AFP Report: Significant Benefits to Eliminating the State Income Tax

February 06, 2013

“If you want more of something, don’t tax it. If you want more jobs, don’t tax the small companies that create by far the most jobs. That’s why the fastest growing, most prosperous states (and countries) are the ones with low tax rates.”

~ Economics Professor Christine Ries, Georgia Institute of Technology

Executive Summary

States with low or no personal and corporate income tax burdens consistently out-perform states, like Nebraska, with such taxes.  Low tax states routinely post faster Gross State Product Growth, Population Growth, State and Local Tax Revenue Growth and Income Growth than states like Nebraska with a high tax burden.

Eliminating Nebraska’s personal and corporate income tax will position our state to compete for new economic investment and good-paying jobs.  Eliminating the personal income tax will save $1,051 for the average Nebraska family.

LB 405
Gov. Heineman has proposed a bold plan to significantly reform Nebraska’s tax code by eliminating the state personal and corporate income tax.  Repealing the state income tax will significantly increase take-home pay for the average Nebraska worker as well as transform Nebraska into a national magnet for new business investment and job creation.

LB 405, as introduced by State Sen. Beau McCoy, would be the most sweeping reform plan in Nebraska in over a generation and make Nebraska one of ten states with no state income tax.  Multiple other states including Louisiana, Kansas, North Carolina and Oklahoma are also seeking to eliminate their state income tax in order to create economic growth and be more competitive for business relocation.

Nebraska’s High Tax Burden

According to the non-partisan Tax Foundation, Nebraska has the 21st highest cumulative tax burden in the nation.  Nebraskans pay $3,853 per capita annually to fund state and local government; this tax burden is much too high considering it is the highest in our region.  In order to remain competitive with Nebraska’s neighboring states, we must reduce our tax burden.

Neighboring state’s comparative national ranking:

Nebraska                   21st Highest Tax Rate

Kansas                       22nd Highest Tax Rate

Iowa                            24th Highest Tax Rate

Colorado                    32nd Highest Tax Rate

Missouri                    34th Highest Tax Rate

South Dakota            49th Highest Tax Rate

Source: Tax Foundation, State and Local Tax Burdens

Nebraska pays the 22nd highest rate of individual income taxes in the nation and our business tax climate, while improving, is still middle-of-the-road.  Nebraska’s business tax climate ranks 31st in the nation, yet we still lag behind regional competitors.  Missouri’s business tax climate ranking is 16th, Kansas is 26th, Colorado ranks 18th and both South Dakota and Wyoming are in the top 5, ranking 2nd and 1st, respectively.  Nebraska’s high tax burden is a barrier to economic prosperity for individuals and local businesses.

The Cost of Nebraska’s Personal Income Tax

Nebraska’s relatively high tax burden directly impacts our ability to attract personal economic investment.  By taxing individual’s income, Nebraska is stifling incentives to invest and save. While bordering states have been able to attract income due to their status as a low tax state, Nebraska has not been able to import income from bordering states.  Nebraskans are moving their assets and other income-generating activity across state borders to South Dakota, Kansas, Wyoming or Colorado in order to protect their wealth; while Nebraska does not enjoy the benefits of an in-migration of wealth from border states.

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Source: Americans for Tax Reform Foundation

Tax policy experts such as the Tax Foundation and Kiplinger continue to reference Nebraska as a high tax state.  The language Kiplinger uses is “Bottom Line: Not Tax Friendly.”  Nebraska’s high tax status directly leads to less economic prosperity.

The evidence suggests that eliminating the income tax for both individuals and corporations has a positive macro effect on a state’s economy.  Reviewing the data from the past four decades, we’ve found that for any 10-year period no-income tax states consistently outperform high income tax states.  Simply put, states without a personal income tax create an environment where personal income is significantly greater than states with an income tax.

premium AFP Report: Significant Benefits to Eliminating the State Income Tax

The Cost of Nebraska’s Corporate Income Tax

Nebraska’s corporate tax burden remains a stumbling block to economic growth, considering our state is competing in a region with a relatively low tax burden.  The data suggests that states with a lower corporate tax burden out-perform states with a high corporate tax burden in Gross State Product Growth, Population growth and State and Local Revenue Growth.

