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December 2013 Policy Study, Number 13-9

   

Iowa Needs Income-Tax Reform!

   

States Adopting Income-Tax Reform

   

 

North Carolina

 

Some states are adopting tax reform and lowering tax rates, if not completely moving to an income-tax free system. The most recent state to adopt significant tax reform is North Carolina. In July of this year, Governor Pat McCrory (R) signed into law the reforms hammered out by the Republican-controlled North Carolina General Assembly. The new tax law will lower the personal income tax to a single-rate flat tax, “eliminate the personal income exemption, but increase the standard deduction,” and cap the mortgage interest and property tax deductions, among other provisions.[6] The tax reform also reduces the corporate-income-tax rate and provides a path for further possible reductions in the corporate-income-tax rate. A press release from Governor McCrory highlights the personal-income-tax and corporate-income-tax changes:

 

Personal Income Tax:
• Reduces and simplifies the 3-tiered state personal income tax from the current maximum rate of 7.75 percent and minimum rate of 6 percent to [a single rate of] 5.8 percent in 2014 and 5.75 percent in 2015.
• Increases the standard deduction for all taxpayers, applied to the:
o First $15,000 of income for those married filing jointly.
o First $12,000 of income for heads of household.
o First $7,500 of income for single filers.
• ​Retains the state child tax credit and increases it for families making less than $40,000.
• Offers a $20,000 combined maximum deduction for mortgage interest and property taxes.
• Makes charitable contributions fully deductible.
• Protects all Social Security income from state taxes.

 

Corporate Income Tax:
• Reduces the corporate income tax from 6.9 to 6 percent in 2014 and then to 5 percent in 2015, a 29 percent rate reduction.
• If the state meets revenue targets (i.e. if there is additional tax revenue growth due to a growing economy), the corporate income tax will drop to 4 percent in 2016 and 3 percent in 2017.[7]

 

John Hood, President of the John Locke Foundation located in Raleigh, North Carolina, commended the North Carolina General Assembly and Governor McCrory for the direction they took in reforming the corporate income tax and the impact on that state’s businesses:

 

If your goal is to foster economic growth and job creation, there’s a right way and a wrong way to cut taxes on business. Fortunately, Pat McCrory and the General Assembly made the right choice.

 

The wrong way is to offer tax credits or other targeted incentives to companies based on where they locate or how they spend their revenue. In order for such incentives to create net economic value, the public officials who craft them would have to possess superior knowledge to that of private entrepreneurs, investors, and managers.

 

This is what Nobel-winning economist Friedrich Hayek and his collaborator W.W. Bartley called the “Fatal Conceit” in a 1988 book of the same name. Central planning doesn’t fail because government officials are dumb or have bad intentions. Central planning fails because no single person or group could possibly possess all of the constantly emerging and changing pieces of information necessary to make welfare-enhancing decisions.[8]

 

North Carolina’s Tax Simplification and Reduction Act also eliminates the state estate tax or “death tax” and caps the state’s gas tax at 37.5 cents per gallon.[9] Additionally the law makes some changes in the state’s sales and franchise taxes, including eliminating the back-to-school and Energy Star sales tax holidays. “Sales taxes would be applied to service contracts and increased for manufactured and modular homes.”[10] “Several controversial tax breaks, such as a subsidy for film production, are now scheduled to expire over the next two years.”[11] The tax reform is “revenue neutral in 2013,” but when fully implemented will result in an “annual $450 million tax cut.”[12]

 

North Carolina Legislators and the Governor also adopted budget reforms this year to accompany the tax reforms. “Legislators improved state government’s balance sheet by boosting reserve funds, speeding up repayment of a $2.5 billion debt to the federal government for unemployment benefits, and imposing a debt limit that forces lawmakers to seek voter approval before they can assume new state debt.”[13]

 

Kansas

 

Kansas adopted tax-reduction legislation in 2012 and again passed a package this year to make improvements on last year’s tax bill. According to a media release from Governor Sam Brownback (R):

 

The [2012] law collapses the current three-bracket structure for individual state income taxes (3.5, 6.25 and 6.45 percent respectively) into a two-bracket system using rates of 3.0 and 4.9 percent. The business income exemption eliminates certain non-wage business income for small business owners (income reported by LLC’s, Subchapter-S Corporations, and sole proprietorships on lines 12, 17, and 18 of federal form 1040).

 

The law also flattens the tax structure and increases the standard deduction amount for single head-of-household filers from $4,500 to $9,000; and for married taxpayers filing jointly from $6,000 to $9,000.[14]

 

In addition to the income tax changes, Governor Brownback and the Republican-controlled Kansas Legislature adopted economic development incentives, including “letting businesses of any size deduct 100 percent of the expense of new business equipment and machinery” and the creation of Rural Opportunity Zones (ROZ) “to help recruit people to counties with sharply declining populations.”[15]

 

Fifty counties which have experienced double-digit population loss over the past 10 years have been designated ROZ counties. The majority are in far northwestern Kansas, but some, such as Kingman in south-central Kansas, are near more urban areas (Wichita)…Those who move to ROZ counties will have their state income taxes waived from 2012 – 2016 if they lived outside the state for the previous five years, or lived in Kansas but had an income of less than $10,000.[16]

 

This year, the Kansas Legislature and Governor Brownback adopted additional income-tax reforms that:

 

• Lower income-tax rates even further, ultimately to 2.3 percent on the first $30,000 of income and 3.9 percent on income above that.
• Set the sales-tax rate at 6.15 percent beginning in July 2013. At first glance, this seems like a tax cut, as the sales tax was 6.3 percent. However, the tax had been scheduled to drop to 5.7 percent in July 2013.
• Reduce the value of itemized deductions by 30 percent this year and by 5 percent per year until 2017, when they will be reduced 50 percent permanently. The charitable deduction is an exception to this treatment and will remain fully deductible.
• Decrease the standard deduction for married filers filing jointly ($7,500) and heads of household ($5,500), down from $9,000. The amounts are still higher than pre-2012 law ($6,000 and $4,500, respectively).
• Restore the low-income, food-tax credit.
• End the itemized deduction for gambling losses.[17]

