By Caleb Taylor
Governor Asa Hutchinson announced his support on Monday in an address to legislators at the beginning of the fiscal session for a reduction of Arkansas’s top individual income tax rate from 6.9 to 6 percent.
This rate reduction is along the lines of one of the reform suggestions outlined by ACRE scholar Jeremy Horpedahl and the Tax Foundation in their book, ‘Arkansas: The Road Map to Tax Reform.’
Members of the Arkansas Legislative Tax Reform and Relief Task Force have been analyzing how to improve Arkansas’s tax climate since May 2017.
Most of their meetings have revolved around educating members on the current status of Arkansas’s taxes and how they compare to our neighbors, and the rest of the nation.
Now, the task force and the governor are are starting to make tax-policy recommendations for 2019 regular legislative session.
Is Arkansas Ready to Follow the ‘Road Map to Tax Reform’?
Many of these recommendations echo those from the ‘Road Map’ book. Here’s that book’s explanation of a tax reform similar to Hutchinson’s proposal called “Option C” in the book:
“This tax change would not raise tax rates on any tax filers, exempting it from the Amendment 19 vote threshold. Most filers would receive a tax cut under this plan; only those between $35,100 and $75,000 in income on the middle rate schedule would not. Their tax rate would stay constant, but they were the main beneficiary of the new rate schedule that went into effect for tax year 2016. [This] would result in a large loss of revenue for the state, but that revenue loss should be offset with changes to the state’s sales tax base. (“Arkansas: The Road Map To Tax Reform,” pg. 45)”
(Note: the ‘Road Map’ was written before legislation reducing taxes on low-income Arkansans was passed in the 2017 session. Therefore, the low-income individual income tax changes proposed in the book’s “Option C” have mostly already been implemented by the Legislature and Gov. Hutchinson’s proposed plan announced this week would only directly benefit high-income earners.)
Another important feature of the reform “Option C” in the book is consolidating the current tax system with three rate schedules into a single rate schedule. Arkansas currently has a unique, complex feature in its tax code which taxes people under different rate schedules depending on their income level (this is different and separate from a progressive rate schedule). Consolidating these rate schedules would also be an important simplification of the tax reform to consider. Other reform options for the individual income tax from the book include implementing a flat tax of 4.95 percent (Option A) or consolidating Arkansas’s three rate schedules into one rate schedule while lowering the rate to get the top marginal rate to 5 percent (Option B).
Task Force Consultant Recommendations
Public Financial Management (PFM), the consulting company that assisted task force members on their tax reform efforts from September 2017 to January 2018, also recently made some policy “observations” in a farewell letter to the task force on January 23rd for Arkansas legislators to consider.
Randall Bauer of PFM noted in the letter that Arkansas’s individual income tax rates are high relative to its surrounding and similar states.
Bauer said:
“Comparisons of marginal and effective rates suggest that this is an area where the State could look to reduce its rates, particularly at the high end of the scale. Getting the top rate into the range of 5 percent (or going to a flat tax with personal exemptions and/or standard deduction that reduces the impact on lower-income taxpayers) would get the state more in alignment with its benchmark states.”
Bauer also discussed ways to pay for or offset state revenue losses from tax. Bauer outlined expanding the sales tax base and reducing sales tax exemptions as possibilities for legislators to consider.
Bauer said:
“Expand the sales tax base to cover additional services. The example provided by North Carolina, where services associated with maintenance and repair are subject to taxation, is a logical course of action. There have been broader efforts, such as was detailed in the preliminary report related to Governors Fallin and Kasich in Oklahoma and Ohio, to tax services. None of these has been successful to date, but if put forward as part of a broad-based tax reform package, with reduced individual income tax rates and/or sales tax rates, it may be possible. In general, few states (other than those without a broad-based individual income tax) have taken on professional services (such as doctors, lawyers and accountants). States have had better luck with expanding the base on consumer-based services. Reduce sales tax exemptions. The framework used by the State of Kansas can be emulated, and it provides a basis for discussion of whether these exemptions fit into logical categories. It is notable that the ‘preferred’ sales tax treatment for groceries applies to high end purchases as well as basic food items.”
Bauer also recommended legislators consider refundable tax credits to address sales tax regressivity concerns. A tax is considered regressive if it disproportionately affects low-income earners. A tax credit can target low-income earners to reduce the harm to them but still collect needed revenue from higher income earners.
Reducing sales tax exemptions, expanding the sales tax base and refundable tax credit options were discussed in a November 6, 2017 blog post by Nicole Kaeding of the Tax Foundation and Horpedahl on how to improve Arkansas’s sales and use tax. Sales tax reform options are also discussed beginning on page 79 of “Arkansas: The Road Map To Tax Reform.”
To Learn More
For more information on tax reform in Arkansas and related issues, check out ACRE’s “Taxes and Spending” page.