STATE OF MICHIGAN

FRANK J. KELLEY, ATTORNEY GENERAL

Opinion No. 6697

December 18, 1991

RETIREMENT AND PENSIONS:

Limitation or repeal of income tax exemption for public pension benefits

Section 30(1)(f) of the Income Tax Act of 1967 which exempts retirement benefits received from a Michigan public retirement system may be prospectively limited or repealed by the Legislature pursuant to Const 1963, art 9, Sec. 1. Such a limitation or repeal would not, however, in and of itself, affect similar statutory tax exemptions presently found in four retirement statutes.

The Legislature may prospectively limit or repeal the state and local tax exemption provisions it has put in four retirement statutes as to all new members joining those systems after the effective date of such prospective legislation.

The Legislature may, without violating Const 1963, art 9, Sec. 24, limit or repeal the tax exemptions now found in four retirement statutes as to current retirees and members if it provides alternative benefits in their place that are equal to or greater than the pension benefit that would be limited or withdrawn since there would be no constitutionally cognizable impairment of the pension benefit.

Honorable John J.H. Schwarz, M.D.

State Senator

The Capitol

Lansing, MI

Honorable Frank M. Fitzgerald

State Representative

The Capitol

Lansing, MI

Honorable William Faust

State Senator

The Capitol

Lansing, MI

You have requested my opinion on a question which can be phrased as follows:

CURRENT STATUTORY INCOME TAX EXEMPTIONS FOR STATE AND LOCAL

PUBLIC PENSION BENEFITS.

State statutes currently exempt from state income tax public pension benefits paid by the state and its political subdivisions. The general source of statutory exemption is the Income Tax Act of 1967, Sec. 30(1)(f); MCL 206.30(1)(f); MSA 7.557(130)(1)(f), as added by 1969 PA 332, which provides in pertinent part that a Michigan resident may:

This exemption, covering all Michigan state and local public retirement system benefits, was added by 1969 PA 332, effective for calendar year 1969 and subsequent years' returns. It also has been extended by decision of the Michigan Court of Appeals to retirement income received by retired federal employees who are residents of Michigan. Davis v. Department of Treasury (On Remand), 179 Mich App 683; 446 NW2d 531 (1989).

Additionally, however, four retirement system statutes each contain a provision broadly exempting benefits from the imposition of any state or local taxation. These acts cover state employees, public school employees, legislators, and city library employees. ⁽²⁾ None of the other retirement acts covering other public employees contain such a tax exemption provision. ⁽³⁾

It should be noted that the tax exemption provisions in the four retirement acts listed in n 2, supra, predate the Income Tax Act of 1967. OAG, 1967-1968, No 4604, p 269 (July 26, 1968), concluded that the exemption from taxation afforded by Sec. 40 of the State Employees' Retirement Act had not been modified, amended, or repealed by implication by the adoption of the State Income Tax Act of 1967, which as originally enacted had no exemption excluding public pension income from the tax base. ⁽⁴⁾

An example of one of the retirement act based tax exemptions is that contained in the State Employees' Retirement Act, Sec. 40, n 2, supra, which has remained essentially unchanged since its enactment in 1943 and which currently provides:

CONSTITUTIONALITY OF LIMITING OR REPEALING THE EXEMPTION

FOR STATE AND LOCAL PUBLIC PENSION BENEFITS IN THE

INCOME TAX ACT OF 1967.

In Const 1963, art 9, Sec. 1, the people have vested the power to levy taxes in the Legislature, and our Supreme Court has held that this power includes the authority to grant exemptions from taxation. See Lucking v. People, 320 Mich 495, 504; 31 NW2d 707 (1948). This authority existed under 1908 Const, art 10, Sec. 2, in effect when the Legislature established the tax exemption component in the four retirement acts listed in n 2, supra. Both art 9, Sec. 1, and art 9, Sec. 24, appear in the Finance and Taxation Article of the 1963 Constitution, and must be read together. Unless an exemption from taxation is rooted in the constitution, cf. Const 1963, art 9, Sec. 4, the Legislature may limit or withdraw the exemption. See Auditor General v. MacKinnon Boiler & Machine Co, 199 Mich 489, 490; 165 NW 771 (1917).

