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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


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reforming wisconsin s income tax what works what doesn t

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

Matt Gardner

mattg@itep.org

www.itep.org

9/6/2012

topics for discussion
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
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
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
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
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
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
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
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
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
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
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
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
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
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.