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 has become a major focus for state legislatures this session, and Missouri lawmakers are tuned in to the action: after adjusting 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. triggers in 2021, the legislature is exploring further tax reform options. Senate Bill 739 would create an additional tax trigger mechanism for the individual income tax, while SB 701 would eliminate the 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. completely in tax year 2023.
In an increasingly mobile post-pandemic economy, tax policy plays a greater role in location decisions for both businesses and residents. State legislatures are cognizant and overwhelmingly acting to make their states attractive to businesses. Thirteen states enacted tax decreases during the 2021 legislative session, and the trend has carried into 2022, as five states have already enacted tax reform bills.
Missouri faces country-wide competition from this rapidly changing tax landscape but must also be able to measure up to its neighbors. While Missouri’s top income tax rate is 5.4 percent, Kentucky and Illinois boast lower rates of 5 percent and 4.95 percent, respectively, and Tennessee levies no individual income tax at all.
Missouri already ties with Oklahoma for the second-lowest corporate income tax rate in the nation at 4 percent—trailing only North Carolina’s 2.5 percent—but further reductions or a total corporate income tax elimination would truly make the state stand out.
Senate Bill 739 creates a tax trigger system that relies on a general revenue baseline of $10.3 billion. In every year that general revenues exceed this baseline, the top individual income tax rate would be reduced by at least 0.1 percentage points. Multiple reductions can happen in the same year: for every $145 million that revenues exceed this baseline, the top income tax rate would be reduced by an additional 0.1 percentage points. The rate reductions would be permanent, and the baseline would increase by $145 million for each triggered reduction.
There is no target rate, meaning that this trigger mechanism could eventually eliminate the individual income tax if the state sees enough growth. However, the revenue loss from the possible income tax reductions makes this event unlikely. Lower income tax rates help promote economic growth, which expands 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. s—under income, consumption, and other taxes. As long as the income tax remains in place, the revenue loss from lower rates can be attenuated somewhat by the revenues from a larger tax base. With full repeal, however, it doesn’t matter how much economic growth may be attributable to the policy: income is not taxed. (Though other tax collections should also be higher.)
The bill’s fiscal report estimates that revenues in FY 2022 would reach $11.2 billion, triggering seven 0.1 percentage point reductions in tax year 2023 and lowering the top rate to 4.6 percent. Because of the reduction in revenue due to the lower rate, the report estimates that general revenue would reach $11.1 billion in FY 2023, falling short of the new $11.315 billion baseline.
Notably, the baseline rises with each cut, but it is not 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. , so it is possible that inflation could bring the state over the baseline before actual growth would have done so. The chosen trigger mechanism makes room for revenue growth—locking in gains—but a better model might trade a lower dollar value on the nominal trigger amount but link it to inflation.
It is important to note that Missouri already has an individual income tax trigger mechanism in place. The system created in 2014 provided for 0.1 percentage point reductions in the top rate per year, subject to revenue availability, for a total of five reductions. Senate Bill 153, enacted in 2021, builds on this by allowing two additional reductions, also subject to revenue triggers. This recent law also provides that the top rate will be reduced by 0.1 percent in tax year 2024, with no trigger necessary.
Rate reductions are helpful, but simplicity and predictability are also important features of a good tax code. If lawmakers are considering this new trigger because they are unhappy with the rate at which rate reductions are being triggered, they should consider circumventing them altogether and voting to lower rates immediately. Alternatively, if the goal of this new trigger is an eventual phaseout of the income tax, lawmakers should consider keeping this trigger, adjusting the baseline for inflation, and more comprehensively folding the other triggers into this design. A single, cohesive tax trigger system is preferable to an overlapping landscape where the triggers may work together or at odds with each other. A responsible rate reduction plan would promote economic competitiveness and growth, paving the way for additional pro-growth tax reforms in the future.
The corporate income tax bill, SB 701, is far more direct, and would eliminate the corporate income tax effective in tax year 2023. If this were enacted, Missouri would become one of only three states that levy neither a corporate income tax nor a more damaging 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. —a significant competitive advantage among states. Corporate income taxes are far more volatile than other tax types, as they are closely tied to the economy and business performance, so a decreased reliance on such taxes is wise.
Missouri currently ranks 13th overall on our annual State Business Tax Climate Index, a comparison of the competitiveness of state tax codes. Without a corporate income tax, Missouri’s rank would improve to fifth overall.
Of course, this kind of competitive change is truly beneficial only if the state can afford it. The bill’s fiscal report estimates that eliminating the corporate income tax would cost the state $280 million in FY 2023 and approximately $561 million per year in following years. The financial institutions tax would also necessarily drop to zero with the repeal of the corporate income tax, which would cost the state around $770,000 a year. This would also reduce local revenues by about $38 million a year, according to the report. By and large, local governments have experienced significant revenue increases in recent years, outstripping state revenue gains.
While these revenue figures seem large at first glance, it is important to put them into context. In FY 2020, Missouri relied on corporate income taxes for 0.9 percent of its total revenue, 1.1 percent of its general revenue, and 2.9 percent of its tax collections.
Missouri is predicted to see a state tax revenue surplus of $1 billion this year, not counting the influx of one-time federal funds. Although one-time funds (other than ARPA dollars) can be used to absorb transition costs and initial revenue losses, permanent tax cuts must be paid for through permanent funding—either through revenue growth or budget adjustments. Fortunately, Missouri is in a solid financial position. The state’s Consensus Revenue Estimate predicts that general revenue collections in FY 2023 will reach $11.4 billion, a 2.1 percent increase compared to FY 2022. The governor’s office has not published any estimates for the following years, but if the state’s economic growth continues, Missouri could absorb the cost of corporate income tax repeal. This would interact with the trigger for individual income tax reductions, allowing the two to be adopted in parallel.
There may be room to tinker with the design of the individual income tax triggers, but policymakers are on the right track in seeking to cut individual income tax rates. And, even if the legislature does not succeed in fully repealing the corporate income tax, rate reductions would help lessen the state’s reliance on a volatile tax and improve Missouri’s standing among states.