in bringing back retirees.

In Michigan, the number of people over age 60 has increased at a faster rate than in most states , while the number of young people is dropping. Seniors, who soon will make up one of every five Michigan residents, require more government services than the young but contribute fewer dollars to the state because they generally spend less. Snyder says this unfairly dumps the tax load onto young people, who already generate 97 percent of all income tax revenue.

Sara Wurfel, Snyder’s spokeswoman, says ignoring the demographic shift “would have strained and stressed the state budget for decades to come and put an increasing burden on our state’s younger taxpayers…With fewer taxpayers supporting an equitable share of public services, programs would likely have to be reduced or eliminated.”

The governor’s remedy was overhauling Michigan’s personal and corporate tax structure to make it simpler and fairer while at the same time boosting revenue . One key piece was abolishing Michigan’s convoluted business tax and replacing it with a cleaner flat corporate tax. The other, more controversial change was to impose a tax on public and private pensions, with some exemptions based on age and income. Snyder said he hoped a more predictable tax system would spur economic expansion and create jobs; the Legislature agreed, though the governor’s plan cleared the state Senate only after Lieutenant Governor Brian Calley cast the tie-breaking vote.

Part of lawmakers’ wavering was based on the worry that the decision to tax pensions would almost certainly land the state in court. Michigan’s constitution guarantees that state and local government pension benefits cannot be “diminished or impaired,” because they are binding contracts between governments and workers.

Snyder, aware that public employees in a historically pro-labor state probably would challenge the pension tax, launched a pre-emptive strike, asking the state Supreme Court to issue an advisory opinion on the constitutionality of lifting the tax exemption on public pension income. The court heard oral arguments from the attorney general, business groups and public employee unions September 7; Snyder has asked the court to rule by October 1, the start of the fiscal year.

The state argues that the “diminished or impaired” clause does not create a permanent tax exemption for public workers and contends that the legislature was lawfully exercising its power to levy taxes. Opponents, who include the Michigan chapter of the AARP, say the bill violates the contract clause of the state constitution because it would take away pension income that public employees have already earned during their working lives. There are 235,899 federal and state employees in Michigan receiving or eligible to receive government pensions, according to court documents.

Snyder is not alone; the same legal questions are playing out in other states. Public employee unions recently filed legal challenges to pension cuts pushed by Florida Governor Rick Scott and New Jersey Governor Chris Christie. Similar lawsuits in other states have had mixed results: Colorado and Minnesota judges upheld public pension cuts but a Rhode Island judge allowed a lawsuit filed by employee unions to proceed. State lawyers had asked the court to dismiss the suit.

Neither governor is assured of success, Snyder because of the potential legal obstacle and LePage because some lawmakers say the loss in tax revenue from eliminating the pension tax could not be replaced without jeopardizing essential services. Both governors say they will fight on. 

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Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.