On Thursday, Missouri Governor Mike Parson (R) is set to sign House Bill 2540, which cuts the top rate of the 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. from 5.9 to 5.5 percent next year, while continuing with triggered reductions that could potentially bring the top rate to 5.1 percent.
Federal 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. reform changed the landscape in the states. Most states captured at least some of the federal law’s base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. , while the corresponding rate reductions do not flow through to states. Consequently, most states could expect additional revenue. Missouri’s situation turned out to be one of the more complex.
The state’s 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 as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. conforms to the federal standard deduction, which nearly doubled under the new law—a substantial savings for taxpayers. Its personal exemption, however, was $2,100 for each exemption a taxpayer is entitled to take at the federal level. The new law wiped out personal exemptions, but it did so by setting their value to $0 (resulting in them being taken off the tax form), not by repealing them outright. Is a taxpayer entitled to take the federal personal exemption if it still theoretically exists, but cannot be claimed?
Statutory language in most other states didn’t create such interpretive difficulties. The most straightforward reading of the Missouri statute is that the state’s personal exemption is eliminated, the interpretation ultimately adopted by the Department of Revenue. So taxpayers were getting a tax break with the higher standard deduction, but losing some of it to the eliminated personal exemption.
While many other states were content to keep revenue windfalls from federal tax reform, Missouri went in a different direction, choosing to return money to taxpayers with individual income tax rate cuts.
Missouri had previously implemented the first of five triggered 0.1 percentage point reductions in its top marginal individual income tax rate, bringing the rate from 6.0 to 5.9 percent. The new law drops the rate to 5.5 percent next year, then allows the remaining triggers to play out. Subject to revenue availability, the rate would eventually reach 5.1 percent.
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This is the top rate, of course: Missouri has a graduated-rate income tax. The bill actually consolidates one of the brackets, which will leave the state with nine brackets rather than 10. The reduction in the top rate impacts the vast majority of taxpayers, though, because those bracket widths are very narrow: the top rate kicks in around $8,000.
The bill also phases out the state’s partial federal deductibility for higher earners. Under federal deductibility, taxpayers can deduct a portion of their federal tax liability from income in calculating their state taxes. Only five other states have such provisions, and one–Iowa–has adopted legislation which will repeal it in a few years’ time.
Finally, it slightly curtails the ongoing phase-in of the state’s pass-through deduction, currently set at 5 percent of qualified business income. The deduction, similar to the new Section 199A deduction, was on a path toward 25 percent, but will now be capped at 20 percent. This represents progress, though the economic justifications for this substantial tax expenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans. are slim.
When all is said and done, Missouri’s top individual income tax rate could be 5.1 percent while the corporate rate drops to 4 percent, the result of a separate piece of legislation which lowered rates, paid for by adopting a single apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. factor (single sales factor) for most businesses rather than allowing them to elect the apportionment regime most favorable to them. (Apportionment refers to how a company’s income is divided up, for tax purposes, among multiple states.)
In the wake of federal tax reform, state tax competitiveness matters more than ever. Combined with legislation earlier this year giving Missouri one of the lowest corporate rates in the country, these income tax reforms will help the state stand out from its peers.Share