Analysis: Gretchen Whitmer's budget banks on Michigan GOP backing one historic tax hike

A single, simple vote. With just the push of a button, Michigan lawmakers can solve the many vexing, expensive problems plaguing the state.

At least, that’s how Democratic Gov. Gretchen Whitmer pitched her first budget proposal to legislators Tuesday, before a joint meeting of the state House and Senate appropriations committees.

The centerpiece of her budget plan for 2020, the item on which much of the whole proposal hinges: A 45-cent gas tax increase phased in over a year.

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It will be a challenging vote for the Republican-dominated Legislature, and she knows it. But without the gas tax increase (or some other way to raise a hefty $2.5 billion for roads), everything else in the budgetary Rube Goldberg machine will fall apart.

How Whitmer’s proposed tax changes interact with one another — and how the Republican-controlled Legislature pushes to adjust them — will also present the first major test of bipartisanship during Whitmer’s young administration.

“It really comes down to that one vote,” said Amber McCann, spokeswoman for Senate Majority Leader Mike Shirkey, R-Clarklake. “We have to make that first decision, and then all the other dominoes fall, so to speak. It’s all predicated on us making that bold and significant choice to raise gas taxes by 45 cents.”

Gilda Jacobs, president and CEO of the Michigan League for Public Policy and a former Democratic state legislator, said it was smart for Whitmer to essentially put multiple hard votes together under one bill; it makes it more palatable for lawmakers who will face scrutiny come election time.

“Politically, it is helpful for both the (Democrats) and the Republicans to just have to take one hard vote,” she said. “Because I’d say there’s probably more good things in this budget than there are that would cause heartburn for some folks who are concerned about tax increases.”

The gas tax hike would raise $2.5 billion more per year to spend on fixing Michigan’s crumbling roads, addressing a central Whitmer campaign promise. Getting a win on the gas tax sets in motion a cascade of money by freeing up $600 million in income tax dollars that would otherwise be used for roads. Those income tax dollars would now go to public universities, replacing funds that have been diverted for more than a decade from the School Aid Fund. Using the Rube Goldberg analogy, that leaves more money for K-12 schools.

The cascading effects of Whitmer’s budget proposal continue.

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She also wants to repeal a 2011 tax on some retirement income imposed by her predecessor, Republican Gov. Rick Snyder, a goal supported by some lawmakers from both parties. To resolve the roughly $300 million hole that would create in the general fund, she offered a measure that immediately received a chilly reception from the business community: Raising the tax rate small businesses pay so it matches that paid by corporations.

“The worst vote a legislator can take is a vote that proposes to solve a problem but doesn’t actually fix it,” Whitmer told lawmakers. “That’s why we wrote this budget so it requires one historic vote — that when you pull that lever, we fix a lot of problems in the state of Michigan.”

Based on early feedback, the budget proposal may be a hard sell. Whitmer encouraged lawmakers to pass a budget before they leave for summer break, seeking to avoid the last-minute wrangling that led to brief government shutdowns during Michigan’s last era of divided government in the late 2000s.

Yet while Democrats praised Whitmer for taking bold action to address the state’s history of underfunding critical state programs, from infrastructure to education, some Republicans say they are concerned about the size of the gas tax hike, repealing the so-called “pension tax” and raising small business tax rates.

“This really is a budget constructed based on a single premise, and all other parts of it are dependent upon the idea that we would seek additional money from our Michigan families,” said McCann, Shirkey’s spokeswoman. “And that is a starting point that Senator Shirkey would not have come up with on his own. We’ll first work through difference of philosophies, I think, and then come to more nuts-and-bolts negotiations.”

The state budget is complicated and interconnected, and spending increases become more difficult to sell to the public if the public doesn’t understand what the money will be used for, said Charles Ballard, a professor of economics at Michigan State University.

“As a result of that fact about how people behave toward taxes, Michigan’s tax system is super-earmarked,” Ballard said. “I think the governor’s budget is trying to make the most sense out of that that she can.”

The gas tax

Whitmer’s plan centers on a 45-cent gas tax increase, to be phased in at six-month increments between Oct. 1, 2019, and Oct. 1, 2020. It is based on estimates from independent studies that showed Michigan needs to infuse roughly $2.5 billion per year into state and local roads on top of what it’s already spending.

The $2.5 billion generated by the gas tax increase would be held in a new fund, to be distributed by road category and how heavily it’s used. The current gas tax of 26.3 cents per gallon, as well as the 6 percent state sales tax currently paid on fuel, would remain in a state formula that divides the money between the state, counties and cities.