Research done by Laffer and Associates principle Dr. Art Laffer indicates that states with the lowest Corporate Income Tax (CIT) rate outperform states with high CIT in overall Gross State Product Growth by nearly 16%.  The term used by Dr. Laffer was a ten-year period and the results demonstrate a significant difference between low-tax states and high-tax states and their ability to generate economic growth.  Not each state on the chart benefits from tourism or abundant natural resources; states included in the low CIT group include Alabama, Ohio and South Dakota.

Not only is Nebraska engaged in inter-state competition for business and job relocation; we are also competing with ourselves.  High tax climates prevent home-grown businesses from expanding rapidly.  A low-tax burden encourages inter as well as intrastate economic investment.

CIT AFP Report: Significant Benefits to Eliminating the State Income Tax

States with the lowest corporate income tax rates have seen state tax revenue grow by 69% while states with the highest corporate tax burden saw revenue growth of only 41%.  Lower taxes burdens in these comparisons did lead to greater net revenues for state and local government.  Nebraska can reduce its tax burden and still provide funding for the core units of government.

High Tax Burden’s Impact on Population Growth

There is a correlation between population growth and the state income tax burden.  States with the lowest income tax burden grew their population at a rate of 12.34% while states with a high income tax burden actually lost population.  Nebraska’s income tax burden has a direct impact on our ability to positively impact population migration to our state.  The ‘brain drain’ – a common epitaph across Nebraska – can be reversed by implementing prudent tax reforms.

personal AFP Report: Significant Benefits to Eliminating the State Income Tax

Impact of LB 405

The impact of eliminating the state personal and corporate income tax would be significant, a savings of $1,051 annually for the typical Nebraska family.

According to the U.S. Census Bureau the median family income in Nebraska is $55,616.  Once non-taxable medical expenses and the standard deduction are included, the median family has $43,224 in taxable income.

Median Family Income Tax Savings

Income Savings at Tax Bracket 1 @ 2.46%        $148

Income Savings at Tax Bracket 2 @ 3.51%        $1,053

Income Savings at Tax Bracket 3 @ 5.01%        $362

Income Savings at Tax Bracket 4 @ 6.84%        $0

Subtract Personal Credit     -$512

 Total Savings                      $1,051

Because Nebraska taxes income at the lowest possible rate until the point that income surpasses the lowest bracket; families who earn $43,224 in taxable income are taxed in the bottom three state income tax brackets.  Thus, under LB 405’s entire elimination of the state income tax, the typical Nebraska family would receive income tax savings under three-of-four income tax brackets and benefit from a total income savings of $1,051.

Eliminating the income tax would increase take-home pay as well as increase economic activity and population growth, based on the experience of other states with no income tax burden.  LB 405 would position Nebraska to reap the economic benefits of being known as a low tax state.

Recommendations to Improve LB 405

A broadened sales tax base creates a more equitable environment which limits businesses or industries from receiving preferential tax status.  Our current sales tax structure allows for over 50 exemptions to the sales tax; this is a system that provides unique advantages for certain businesses and industries that put them at an inherent advantage to their competitors.

While LB 405 eliminates 24 sales tax exemptions, it retains certain exemptions that do not meet the standard of being essential to our economy or supporting the less fortunate in our state.  LB 405, as currently written would retain the following exemptions we believe should be eliminated with an estimated value of approximately $30 million:

Recommended Exemptions to Eliminate

Conference bridging services:          $1.2 million

Newspapers:                                     $2.5 million

Tele-floral services                           $256,574

Nebraska Lottery                              $17.3 million

Fine art purchases by museums       $493,069

Soda Pop                                          $8.1 million*

Total Recommended Exemption Value  $29,925,814

*Source: Fiscal Note for Sen. Avery’s LB 753

By removing these recommended exemptions kept intact by LB 405 there would be adequate revenue to either retain exemptions proposed for elimination, such as the exemption for either Non-durable or Durable medical equipment, or a combination of exemptions on business inputs.

Another alternative is eliminating these exemptions along with select others, in order to broaden the sales tax base to the point that the overall tax rate could be lessened.  Former Senator Rich Pahls was a strong advocate for the concept of eliminating exemptions so that the overall burden for all Nebraskans could be decreased.  In short, ensure all Nebraskans pay the sales tax so that all Nebraskans could pay less.

It is the position of Americans for Prosperity-Nebraska that eliminating the state income tax would be a catalyst for economic growth and create an environment where hard-working Nebraskans would enjoy greater take-home pay.  Yet, LB 405 can be improved.

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