The Missouri House of Representatives passed House Bills 1295 and 1253 last week, which would change the way the state 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. es individual and corporate income, respectively. Unfortunately the bills include distortionary carve-outs and fail to address the state’s severely antiquated 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. code.
House Bill 1295
HB 1295 very slightly reduces Missouri’s top income tax rate. The Show-Me state currently has ten brackets, with a top rate of 6 percent kicking in at just $9,000 of income. In particular, HB 1295 would drop the top rate from 6.0 percent to 5.3 percent over a period of seven years beginning in 2015. Each year, if the state meets certain revenue requirements, the rate would decrease by one-tenth of one percent.
Overall, this would only reduce the number of brackets from ten to nine—a barely noticeable change. We noted that this was a “glacial pace” when we discussed a similar plan last year, and that critique still stands.
Instead, Missouri should do one of two things: reduce the number of brackets, or increase bracket levels so that they reflect the current economy (or both). Since the top rate kicks in at just $9,000, it is likely that a large majority of taxpayers fall in the top bracket. The other nine brackets just add unnecessary complication and don’t make the code any more progressive. Instead, Missouri should consider a single-rate individual income tax with a generous personal exemption.
It’s also worth noting that an ideal code, brackets should also be indexed for inflation to prevent bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. over time—something that the Missouri tax code fails to do. Unfortunately, an amendment offered to inflation-adjust brackets was not adopted.
House Bill 1295 would also create a pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. income deduction (phased in over a period of five years with a maximum deduction of 50 percent of business income) and an additional low-income deduction of $1,000 for taxpayers with state adjusted gross income of $20,000 or less. There would be no need to do either of these things if brackets didn’t kick-in at such low levels of income.
Governor Nixon noted in his State of the State address that he would “not support anything that takes money out of our classrooms,” reminding lawmakers of his income tax cut veto last year. According to the Associated Press (AP):
Nixon said last week that he’s willing to sign legislation cutting individual income taxes by up to one-half of a percentage point, but only if certain contingencies are included to protect funding for schools. Nixon also has objected to the proposed tax break for business income, saying it rewards “creative accounting instead of a hard day’s work.” He has threatened to veto any bill that doesn’t abide by his parameters.
I expect that the amendment passed diverting more revenue towards education was meant to partially assuage the Governor’s first concern. Governor Nixon is correct in his critique of the business tax break. Special carve-outs like this simply encourage individuals to structure themselves as pass-through entities for tax reasons, even if there is no economic or business reason for doing so. A better option would be to apply this deduction to all types of businesses, regardless of their type.
Once the provisions were fully phased, HB 1295 would reduce general fund revenues by just over $700 million.
House Bill 1253
HB 1253 would make changes to Missouri 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. rates, contingent upon certain revenue requirements. The rate would be lowered from the current level of 6.25 percent to 3.125 percent over a five-year period. Similar reductions would be made to the state’s Bank Tax rate, as well. (The Bank Tax is levied at a rate of 7 percent of net income on financial institutions. Ninety-eight percent of revenues go to local governments and the remaining two goes to the State General Fund.) Missouri only obtains 1.4 percent of its total state and local tax collections from the corporate income tax, so a rate reduction is both smart and feasible.
Not so smart is the bill’s creation of a business income deduction similar to HB 1295. It also would be phased-in over five years, contingent upon revenue requirements. Overall, HB 1253 is expected to reduce general fund revenues between $71.9 and $347.3 million.
Though I commend Missouri lawmakers for realizing their tax system is flawed, there are better ways to change it than what was passed by the House. Most of the problems lawmakers are trying to fix with these bills stem from an outdated individual income tax system. Rather than try to pick away at the negative effects that result from it (such as implementing the pass-through deduction and the new low-income deduction), they should consolidate brackets and adjust them 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. . The lower corporate rate is a good move, but the Kansas-style pass-through income carve-out isn’t.
Both bills passed the House, with members voting on party lines. They now await action in the Senate. AP reported earlier this year that a Senate panel was favorable to income tax cuts and even had a bill similar to the House version (SB 509). But the St. Louis Post-Dispatch reported that a “clash” with the Senate was “likely” since many Senators want bolder cuts and special interests abound.
More on info on both bills can be found below.