A package of bills will be heard in the Senate Committee on Revenue and Fiscal Affairs in the waning days of the legislative session that attempt to reform Louisiana’s personal and corporate income tax structure. While these bills would eliminate a costly and unorthodox tax break, they fall far short of the revenue that is needed to address the looming $1.3 billion fiscal cliff in 2018 and put the state budget back on a more sustainable path.
In fact, passage of these bills – which would require a vote of the people – would make it harder for policymakers to solve the state’s structural revenue shortfall in a future special session.
House Bill 501 and House Bill 359 are nearly identical bills that are both tied to House Bill 353, a constitutional amendment. They would eliminate the state deduction for federal income taxes paid and enshrine a single “flat” income tax in the state constitution. A separate package of bills (House Bills 356 and 360) would do a similar swap for corporations by eliminating the federal deduction and imposing a 6.5 percent flat rate.
If voters agreed to eliminate the deductibility of federal taxes, Louisiana’s graduated personal income tax rate would be replaced by a single rate of 3.95 percent on income above $12,500. Voters would also lose certain deductions and exemptions, and the tax rate on large estates and trusts would be lowered as well.
The Task Force on Structural Changes in Budget and Tax Policy noted that part of the fix to Louisiana’s tax structure involves rebalancing revenues from the sales tax and income tax.
The Task Force recommends that the individual income tax and the sales tax be structured to provide approximately the same amount of revenue to support the state’s budget as this allows the state to keep the rates for both the sales tax and the income tax as low as our identified revenue requirements allow. (page 41)
According to the most recent Revenue Estimating Conference forecast, the sales tax is bringing in $784 million more than the income tax. Enacting these income tax changes would make it harder to rebalance to tax structure in line with the Task Force’s recommendations.
The federal deduction
The federal deduction is the single largest tax income-tax break the state offers, costing the state more than $1 billion each year in lost revenue. The vast majority of this tax break flows to the wealthiest households. It also makes Louisiana uniquely vulnerable to changes in federal tax policy. Several groups and organizations, including the Task Force on Structural Changes in Budget and Tax Policy and LBP, have recommended its elimination.
In isolation, this move would lead to a fairer, more adequate and sustainable revenue structure. However, the flat tax proposal and other tax cuts included in HB 501 and HB 359 would wipe out virtually all of the revenue gains, and would leave the state with the same revenue shortfall it currently faces. The Legislative Fiscal Office estimates that HB 501 would raise $4.6 million – less than one half of 1 percent of the looming fiscal “cliff.” With the state facing a loss of up to $1.3 billion in tax revenue in FY 2019 as temporary taxes expire, voters should be given the option of fixing the state’s broken tax structure by ending this exemption – without provisions that negate its fiscal impact.
Source: Revenue Estimating Conference, May 16, 2017
Flat vs. graduated tax rates
Right now, low- and middle-income Louisianans pay state and local taxes at twice the effective tax rate of the richest 1 percent of Louisiana tax filers. This is largely due to Louisiana’s high sales tax, which tends to hit poorer households the hardest since they spend a higher percentage of their income on basic needs. The state’s current graduated income-tax structure, where the income tax rate rises as income increases, is the only feature of the tax code that ensures wealthy taxpayers pay a fair share toward the cost of vital state services such as education and healthcare.
Replacing the graduated rates with a 3.95 percent flat rate, when combined with elimination of the federal deduction, means households in the bottom 60 percent of the income distribution would pay a little less while the rich would pay a little more. But by not addressing the fiscal cliff, people in the bottom and middle would likely end up paying more in the end, as any short-term revenue solution to fix the cliff would probably focus on the regressive sales tax.
Distributional impact of HB 501
House Bill 501 seeks to protect low-income households by eliminating personal income taxes on the first $12,500 of earnings ($25,000 for married couples), which is currently taxed at 2 percent. The flat tax would be charged on all income above that threshold. But these gains would be partially offset by the elimination of the personal exemption ($4,500 for single filers; $9,000 for joint filers).
Research shows that states that have “flat” personal income taxes tend to tax middle-income households more than states with graduated rates. For example, taxpayers in the middle 20 percent of the income range in states with flat-rate taxes pay an estimated 3 percent of their annual earnings in income taxes, compared to states with graduated-rate taxes, where families in that range pay only 2.4 percent. The gap between flat-rate states and graduated-rate states is even wider for taxpayers at lower levels of income.
In Louisiana, as elsewhere, incomes are rising fastest for households at the top of the income ladder, and have been generally stagnant for those in the middle and bottom. Having a tax structure that keeps up with economic growth and future needs requires capturing part of this income growth through a graduated income tax structure.
The income tax bills pending in the Senate represent a well-meaning attempt to repair Louisiana’s broken tax structure. They contain elements of reform that have been recommended by a broad range of stakeholders. But they do virtually nothing to solve the most urgent problem facing state policymakers: The looming revenue shortfall that threatens our state’s ability to provide adequate healthcare, educational opportunity and other basic services that citizens need.
With time running out on the current lawmaking session, legislators would be wise to heed the words of the task force they created to advise them on tax policy:
The Task Force offers the following recommendations that should be considered as a package. Although the changes will require separate pieces of legislation, they should be considered in their entirety as a whole and not individually in isolation, because of their interactions with one another in establishing a balanced and fair tax system.
Considered in isolation, these bills would make the difficult job of reforming Louisiana’s tax code even harder.