Whitmer noted that other states, including Ohio, have proposed hikes to their gas taxes. Michigan’s tax, however, would become the highest in the nation. Whitmer argues that this is an unpleasant necessity given that the state now spends less per capita on roads than surrounding states.

She also proposed doubling the state’s Earned Income Tax Credit for low-income residents from 6 percent to 12 percent over the same period as the gas tax goes up, to offset the burden on the poorest drivers.

“No one likes to raise taxes,” she told lawmakers Tuesday. “I wish I didn’t have to come here today and put this budget before you, because I know it’s hard. But the hard truth is, we’ve got to get to work. Every day we don’t, we are jeopardizing our economic future, wasting our money and endangering our people. No more shell games and half measures. Here’s a real plan.”

A $1.2 billion road-funding plan GOP legislators passed in 2015 has not yet fully materialized. By 2021, roughly $600 million in income tax dollars will be diverted to roads, with the other half coming from a previous gas tax hike and higher vehicle registration fees. Yet that plan has been criticized as inadequate to get Michigan’s roads into good and fair condition.

More than three-quarters of Michigan’s state-maintained roads, or 78 percent, are in good or fair condition, though that’s predicted to decline even with the 2015 investment. Whitmer’s plan would increase the percentage to 91 percent by 2029.

Business groups, from the Michigan Chamber of Commerce to the Detroit Regional Chamber, issued statements calling the road-funding aspect of Whitmer’s proposal bold.

“We are prepared to support a meaningful increase in user fees phased in over time,” the Michigan Chamber’s statement read, adding that it commends Whitmer’s office for the proposal. “We urge lawmakers to recognize that state government must take bold action to fix the roads and we look forward to working with them to solve this problem.”

Jacobs, of the Michigan League, acknowledged the increase is a “big bite,” but said it’s a necessary step given the state’s unwillingness in the past to address infrastructure maintenance.

“In this life, you get what you pay for,” she said.

Some Republican lawmakers, however, criticized Whitmer’s road-funding proposal as unrealistic.

“Tax increases aren’t solutions. Unfortunately, what we heard from the governor are plans to tax and spend — not real solutions for fixing our roads, improving our schools or continuing Michigan’s economic comeback,” said state Rep. Shane Hernandez, R-Port Huron and chairman of the House appropriations committee, in a statement.

“Michigan drivers deserve every possible effort to make sure the taxes they’re already paying are used effectively and efficiently. But I didn’t see that in her plan,” Hernandez said. “Coming out of the gate by proposing a 45-cent per gallon tax increase starts the conversation on the wrong foot. Taxpayers deserve better.”

Is the idea dead on arrival? Not necessarily, said James Hohman, fiscal policy director at the Midland-based Mackinac Center for Public Policy, a free-market think tank.

It could be a moon shot that draws Republican lawmakers, concerned about the size of the increase, to the table to discuss alternatives, Hohman said.

"Proposing to become the state that taxes fuel the most by far is a heavy lift by itself, but it’s a heavy lift we should have expected, because Governor Whitmer ran on more road spending," he said. “She started by making a pretty substantial ask, so if that is unacceptable — and it seems like at least for the House Appropriations Chair (Hernandez) it is — it’s up to them to try and find consensus on other priorities.”

Tom Shields, a Republican consultant at Lansing-based Marketing Resource Group, said it’s such a high hike that it will force the Legislature to essentially rewrite the budget.

“While it’s common political strategy to take on controversial issues in the first year in hope the voters will forget by 2022, these tax proposals will never see the light of day in the Republican Legislature,” he said.

The higher education funding shift

Covering the state’s $2.5 billion road-funding need with the new gas tax revenue would free up the $600 million in diverted income taxes from the 2015 road-funding plan to use for other general-fund priorities, state budget Director Chris Kolb said Tuesday.

How it would be used instead: To offset about $500 million for public universities paid out of the state’s School Aid Fund, which primarily funds K-12 public schools.

Moving higher education out of the state’s K-12 budget was one of Whitmer’s campaign issues, and a practice she opposed as a state legislator. Her budget would keep community colleges in the School Aid Fund as part of a streamlined, preschool-to-grade 14 education approach.

