Yesterday, the Governor and legislative leaders announced agreement on a ‘joint proposal for income tax reduction and tax code simplification’. (Click here for a summary and here for HB 3061 which contains the proposal). Here are some questions and answers addressing the main aspects of the agreement: tax rates, offsets, fiscal impact and triggers. You can see our statement on the plan here.
Question #1: What are the changes in the income tax rates?
Answer: Personal income tax rates will change in two ways. First, the top rate will be lowered from 5.25 percent to 4.8 percent as of January 1, 2013. Second, the number of brackets is reduced. Currently, there are seven tax rates, ranging from 0.5 percent on the first $1,000 of taxable income for a single individual ($2,000 for a married couple) to 5.25 percent on taxable income above $8,700 ($15,000 for married couples) (see the current brackets here). The proposal will reduce this to three brackets: 1 percent on the first $2,500 of taxable income ($5,000 for married); 3.3 percent on income between $2,501 and $7,500 ($5,001 – $15,000 for married), and 4.8 percent on all income above that. If you make over $7,500 in taxable income ($15,000 for married), you will be in the top income tax bracket, and your income above that amount will be taxed at the top rate.
Q #2: The proposal states it eliminates the existing ‘marriage penalty’. What does that mean?
A: Currently, the income thresholds for some of the lower tax brackets do not match between single individuals and married couples. For example, a married couple making $13,000 and filing a joint return will pay at a slightly higher rate than two single individuals making a combined $13,000. The proposal realigns the brackets so a married couple filing jointly is taxed at the same rate as two single people.
Q #3: The plan proposes to partly offset the cost of lowering the top rate by doing away with some existing tax preferences. What deductions, exemptions and credits will be affected?
A: There are several –
- Currently, all taxpayers can claim a personal exemption of $1,000 per household member. Under the plan, only taxpayers with adjusted gross income of $35,000 or less for single individuals ($70,000 or less for joint filers) will be able to claim the personal exemption.
- Currently, taxpayers who claim itemized deductions on their federal and state returns are allowed to deduct their state income tax (see our discussion here). Under the plan, this one itemized deduction would no longer be allowed.
- The current state income tax deduction of up to $100 ($200 for married couples) for political contributions would be eliminated.
- Some 30 existing tax credits would be eliminated (see the list). These tend to be narrow credits that are claimed by a small number of businesses and individuals; some are not claimed by anybody. The total fiscal impact of eliminating these credits is estimated to be just over $4 million.
Other tax preferences that were targeted for elimination in earlier proposals – including exemptions for retirees, veterans and military personnel; broad-based credits such as the earned income tax credit, sales tax relief credit, and child/child care tax credit; and the most significant business credits, including those for oil and gas production – were left intact.
Q #4: Will some people end up paying higher taxes under this plan?
A: Yes. While the plan represents an overall tax cut and many taxpayers will pay less, some will pay more. The Oklahoma Tax Commission (OTC) states that 54 percent of taxpayers will pay less tax, 21 percent will have unchanged tax liability, and 25 percent will pay more. Some lower income individuals will pay slightly more due to the changes in the bracket structure. An OTC analysis shows that the average taxpayer with income between $0 – $24,000 will pay more under the plan. Some higher-income taxpayers will lose more as a result of losing their eligibility for the personal exemption and the deductability of state income taxes than they will gain from the cut in the top rate. Larger families with incomes between $70,000 and $100,000 who itemize their deductions are likely to fare worst.
Q #5: Is this plan revenue-neutral?
A: No. Even with the offsets from eliminating certain tax preferences (see #3), the tax cut is projected to reduce state tax collections by $32.7 million in FY 2013 and by $102.0 million in FY 2014. This will mean less available revenue to be appropriated for state services.
Q #6: What future tax cuts are included in the plan?
A: In tax year 2015, a trigger would reduce the top income tax rate an additional 0.30 percentage points, from 4.8 to 4.5 percent, if revenues grow by at least 5 percent. Five revenue sources – personal income tax, corporate income tax, sales, use and motor vehicle taxes – would be used to calculate revenue growth.In December 2014 (mid-way through FY 2015), the Board of Equalization will determine if FY 2014 revenues rose by 5 percent from FY 2013; if so, the rate reduction will take effect in January 2015. This could have the effect of reducing revenues for the remaining six months of FY 2015 as well as subsequent years. The revenue impact of lowering the top rate to 4.5 percent is projected to be an additional $171 million.
Our calculations show that over the past 20 years, annual revenue growth from the five taxes exceeded 5 per cent eleven times.
Q #7: What if the trigger is not activated for 2015?
The proposal states that this is a ‘one-time revenue trigger’; if the trigger does not kick in for 2015, the top rate will remain at 4.8 percent. Of course, there is nothing to prevent the Legislature from revisiting this down the road.
Q8: What happens now?
The legislation will need to be passed by House and Senate conference committee and then be approved by both chambers before session adjourns on Friday, May 25th.