Recently, two taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. bills were approved by the Delaware legislature and three bills were introduced. Facing a $386 million shortfall in 2018, the state is in desperate need of budget actions. Along with a proposal to eliminate the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. , the state is considering four other revenue-raising proposals in a broad attempt to cover the deficit.
Estate Tax
Estate taxes are levied against the value of an estate or trust. Currently, Delaware has a top estate tax rate of 16 percent, second only to Washington state, which has a top rate of 20 percent. Delaware excludes income below $5.49 million from the tax, which matches the federal estate tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. .
HB 16 would “sunset” the Delaware estate tax on December 31. The bill passed in the House 26 to 14 and in the Senate 13 to 7, and awaits the governor’s signature. A Fiscal Note prepared by the Delaware Office of the Controller General estimates that repealing the estate tax will cost the state $3.75 million in lost revenue in 2019, and $5 million in 2020. The 2020 figure is based on the average amount of estate tax revenue collected in the state, although revenue collections vary considerably from year to year.
In 2011, $13.7 million was raised from the estate tax, when adjusted for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . In 2014, just $1 million in revenue was raised. The estate tax raised $9.3 million in revenue in 2016, with revenue predicted to fall to $2.5 million in 2017, illustrating the instability of the estate tax as a revenue source.
Studies find that estate taxes have high compliance costs, and are often detrimental to economic growth. If the governor approves the measure, Delaware would join a growing cohort of states eliminating their estate tax. Repealing the estate tax not only reduces revenue instability, but it also eliminates a source of high costs for a state looking to cover a major shortfall. Eliminating the estate tax in Delaware is a sound policy for long-term economic and revenue growth at the cost of a potential short-term windfall.
Corporate Franchise Tax
HB 175 alters numerous aspects of state policy for collecting franchise taxes. A franchise tax is levied against businesses incorporated in Delaware, even if those businesses don’t conduct their operations in the state. Unlike a corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , a franchise tax is based off the number of authorized shares or a measure of the company’s capital. Generally, tax payments are capped under this system.
The bill makes a few inflation adjustments and one major policy change. The bill raises the maximum tax payment for corporations from $180,000 to $200,000. This change adjusts the cap for inflation since 2009, the last time the payment cap was raised. The bill also increases several administrative fees related to the collection of the tax, including the fee for late payment.
The creation of a second bracket for large corporations is the main policy change outlined in the bill. A maximum tax payment of $250,000 would apply to corporations with either more than $750 million in revenue and at least $250 million in assets or with more than $750 million in assets and at least $250 million in revenue.
Under this framework, a company with $4 billion in revenue but only $150 million in assets would not be in the new bracket. However, a corporation with $800 million in assets and $300 million in revenue would be placed in the new bracket. This policy would affect about 0.2 percent of Delaware corporations.
The bill passed the Senate 16 to 4 and the House 39 to 1, and is awaiting the governor’s signature.
Personal Income Tax
HB 240 would overhaul Delaware’s personal income tax system by raising rates and broadening the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . The bill would:
- Raise income tax rates: The tax rate for all existing brackets would increase between 0.15 and 0.4 percent, depending on the bracket. A new top bracket with a rate of 6.95 percent would be created for income above $150,000. The current top rate of 6.6 percent applies to income above $60,000.
- Restrict retirement income deductions: Delaware currently allows retired residents to deduct a portion of pension income from their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . Presently, those under age 60 can claim a $2,000 deduction, while those over age 60 can claim a $12,500 deduction.
The bill does not change the amount of the deductions, but does increase the age limit for claiming them. The qualifying age for the $12,500 deduction will be raised from 60 to 65 over a five-year period.
- Eliminate itemized deductions: Delawareans can claim deductions for the same expenses the federal government considers deductible. Most citizens claim a standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. instead, which is available to everyone regardless of their expenses. In general, high-income residents claim itemized deductions instead of the standard deduction since their itemized deductions are likely to exceed the standard deduction.
The proposed legislation would eliminate itemized deductions while increasing the standard deduction from $3,250 to $5,000. These actions would increase the deduction for low-income residents, while decreasing the deduction for high-income residents who utilized itemized deductions.
- Reduce personal tax credits: Delaware offers a personal tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. to each resident on an unconditional basis. The proposal decreases the personal credit from $110 to $85. An additional $85 credit is available for residents over the age of 60, with the eligibility age increasing to 65 over a five-year period.
Alcoholic Beverage Taxes
HB 241 aims to increase the taxes imposed on alcoholic beverages in Delaware. The bill would increase the tax on beer from $4.58 to $11.46 per barrel, a 150 percent tax increase. Similarly, the bill would increase the tax on wine from $0.97 to $1.72 per gallon, a 77 percent increase.
While Delaware would reap more revenue per unit of alcohol sold under the new bill, alcohol sales would likely decline in the state. Delawareans could easily buy beverages in neighboring Pennsylvania and New Jersey, which have significantly lower tax rates for both beer and wine. Since substituting beverages bought in Delaware for beverages bought in other states is fairly simple, it is unlikely that the state will see a dollar-for-dollar revenue increase by raising tax rates on alcohol.
Tobacco Taxes
HB 242 would increase existing taxes on tobacco products, in addition to introducing a tax on vapor products of $0.05 per fluid milliliter. Specifically, the cigarette taxes would be increased from $1.60 to $2.10 per pack, and the tax on snuff would be increased from $0.54 to $0.93 per ounce.
While tobacco taxes can increase revenue in the short run, collections will decline sharply in the future. The proposed increase would vault the tax in Delaware above the per pack tax in Maryland, making it easy for Delawareans to skirt the tax by purchasing cigarettes across state lines. Increasing cigarette taxes would not be a sound policy.
The Delaware legislature is casting a wide net on tax reform in an attempt to raise state revenue. Last Wednesday, the income, alcohol, and tobacco tax bills successfully passed out of committee for consideration by the full House. While these bills could raise short-term revenue, they may not be advisable long-term policies. Repealing the estate tax and adjusting the franchise tax for inflation are more reasonable measures.
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