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Reforming Wisconsin’s Income Tax: What Works, What Doesn’t. Matt Gardner mattg@itep.org www.itep.org 9/6/2012. Topics for Discussion. ITEP’s Microsimulation Tax Model Incidence of Wisconsin taxes Why the income tax– and why not? Complexity and the income tax Volatility and the income tax
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Reforming Wisconsin’s Income Tax: What Works, What Doesn’t Matt Gardner mattg@itep.org www.itep.org 9/6/2012
Topics for Discussion • ITEP’s Microsimulation Tax Model • Incidence of Wisconsin taxes • Why the income tax– and why not? • Complexity and the income tax • Volatility and the income tax • Income taxes and economic growth • Income tax reform proposals in other states
ITEP’s Microsimulation Tax Model • Built in 1994-1996, but still evolving in 2012 • Designed to: • Predict the distributional effect of proposed tax changes on taxpayers at different income levels • Predict the revenue gain (loss) from proposed tax changes • Estimate the impact of current state and local taxes in all 50 states • Measure the interaction between state and federal tax changes • Employs the same technology used by the US Treasury, Congressional Joint Committee on Taxation, Congressional Budget Office, and some state departments of revenue (e.g. TX, MN, ME) • Consists of four basic modules: personal income tax, property tax, consumption tax, and business tax
Data Sources Joint Committee on Taxation ACS CBO Current Population Survey 750,000 records aka 140 million American taxpayers + = Consumer Expenditure Survey State Specific Data Economy dot com IRS Tax Return Data
Why the Income Tax (and why not)? • The only option for states seeking a modicum of fairness. • Interacts with sales/property taxes; effectively becomes a hybrid tax, not a separate income tax. • Uniquely among state taxes, based on ability to pay • Can grow as rapidly as the cost of public services • BUT…. • Can be volatile • Can be complicated • Is sometimes asserted to hurt state economic growth
Complexity and the Income Tax • Some income taxes are simpler than others • Wisconsin’s income tax is less simple than many • But the graduated rate structure is NOT the reason • Proliferation of credits, adjustments, exclusions is the culprit
Volatility and the Income Tax • California: $4.3 billion jump in one year (2006) • Trough in 2009 was just as deep • The charge: progressive income taxes are unmanageably volatile • The reality: in practice, sales taxes tend to be as volatile in the short run. • And income taxes tend to grow faster over the long haul. • The challenge: managing revenues with rainy day fund.
Volatility: Is a Flat Rate the Solution? • California LAO: converting state income tax to flat rate would result in slower revenue growth over time • In other words, the price of reducing volatility is slower revenue growth. • Implication: income tax grows faster than sales tax; progressive income tax grows faster than flat tax.
Economic Growth and the Income Tax: A Catalog of Misleading Claims • 2009: Wall Street Journal asserts 1/3 of Maryland millionaires are “missing” following tax hike. Reality: they “moved” to lower income groups. • 2010: WSJ makes same claim about Oregon. Reality: same. • 2012: Arthur Laffer asserts that repealing Oklahoma’s income tax would double the state’s growth rate.
Why Wouldn’t Income Tax Cuts Lead to Economic Growth? • Tax cuts must be paid for; spending cuts have the opposite effect of tax cuts • Spending cuts typically affect in-state income exclusively; tax cuts tend to “bleed” into other states • Revenue-neutral income tax rate cuts will necessarily hike taxes on middle- and low-income families; net impact on economy far from certain • Federal deductibility of state taxes blunts cross-state tax rate differences.
Income Tax Reform: A Survey of Policy Choices • Tax Rate or Tax Base? Loophole-closing allows revenue-raising without rate hike. • Base changes include: deductions, exemptions, credits. • Base changes tend to be permanent structural improvements in the tax. • Permanent or Temporary? Most recent rate hikes have been temporary. • Hike taxes on “millionaires” or on everyone? Most have chosen to hike only upper-income rates.
Income Tax Reform: Recommendations from Other States • South Carolina: Reduce capital gains exclusion, but maybe increase it for SC-based investments. • Georgia, SC, MS: pare back retirement income tax breaks. • Georgia, NC: conform more closely to federal AGI by eliminating tax breaks. • Georgia, Kansas,NC: eliminate itemized deductions. • Oklahoma, KS, Georgia: sunset many/all tax credits. • Kansas, California: flatten income tax rates
Base-Broadening Income Tax Reform: Recent Actions: Itemized Deductions • Rhode Island: Repealed itemized deductions; increased basic standard deduction, dropped top rate, repealed some credits. • Utah: Replaced itemized deductions/personal exemptions with means-tested tax credit; reduced top tax rate. • Maine: Repealed all itemized deductions, lowered and flattened rate structure (rejected by ballot measure, June 2010). • New Mexico: Repealed itemized deduction for state income taxes • Hawaii: Put a cap on the $ value of itemized deductions. • Vermont, New Jersey, New York: Put caps on specific itemized deductions.
Base-Adjusting Income Tax Reform: Recent Actions: Capital Gains, Other • Colorado, Rhode Island, Vermont, Wisconsin: Pared back existing capital gains tax preferences. • Virginia: Pared back retirement tax break for upper-income taxpayers only ($>$75K married). • BUT…. • Kansas, South Carolina: Reduce or repeal income tax on pass-through business income. • Arizona: Create 25% capital gains exclusion
Summary Thoughts: • Broadening the income tax base is a sensible first step. No tax break is sacred: all should be evaluated regularly. • Adjustments to tax rates—either up or down—should be a second choice. • Complexity is the product of tax loopholes, not graduated rates. • Linkage between tax rate reductions and economic development is not at all obvious. • Volatility is a two-sided coin. Short-term variability, long-term growth.