The constitutional provision which is the subject of your inquiry, Const 1963, art 9, Sec. 24, provides:

The purpose of this constitutional provision was examined in OAG, 1989-1990, No 6583, pp 118, 123 (June 1, 1989):

Pursuant to the foregoing, Const 1963, art 9, Sec. 24, confers a contractual right upon a public employee to receive those benefits "under the terms of the statute or ordinance prescribing the plan" once that employee has performed service in reliance upon the prescribed benefits.

Analyzing the statutory exemptions here at issue, there is little question that an exemption from taxation for pension benefits constitutes "financial benefits" within the meaning of Const 1963, art 9, Sec. 24, since the exemption usually will result in greater net pension payments for the recipient. In Robert Tilove's treatise, Public Employee Pension Funds (1976), cited with approval by Justice Williams for the unanimous Court in Kosa v. State Treasurer, 408 Mich 356, 372 n 22; see also pp 372-373; 292 NW2d 452 (1980), the author, Tilove, in referring to public pension income tax exemptions generally, states: "[a]n income tax exemption has precisely the same effect as a benefit." (At p 244.)

With respect to the financial benefit conferred by the general exemption from income tax provided by the Income Tax Act of 1967 for public pension plan benefits, it is clear that such benefit cannot be a contractual obligation protected by Const 1963, art 9, Sec. 24. This is so because, as noted above, benefits intended to receive constitutional protection are limited to those arising "under the terms of the statute or ordinance prescribing the plan." 1 Official Record, supra, pp 770-771. The Income Tax Act of 1967 establishes and is intended to regulate solely a system for income taxation. The amendment of such act to provide for a general exemption for all public pension plan benefits post-dated and was in no way directly connected with the statutory establishment of the various public retirement plans. It follows, therefore, that the income tax exemption conferred by the Income Tax Act of 1967 was not intended to be nor may it be interpreted to be a benefit under the terms of the statute "prescribing the plan."

It is my opinion, therefore, that section 30(1)(f) of the Income Tax Act of 1967 concerning retirement benefits received from a Michigan public retirement system may be prospectively limited or repealed by the Legislature pursuant to Const 1963, art 9, Sec. 1. However, such limitation or repeal would not in and of itself affect similar statutory tax exemptions presently found in four retirement statutes.

CONSTITUTIONALITY OF LIMITING OR REPEALING THE INCOME TAX

EXEMPTIONS IN THE RETIREMENT STATUTES AS TO

PERSONS HIRED AFTER THE EFFECTIVE DATE

OF THE STATUTORY LIMITATION OR REPEAL.

As to the tax exemptions conferred by the four retirement acts, on the other hand, it is clear that they are benefits arising "under the terms of the statute or ordinance prescribing the [retirement] plan." 1 Official Record, supra, pp 770-771. Thus, to the extent that such benefits are "accrued," they could comprise a contractual obligation, protected by Const 1963, art 9, Sec. 24, from diminishment or impairment.

The meaning accorded the term "accrued" by the drafters of Const 1963, art 9, Sec. 24, is evident from the constitutional convention minutes set forth supra, page 6, wherein Delegate Van Dusen stated "it is the belief of the committee that ... the public employee should have a contractual right to benefits of the pension plan, which should not be diminished by the employing unit after the service has been performed. Now this does not mean that a municipality or other public employing unit could not change the benefit structure of its pension plan so far as future employment is concerned." [Emphasis added.]

In a later discussion, 1 Official Record, Constitutional Convention, 1961, p 774, Delegate Van Dusen, speaking for the Committee on Finance and Taxation, reiterated:

In view of the foregoing history, "accrued financial benefits" clearly are those with respect to which the employee has already provided or performed services.

This view is confirmed by Advisory Opinion re Constitutionality of 1972 PA 258, 389 Mich 659; 209 NW2d 200 (1973), wherein the Court discussed provisions requiring a subclass of members of the public school employees' retirement system to make increased contributions of $84 per year on future service in order to equalize their contributions with those of other members. The Court went on to hold that such increased contributions did not diminish benefits in violation of Const 1963, art 9, Sec. 24, even though there was no increase in the pension benefits of those members. The Court stated:

More recently, in a case involving the funding requirements of Const 1963, art 9, Sec. 24, Shelby Twp Police and Fire Retirement Board v. Charter Twp of Shelby, 438 Mich 247, 254 n 3; --- NW2d --- (1991), the court discussed its prior opinions in Advisory Opinion and Kosa, supra; stating "[w]e defined 'accrued financial benefits' as the right to receive certain pension benefits on the basis of service performed...." [Emphasis added].

