In 2009, the state of Delaware passed a series of “temporary” tax increases in order to fill a state budget gap. These changes included an increase in the top individual income 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. rate from 5.95 to 6.95 percent, in addition to higher gross receipts, franchise, and 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. es. Though these measure are scheduled to sunset in the coming year, the state again finds itself in the face of a budget shortfall and must do something to balance their budget.
The state’s Governor, Jack Markell (D), has proposed keeping some of these temporary changes permanent. We’ve quipped in the past that there’s nothing so permanent as a temporary tax increase, and the situation in Delaware is a perfect example of this. In the face of year-to-year revenue fluctuations and spending obligations, states have few options to address budget gaps. Most are subject to balanced budget obligations, so if a state doesn’t have adequate savings in rainy day funds, it must turn to spending cuts or tax increases to meet short-run budget requirements.
The Governor’s tax package contains the following:
- Instead of allowing the current top individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate drop from its current level of 6.75 percent to the scheduled 5.95 percent, lowering it to only 6.6 percent;
- A 1.0 percent rate decrease in gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. , rather than allowing for the 2009 8 percent increase to fully sunset (as well as granting additional cuts to manufacturers);
- Fully lifting the sunset on corporate franchise and estate taxes (excluding certain farms).
House Republicans argue that the 2009 increases were only agreed upon because of the “understanding that the taxes would begin to go away this year.” Unfortunately, their solution is to again dub this year’s increase as “temporary.” Stability is crucial in a sound tax system. When tax laws fluctuate from year to year (or lawmakers have the reputation of changing laws frequently), it is difficult for taxpayers to engage in confident long-term financial planning.
Stability isn’t my only concern with the Governor’s plan. He proposes the state maintain reliance on gross receipts tax revenues. Gross receipts taxes are arguably one of the worst ways to raise revenue because of their lack of neutrality and simplicity. They lead to inefficient economic distortions. Further, the state is using higher-income taxpayers as a means to close a budget hole. This is problematic due to the volatile nature of these revenues. Individual income tax revenues are one of the most unstable sources of tax revenue.
Delaware currently has the 15th highest top individual income tax rate in the country. Though lowering the rate to 6.6 percent is a move in the right direction, reducing it to pre-2009 levels would be more conducive to economic growth. The state would also do well to move away from taxes on gross receipts, as these are an inefficient, non-neutral, and overly-complicated way to raise revenue. Finally, enacting “temporary” tax measures makes it difficult for taxpayers to plan financially and gives them the impression that the state will raise taxes every time there is a budget crisis—not exactly the best way to foster confidence in the government’s ability to weather the business cycle. Instead, Delaware should design a tax system that is able generate adequate revenue regardless of the state of the overall economy and does so in an efficient, simple, and neutral way.
UPDATE: The Governor's tax package was approved as detailed above.
More on Delaware here.
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