“The School Aid Fund has been robbed to fill other budget holes for 10 years. Out of the 50 states, we ranked dead last in revenue growth for K-12 schools between 1995 and 2015,” Whitmer told legislators. “And not coincidentally, in that same period of time, our kids have paid the worst price, because we have fallen precipitously (in academic performance) over the last 20 years. Every other state in the nation is meeting their kids’ needs better than we are.”

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That shift will allow Whitmer’s administration to pay for increases to the state’s per-student funding formula for school districts, including more money for literacy coaches, career and technical education and special education services.

Unsurprisingly, Whitmer won praise from education advocates, including teachers unions and the School Finance Research Collaborative, which issued a report calling for more public school funding.

“We applaud Gov. Whitmer for calling for a new, fairer school funding approach that will help meet the needs of all Michigan students,” Wanda Cook-Robinson, project director for the collaborative, said in a statement. “We look forward to working with Gov. Whitmer on a new funding method that provides all students the same opportunity to get a high-quality education and compete for jobs.”

Yet achieving this will depend on Republican legislators who control the budget process supporting the end of using state income tax dollars for roads, especially before that money has been phased in.

Shirkey, for one, has said previously that while new revenue is needed to solve the road-funding problem, it should not be the first place the state looks for a solution.

“Senate Republicans are going to take time through the (appropriations) committee process (and) look at where we can find funding first within the current budget,” said Sen. Jim Stamas, R-Midland and chairman of the powerful Senate appropriations committee.

Stamas added that after that point, if new revenue is needed, lawmakers will have a conversation about how much funding is needed and the best approach to generate it.

The pension tax and small business taxes

Whitmer also proposed repealing the state’s unpopular tax on some retirement income, adopted in 2011 as part of Snyder’s broader tax overhaul that also changed how businesses are taxed in Michigan.

A repeal of that tax would cost the state about $330 million in individual income tax revenue, according to a recent House Fiscal Agency analysis of a bill that has cleared a House committee. That would amount to about $255 million from the state’s general fund, and another $75 million from the School Aid Fund.

State Treasurer Rachael Eubanks told Bridge the state estimates repealing the Snyder-era pension tax will cost the state $355 million in 2021.

Supporters of repeal include lawmakers from both parties, who contend the tax shift placed a bigger tax burden on individuals, especially seniors, than on businesses.

“Democrats have been talking about this forever,” House Democratic Leader Christine Greig, of Farmington Hills, told Bridge before Whitmer’s budget presentation. “It does put a strain on the budget. So again, I think the governor’s overall approach of making these shifts is very important, but you also have to do it in a fiscally responsible way.”

That approach creates what Kolb, the state budget director, called “business tax parity.” Whitmer proposed creating a new 6 percent business tax for small businesses, typically limited liability companies, or LLCs, that currently report their business income on their personal income tax returns, which is taxed at the individual income tax rate of 4.25 percent.

Corporations, however, pay the 6 percent corporate income tax created in 2011. Whitmer’s proposal would tax smaller businesses at the 6 percent rate to match what larger corporations pay, while allowing them to use a credit for their business tax on their personal income tax returns to avoid taxing business income twice, Eubanks said.

The state also proposes exempting the first $50,000 of business income from the new small business tax, intended to help smaller companies, Eubanks said. And the state also expects that small businesses that currently report their business income on their personal income tax returns could see a federal tax benefit because new tax law changes limit state and local tax deductions to $10,000.

The reaction from business groups was swift: That will kill jobs.

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The Small Business Association of Michigan said it would essentially serve as a 41 percent tax increase on more than 100,000 small businesses in the state.

“Michigan has made substantial economic gains in employment since double taxation on small businesses was eliminated in 2011,” said Rob Fowler, SBAM’s CEO, in a statement. “Gov. Whitmer’s proposal would be a major step backward and a job-killer for small businesses, who make up most of the employment and employment growth in our state.”

Democrats contend that businesses won billions of dollars in tax cuts eight years ago, at the expense of working Michiganders. The state also is obligated to pay out tax refunds under the state’s old Michigan Business Tax, which reduces the amount of net tax revenue the state receives from businesses.

“One of the problems that we had under the last governor was basically allowing some companies to pay the business tax and others not,” said Sen. Curtis Hertel Jr., a Democrat from Ingham County’s Meridian Township, in an interview.

“We should be actually making sure they’re paying their fair share,” Hertel said. “We all know that businesses drive on roads (and) businesses need an educated and talented workforce. They should pay the cost of actually investing in Michigan.”

Bridge staff writer Jim Malewitz contributed to this report.