The Always Tricky Reverse-Commuter Tax

When cities try to tax people who work in one place and live in another, things get really complicated really fast.

The commuter tax is a tricky one. Many big cities struggle with meeting the needs of thousands of workers who flood downtown every day and then head home to the suburbs (where they’re actually taxed) at night. But other places struggle with the exact opposite problem: capturing revenue from residents who live in the city but commute out to the ’burbs to work. When residents work in suburbs, the whole city misses out on essential revenue -- in many places the city income tax is the largest single source of revenue. Two variations on the reverse-commute hurdles -- one in Michigan and the other in Kansas -- show just how complicated the issue can be.

In Michigan, Detroit levies a tax on outward-bound commuters, but only 15 percent of them actually pay the self-reported tax. The loss adds up, because 62 percent of Detroit residents commute out to the suburbs, according to the nonprofit Citizens Research Council of Michigan.

This summer, state lawmakers looked at options that would help the Motor City collect the tax. One idea was to require suburban employers to withhold city income taxes and then turn them over to Detroit. That would take the burden off Detroit residents to figure out how to report and pay their taxes, and it would boost revenue for the city. But a reverse-commuter tax itself, which is also levied in 21 other cities in Michigan, may discourage residents from living in urban centers, say critics like Eric Lupher, president of the Citizens Research Council of Michigan. Most of Michigan municipalities are “trying to revitalize themselves and be attractive in getting people to move there,” he told Crain’s Detroit Business
. This kind of tax might be a disincentive.

Things get even thornier when commuters cross state lines. That’s a big issue in Kansas, where lots of state residents cross the border every day to work in Kansas City, Mo. Those commuters must pay a 1 percent earnings tax to the Missouri city. But now that may prove to be a big revenue loss for the state of Kansas. Why? Because of a U.S. Supreme Court ruling earlier this year that said states must provide full credit to a resident for any income taxes paid to other states. Otherwise, that part of that resident’s income is essentially being double-taxed.

The court case had to do with Maryland. But the Kansas Department of Revenue has determined that it applies there as well: Any Kansas resident who pays a tax in Missouri should be allowed to claim that tax against their Kansas bill. What’s more, the August ruling by the revenue department said that commuters can apply for a rebate for each of the past three years. That might be a modest refund for those commuters, but it could be devastating to Kansas’ revenue. Paying just one year’s worth of refunds could mean $36 million in costs to the state, which is already struggling with a budget shortfall. “This has the potential,” says Kansas state Rep. Kathy Wolfe Moore, “to make an already disastrous financial situation much worse.”

Remember when I said the commuter tax was complicated? I rest my case. And as cities become bigger hubs of residents -- and as those residents commute farther afield for work -- it’s not an issue that’s going away. 

Director of the Center for State and Local Government Leadership at George Mason University