Thanks to increased 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. revenues from higher consumer spending, sustained economic growth, and both the primary and secondary effects of federal COVID-19 relief programs, many states are flush with cash, and a significant number have used at least some of their surplus to provide tax relief. Many Mississippi lawmakers would like to join them.
As part of Republican Gov. Tate Reeves’ budget proposal, Mississippi policymakers will once again consider a plan to eliminate the state’s 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. . Under the governor’s proposal, the 4 percent bracket, imposed on the range of $5,000 to $10,000 of 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. , would be eliminated in 2023, along with a portion of the 5 percent bracket, which kicks in at $10,000. Under the Taxpayer Pay Raise Act, adopted in 2015, the lowest (3 percent) bracket, on taxable income below $5,000, is already scheduled for elimination next year.
To compensate for the change in revenue, the governor’s plan relies almost entirely on the state’s $1 billion budget surplus from FY 2021. Then, to ensure the reduction can be sustained, future budget growth would be capped at 1.5 percent per fiscal year.
There are many reasons to believe that income tax reduction in Mississippi would yield positive economic benefits, and policymakers’ instincts there are correct. Income tax reduction is good for economic growth, because tax rates influence how much people work. All things being equal, it also makes a difference in where people choose to live. However, budget sustainability will be essential to realize the full potential of any tax cut. That could prove challenging given the individual income tax accounted for $1.9 billion in revenue, or 33 percent of the state’s total general fund receipts, in FY 2019.
Unlike previous income tax repeal plans, the current plan would eliminate the individual income tax without adjusting other tax rates or bases. House Bill 1439 (which passed the Mississippi House of Representatives this year) proposed a 2.5 percentage point increase to the state sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. to offset revenue losses associated with a substantial income tax rate reduction, with the aim of ultimate repeal. Here, Gov. Reeves makes clear that no direct revenue offsets are being considered, though presumably he hopes for increased revenues from other taxes, and from population growth, to help offset some of the revenue loss. While tax reductions are certainly helpful for economic growth, and states without individual income taxes are particularly attractive for relocations, Mississippi lawmakers certainly should not expect higher sales tax or other revenues to replace the revenue forgone by income tax repeal.
When people make decisions, they most often do so on the margins. In the workplace, they consider the trade-off of working one more hour, one more day, or one more week. Individual preferences—including the value of time—will vary, but on average, if the benefits of working an additional term outweigh the cost of giving up that time to do something else (e.g., leisure), people will choose to work. Marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s exist in that paradigm. This is particularly important for small businesses, most of which are pass-through entities and taxed under the individual income tax. Domestic migration—for both individuals and businesses—can also be driven by tax systems.
With a top marginal rate of 5 percent, Mississippi is middle of the pack: once all the income tax cuts adopted in 2021 are in effect, 5 percent will be the nation’s median top marginal rate. However, Mississippi taxpayers need earn only $10,000 in taxable income before reaching the highest bracket.
All else being equal, people will opt to reside where they can generate the greatest return to their labor. This should mean that the state with the lowest income tax rate will attract the largest number of residents. In practice, other factors also impact domestic migration. Income tax policy may be eclipsed by a business’s requirements for infrastructure or access to technology. Others may prioritize access to human capital or local property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. rates. Even if taxation were the single largest weight on the residency decision scale, a basket of other preferences may still tip the balance out of a state’s favor. These observations do not negate the economic importance of sound income tax policy, but they caution against relying too heavily on one reform for economic growth to the exclusion of all others.
In tax reform as in program creation, policymakers should be cautious about inadvertently fashioning unfunded liabilities. Presently, the United States is dealing with an 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. rate unseen since 1990. Government is not immune to these effects. Like any other consumer, revenue growth must match the inflation rate if purchasing power is to remain constant. The wrong timing or wrong combination of revenue reductions and spending restrictions could make service delivery especially challenging. Even if price inflation returns to the Federal Reserve’s target rate of 2 percent, a 1.5 percent increase in Mississippi’s annual budget would still result in a 0.5 percent budget cut in real terms. Some states have high levels of spending that might well be reduced, whereas there may be much less room to cut in Mississippi.
Ultimately, it is up to Mississippi policymakers and their constituents to decide how many and what type of government services the state should provide. Lawmakers are right to key in on the income tax as an appropriate vehicle for tax relief given the state’s robust revenue growth, and to see a reduction or elimination of the income tax as a pro-growth choice, particularly in this increasingly mobile era. Phased reductions of rates subject to revenue availability can be a good approach, and policymakers must decide how much revenue growth to dedicate to this project, and how much—if any—to constrain the growth of government in doing so.
As lawmakers debate the benefits of income tax repeal, they should be clear-sighted about the trade-offs. One way to reduce reliance on the income tax is to shift part of the tax burden to a less economically harmful tax, as lawmakers have considered previously. (We evaluated prior proposals here.) If, alternatively, lawmakers concur with the governor’s approach of phasing in rate reductions without replacement revenue, they must be clear-eyed about the pace—and sources—of that tax relief. Given the current revenue trajectory, there is room for tax relief without offsetting increases elsewhere, but “getting to zero” would require strict fiscal discipline, and difficult choices within the state’s budget.
Income tax reduction can be an effective treatment for economic ailments, but it tends to fall short as a panacea. Income tax relief is, after all, an instrumental goal, not an ultimate one: the ultimate goal is economic growth and prosperity, so how a tax is paid for—what revenue offsets, or what spending reductions—remains an important consideration. Mississippi lawmakers should deliver tax relief in 2022, but they need not take an all-or-nothing approach. There are many ways to improve the state’s tax code, even if full income tax repeal doesn’t remain on the table.
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