Finally, in Assn of Professional & Technical Employees v. City of Detroit, 154 Mich App 440; 398 NW2d 436 (1986), cited by the court in Shelby, supra, the Michigan Court of Appeals held that Const 1963, art 9, Sec. 24, barred the city from unilaterally imposing, on current member-employees, a minimum age requirement for receipt of pension benefits, action that would directly diminish and impair their accrued financial benefits. Relying on Advisory Opinion, supra, the Court stated, 154 Mich App at 446:

Thus, it is clear that, inasmuch as Const 1963, art 9, Sec. 24, encompasses only benefits payable for work already performed, no contractual right to a prior benefit structure could arise as to those who become members of a retirement system subsequent to the enactment of changes in the benefit structure.

It is my opinion, therefore, that pursuant to Const 1963, art 9, Sec. 1, the Legislature may prospectively limit or repeal the state and local tax exemption provisions it has put in the State Employees' Retirement Act, the Public School Employees' Retirement Act of 1979, the Michigan Legislative Retirement System Act and the city library employees' retirement systems act (see n 2, supra,) as to all new members joining those systems after the effective date of such prospective legislation.

CONSTITUTIONALITY OF LIMITING OR REPEALING THE INCOME TAX

EXEMPTIONS IN THE RETIREMENT STATUTES AS TO

CURRENT RETIREES AND MEMBERS OF THOSE

RETIREMENT SYSTEMS.

In Dunn v. Bd of Trustees of Wayne County Retirement System, 160 Mich App 384; 407 NW2d 657 (1987), the Michigan Court of Appeals held that the Legislature lawfully amended the retirement allowance formula of the Judges' Retirement Act to apply to member-judges who retired or rendered service after the amendment. The judges in service had a vested contract right to undiminished benefits, but did not have "veto power over the method or formula constructed to convey those benefits ... [The judges] are without any vested rights to pension benefits computed under ... [the prior] formula ... so long as the benefits to be paid are equal to or better than those provided by the prior formula." [Emphasis added.] 160 Mich App at 392-393.

In determining whether the pension benefits to be paid equal or exceed those previously provided, the courts will be guided by the principle that:

Seitz v. Probate Judges Retirement System, 189 Mich App 445, 456; --- NW2d --- (1991), app lv pdg Mich Sup Ct No. 91777.

It is my opinion, therefore, that the Legislature may, without violating Const 1963, art 9, Sec. 24, limit or repeal the tax exemptions now found in the four retirement statutes as to current retirees and members if it provides alternative benefits in their place that are equal to or greater than the pension benefit that would be limited or withdrawn since there would be no constitutionally cognizable impairment of the pension benefit.

The remaining question is whether the Legislature may, without violating Const 1963, art 9, Sec. 24, limit or repeal the tax exemptions in the four retirement statutes in n 2, supra, as to current retirees and members without providing equal alternative benefits in place thereof. The response to that question is still being researched. When the research is completed, my response will be forthcoming.

Frank J. Kelley

Attorney General

(2 These retirement acts provide similar tax exempt status:

^{(a) State Employees' Retirement Act, 1943 PA 240, Sec)} 40, MCL 38.40; MSA 3.981(40).

(b) Public School Employees Retirement Act of 1979, 1980 PA 300, Sec. 46(1); MCL 38.1346(1); MSA 15.893(156)(1). See also the predecessor act, 1945 PA 136, Ch 1, Sec. 25, providing an exemption for retirement benefits from state or local taxation for only Chapter I members since enactment in 1945.

(c) Michigan Legislative Retirement System Act, MCL 38.1057(1); MSA 2.169(57)(1) (exemption added by 1961 PA 167).

(d) City library employees' retirement systems, 1927 PA 339; MCL 38.705; MSA 15.1775 (exemption since 1927).

(b) Probate Judges Retirement Act, MCL 38.901 et seq; MSA 27.3178(60.1) et seq.

(c) Fire Fighters and Police Officer Retirement Act, MCL 38.551 et seq; MSA 5.3375(1) et seq.

(d) State Police Retirement Act of 1986, MCL 38.1601 et seq; MSA 5.4002(1) et seq. See also the predecessor act, 1935 PA 251.

(e) Municipal Employees' Retirement Act of 1984, MCL 38.1501 et seq; MSA 5.4001(1) et seq. See also the predecessor act, 1945 PA 135.

(f) County pension plan act, MCL 46.12a; MSA 5.333(1).