by Howard Stephenson
Utah’s Tax Reform Task Force is considering a flat state income tax with one rate and no itemized deductions or dependent exemptions. The proposal has been recommended by Income Tax Sub-committee and will now be considered by the full Task Force.
Governor Jon M. Huntsman, Jr. has also recommended a flatter, broader tax than the current 7% top rate. The Utah Taxpayers Association and many tax practitioners and economists believe that ideally, a 4% flat tax could help all Utahns by generating revenues similar to the current tax without deterring CEOs of better-paying firms from locating their companies here.
Despite opposition by religious groups to eliminating deductions for charitable giving and opposition from others to repealing the deduction for mortgage interest and dependent exemptions, so far the Task Force appears to be supportive of the flat tax. Only time will tell if the full legislature will enact a flat tax. Most tax experts believe the loss of deductibility on state taxes will make no difference to the level of charitable giving, as described below.
What are the benefits of a flat tax?
Economists agree that tax systems should be broad-based with low rates. Low rates reduce the distortion that tax systems have on business and household economic decision making. By eliminating deductions and exemptions, Utah could reduce its top marginal tax rate from 7% to a flat rate of around 4 or 5%.
Will the flat tax shift the tax burden from lower income households to higher income households?
Not necessarily. A flat tax consists of four variables: tax rate, amount of AGI-based standard exemption, rate at which exemption is phased out as AGI increases, and amount of revenue to be generated. These variables can be adjusted to achieve an income tax that is completely flat, moderately progressive, or steeply progressive. The association supports a flat tax that does not shift the current tax burden from one income group to another, although individual households would experience tax cuts and tax increases under any meaningful reform.
Will elimination of deductions for charitable contributions reduce donations to charities?
No. Evidence is very clear that changes in the tax code do not impact charitable giving. During the 1980s, top federal rates were dramatically decreased from 70% to 28%. Critics of the Reagan Tax Reform Act (TRA) of 1986, which reduced the top rate from 50% to 28%, predicted that charitable giving would decrease because reducing marginal tax rates would decrease the value of charitable contributions for tax purposes. Instead, charitable giving increased after TRA was enacted. As a percent of personal income, charitable giving has been fairly constant, despite significant changes in the tax code.
In a static sense, the TRA was revenue neutral, which means that taxpayers as a whole did notincrease charitable giving because they had more after-tax income. The largest determinant oncharitable giving is the state of the economy, not the tax code.
Will elimination of deductions for mortgage interest make home ownership less achievable?
No. During the past forty years, the percent of federal taxpayers that itemize deductions – and consequently the percent of those who deduct mortgage interest — has fluctuated wildly as has the tax value of these deductions since federal tax rates have fluctuated wildly also. However, home ownership rates have been very stable over this time, with a slight increase. Broad-based mortgage interest deductions lower the effective interest rate for buying a house, and this is usually reflected in higher home prices, not necessarily increased home ownership. In recent years, the biggest impact of low interest rates has been increased home prices, not increased home ownership.
Moreover, should Utah’s tax system incentivize borowing in a state whose bankruptcy rate is thehighest in the nation?
Finally, supporters of deductions for charitable contributions and mortgage interest would haveto oppose any reduction in federal and state income tax rates since these reductions would reducethe tax value of these deductions.
Single Sales Factor for Corporate Income Taxes
Instead of eliminating the state corporate income tax entirely, the Utah Taxpayers Association and the business community in general recommends allowing companies to choose between an evenly weighted three-factor formula or single sales factor (SSF). An electable SSF is based on the same underlying principles as the electable double weighting of sales that the Legislature passed in the 2005 General Session.
Concerns about Complete Elimination of Utah Corporate Income Tax
Tax cuts are always appreciated. However, some tax cuts are more valuable than others, especially if taxes are increased elsewhere to make up the difference.
Eliminating sales taxes on business inputs is a more valuable tax cut thancomplete elimination of state corporate income tax. According to the Utah Constitution, intangible property may not be taxed if a corporate income tax is imposed. If the corporate income tax is repealed and the state constitution is not amended, intangible property would be taxable.
Reasons For Electable Single Sales Factor
SSF benefits companies that invest in Utah and export goods and services. A company with 100% of its production and employees in Utah and 100% of its sales outside of Utah would pay zero Utah corporate income tax (but would still pay local property taxes).
Companies with lower sales factor than overall apportionment factor will experience a reduction in Utah corporate income tax, meaning that a company that is primarily located in Utah and exports most or all of its product would benefit.
Exporting companies are typically high wage companies like manufacturers, IT, mining, and other basic industry. States are generally moving away from evenly weighted three factor to heavier emphasis on sales.
The complete elimination of state corporate income taxes would decrease state revenues (using static analysis) by about $150 to $200 million while estimated revenue reduction for electable SSF would be $63 million.
SSF eliminates constitutional concerns
Utah Constitution Article XIII, section 2, part (5): “If any intangibleproperty is taxed under the property tax, the income from that property may not also be taxed.” Taxation of intangible property (patents, copyrights, expertise, know-how, customer base, sales force, etc.) would be catastrophic for many companies. The single sales factor also a ddresses many of the objections raised against corporate income taxes in general. Taxing corporate profits is double-taxation since individuals are also taxed on dividends and capital gains. Reducing corporate income tax revenues by allowing SSF reduces revenues from a volatile and slowly declining revenue source.
The Legislature is still early in the process of reforming individual and corporate income taxes, but now is the time for interested persons to have the most effective input.