Governor Olene Walker unveiled a comprehensive proposal to overhaul Utah ’s state and local tax system, with particular emphasis on lowering tax rates and broadening the tax base. The Governor has repeatedly emphasized that the proposal is revenue neutral and is intended to reform the system and is not an attempt to increase tax burdens on Utah ’s families and businesses.
This week I will describe the plan in some detail. Next week I will describe what I believe is good about the plan and what is perhaps not so good.
The governor’s proposal recommends 16 changes to Utah ’s tax structure. These recommendations are based on sound tax policy principles of
- Revenue stability
- Ease of compliance and administration
- Taxing final consumption and exempting production inputs
Recommendation 1: Retain “Three-legged Stool”
Utah ’s tax system is based on the “three-legged stool” of taxing income, consumption, and wealth, and the Governor recommends maintaining this system in order to maintain revenue stability through diversification.
Recommendation 2: Lower individual income tax rates and broaden the base
Utah ’s individual income tax currently has six brackets, with the top marginal tax rate of 7% applying to taxable income above $8,626 for married households. The Governor’s proposal offers to two options for changing individual income taxes:
- Option 1 proposes a flat rate of 4.9% based on federal taxable income and an increase in the statewide basic property tax levy for education. This proposal would allow taxpayers to continue to claim deductions such as mortgage interest, charitable contributions, and dependent exemptions.
- Option 2 proposes a flat rate of 4.1% based on federal adjusted gross income. No deductions would be allowed under this proposal, and no increase in property taxes would be required.
Both options would eliminate state-only deductions and credits and could complicate efforts to reform education through tuition tax credits.
Recommendation 3: Eliminate the corporate income tax
The Governor recommends eliminating the corporate income tax (CIT), a volatile source of revenue, and offsetting this reduction by increasing the statewide basic levy for education, a stable source of revenue. The CIT comprises less than 5% of overall state revenues and about 1% of total state and local revenues. The corporate tax base is declining due to increased sheltering of income by multi-state firms and increasing popularity of pass-through entities such as LLCs and s-corporations which are taxed at the individual level.
Elimination of the CIT would improve Utah ’s business climate and make the state more attractive for investment.
If eliminating the CIT is not politically feasible, the Governor proposes a “fallback” position of double-weighting the sales factor which most states have already done. This would benefit businesses that have a large share of their payroll and property in Utah while shifting taxes to businesses that have a large share of their sales in Utah .
Recommendation 4: Simplify and expand the sales tax exemption for business inputs.
Utah currently exempts manufacturing equipment from sales taxes. The Governor proposes extending this exemption to all business inputs that can be capitalized under federal income tax law, thereby creating a system that taxes final consumption. Exempting business inputs from sales taxes avoids “tax pyramiding” where taxes are imposed on taxes throughout the various stages of production. This hides the true cost of government from taxpayers and discourages investment in capital.
Recommendation 5: Broaden the sales tax to include services
Utah already taxes some services such as repair of personal property, entertainment, transportation, cleaning, and many other services. The governor proposes to expand the base to include professional services such as medical, legal, and accounting. The tax would be applied to final consumers and businesses would be exempt from paying these taxes.
Recommendation 6: Reduce state sales tax rate from 4.75% to 3.75%.
Broadening the tax base to include professional services would allow the state to reduce the sales tax rate from 4.75% to 3.75%, a 21% reduction. (Presumably, local tax rates would also be reduced 21%). Reducing the sales tax rate would make the sales tax much less regressive.
Recommendation 7: Continue to participate in the Streamlined Sales Tax Project
Imposing taxes on remote sales such as Internet and mail order catalog purchases prevents further erosion of the tax base and allows for equitable tax treatment of main street retailers and remote sellers.
Recommendation 8: Distribute sales tax revenues based on population and create a single statewide state/local sales tax rate
Distributing sales tax revenue based on population will prevent “zoning for dollars” where cities use RDAs to divert property taxes, most of which would go to the local school district, to attract retail under the guise of “economic development”.
Creation of a single statewide sales tax rate will simplify collection for retailers, particularly small retailers who deliver goods and services to customers in multiple tax entities. With a uniform statewide rate, retailers would not have to track location of deliveries. Local governments would be required to reduce property taxes if sales tax rates were increased.
Recommendation 9: Retain the general structure of the current property tax system
The governor recommends keeping the existing property tax system with one major change (see recommendation 13)
Recommendation 10: Fund urban and suburban water use with fees, not general taxes
The governor proposes ending the taxpayer subsidy of water consumption. Utah is the nation’s second driest state and has some of the lowest water rates due to tax subsidies of water.
Recommendation 11: Study centrally assessed property
Centrally assessed valuation is a contentious issue as counties continue to claim that centrally assessed properties like mines and utilities are not paying “their fair share.” The governor’s report treats this claim with some skepticism, noting that assessed valuation imposed on utilities and mines are among the highest in the western U.S. The governor recommends both sides participate in a summit to discuss this issue.
Recommendation 12: Allow school districts to opt out of RDAs.
Cities currently use property taxes, about 55% of which go to local school districts, to encourage retailers to local in their cities. Allowing one tax entity (a city) to steal the tax base from another tax entity (school district, county) is poor tax policy. This recommendation would end this practice.
Recommendation 13: Adjust property tax rate for inflation
Under Utah ’s Truth-in-Taxation law, property tax rates are reduced as valuation of existing properties increase. Therefore, local governments do not receive a revenue windfall when valuations increase. The governor proposes changing this so that property tax rates are allowed to capture inflation.
Your taxpayers association has opposed this legislation in previous years. To read the association’s position on the impact of Truth-in-Taxation on property tax revenues, please visit www.utahtaxpayers.org/NEWSLTTR/PDFs/nl_2004/aug_2004e.pdf.
Recommendation 14: Impose both sales and gas tax on fuel purchases
The governor recommends imposing sales taxes on gasoline and fuel purchases and reducing the gas tax rate to avoid a revenue windfall.
Recommendation 15: Simplify severance tax and invest the proceeds
The governor recommends eliminating the two-tier severance tax system and replacing it with a flat rate. Since mineral resources are not renewable, the governor also proposes discontinuing the use of using severance tax revenues for ongoing expenditures and instead proposes using the revenues for long-term investments and trust funds.
Recommendation 16: Retain state inheritance tax unless the federal estate tax is eliminated.
The governor recommends that Utah continue to tie its state inheritance tax to the federal state inheritance tax credit.
Next week I provide my evaluation – for what it’s worth — of the Walker proposal and describe how I believe it would affect the Utah economy. In the meantime, if you wish to read the proposal, go to www.utah.gov/governor/ and click on current news of 11/22/04 .
For more information go to WWW.utahtaxpayers.org