 

The Rural Opportunity Zone program was also expanded from the original 50 counties to cover 73 counties in Kansas.[18]

 

Joseph Henchman and Scott Drenkard of Tax Foundation indicate that “while the [2013] bill is a tax increase, the combined effect of both years’ bills remains a net tax cut.”[19] They believe Governor Brownback’s tax reforms will contribute to economic growth because “Kansas’ tax code is now based more on consumption than it used to be… [and] good tax reform includes broadening the tax base while lowering the rate, which appears to be Governor Brownback’s intention.”[20]

 

Governor Brownback highlights his reasoning for pushing for income-tax reform for his state:

 

We [Brownback and Lt. Gov. Jeff Colyer] did this because it was time to shake up the status quo of taxing, spending, and declining. In our federalist system, state governments are forced to compete against each other for capital, jobs, and residents. Competition offers two options: you can either refuse to adapt to changing conditions and fall behind those who do, or you can lead the way to the future. Kansas had to change the way it competes regionally and nationally for residents and jobs, and so far we have made great progress.[21]

 

Indiana

 

In May of this year Indiana Governor Mike Pence (R) signed a two-year budget bill into law that includes “the largest state tax cut in Indiana history.”[22] The individual income-tax rate will fall from the current 3.4 percent to 3.3 percent in 2015 and 3.23 percent in 2017.[23] While a flat income-tax rate of 3.4 percent was already one of the lowest rates in the country, Governor Pence, “well aware of the burden put on citizens by the federal tax hike on January 1 and by the looming costs of Obamacare,…was determined to do what he could to ease the pain for Hoosiers. ‘He felt pretty strongly that what he could do as Governor was to reduce the price of living and working in our state,’ explains Ryan Streeter, a top Pence adviser.”[24]

 

The budget bill also repealed the state’s inheritance tax retroactive to January 1, 2013. Previous Governor Mitch Daniels (R) adopted legislation to phase out Indiana’s inheritance tax by 2022, but the recently signed budget bill repealed the tax beginning this year rather than continuing the phase-out over the next nine years.[25] Indiana’s inheritance tax had a top rate of 20 percent before the tax was repealed.[26]

 

Additionally, the budget bill let stand a reduction in the state’s corporate-income tax that was adopted in 2011. That legislation reduced the corporate-income tax from 8.5 percent to 8 percent on July 1, 2012, 7.5 percent this year, 7 percent in 2014, and 6.5 percent in 2015, with “each reduction tak[ing] effect on July 1 of each year.”[27]

 

Rhode Island

 

Just a few years ago, Rhode Island had one of the highest top personal income-tax rates in the country, at 9.9 percent. In 2006 the Democrat-controlled Rhode Island General Assembly adopted and then-Governor Don Carcieri (R) signed into law an optional flat tax with no deductions. Rhode Island taxpayers could choose between the ongoing tax system with rates and brackets and deductions or could choose the flat tax and forgo the exemptions and deductions, whichever system would give them the lowest tax bill.[28] The optional flat tax was set at 8 percent for the 2006 tax year and was scheduled to drop by 0.5 percent each year until reaching a floor of 5.5 percent in 2011.[29]

 

While many state tax reformers have discussed implementing a dual-tax system in which taxpayers decide which tax to pay, Rhode Island has been the only state to adopt such a reform. However, very few Rhode Island taxpayers took advantage of the optional flat tax:

 

As the Providence Journal reports, only 838 residents used the flat tax in 2007…. That seems like a remarkably low number, considering 2007 was a boom year for many high earners, but the flat-tax rate that year was 7.5 percent, not exactly a bargain considering that the tax filer has to give up every deduction.[30]

 

In April 2010, House Finance Committee Chairman Steven Costantino (D) proposed eliminating the optional flat income tax. However, Representative Costantino also indicated that simply continuing with a tax system with a high top rate was not acceptable and also proposed tax reform that would “make Rhode Island ‘more competitive with neighboring states,’ and ‘get that 9.9 percent monkey off our backs.’”[31]

 

Two months later, in June 2010, Governor Carcieri signed legislation to overhaul Rhode Island’s personal-income-tax system, with the following elements:

 

• Eliminates the optional flat-tax system and the alternative-minimum tax.
• Reduces the number of tax credits.
• Increases the standard deduction for most taxpayers.
• Eliminates the option to itemize deductions.
• Reduces the number of brackets from 5 to 3 and reduces the top tax rate from 9.9 percent to 5.99 percent.[32]

 

“Under the legislation, the vast majority of Rhode Island taxpayers – those with adjusted gross income below $500,000 – would see a tax decrease…. The new standard deductions would be $7,500 for individuals and $15,000 for those filing jointly.”[33] The tax reform also “eliminates most of the state’s roughly 40 tax-credit programs.”[34]

 

As described by Joseph Henchman of Tax Foundation:

 

Overall, the reform was designed to be revenue-neutral and actually increase progressivity, while dramatically reducing compliance costs and barriers to economic growth. While Rhode Island still has problematic property and corporate income taxes…their tax reform will greatly boost the state’s competitive position. That an overwhelmingly Democrat Legislature and the Republican Governor came together to enact it shows that tax reform is a possibility in any state.[35]

 

While the dual-tax system was not a success in Rhode Island due to the high rate of the flat tax, elected officials in that state did recognize the need to reform their system and reduce the high tax rates and complexity of their state’s income tax.

 

   

 

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