Reforming Wisconsin’s Income Tax: What Works, What Doesn’t

1. Reforming Wisconsin’s Income Tax: What Works, What Doesn’t Matt Gardner mattg@itep.org www.itep.org 9/6/2012

2. 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

3. 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

4. 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

5. Wisconsin taxes are generally regressive overall.

6. Sales and property taxes drive this regressive result.

7. Wisconsin’s income tax ranking varies by income group

8. Regional Comparison of Income Tax Incidence

9. 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

10. 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

11. 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.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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

17. 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.

18. 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

19. 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.