Larger than expected growth in 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. revenues (which we blogged about recently) is filling state coffers. Lawmakers have different priorities for emptying the coffers, but they need to consider investing their surpluses in improving state business tax climates.
Nebraska Governor David Heineman agrees, and he wants to use part of his state’s surplus to reduce taxes. He has proposed the following specific changes:
• Return Nebraska’s four 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. rates to their 1998 levels (the top rate is currently 6.84 percent) • Restore an exemption for construction remodeling labor in the state sales tax base • Accelerate a previously scheduled reduction in the property tax levy for schools
The individual income tax rate cuts, in particular, will be helpful. Nebraska ranks 28th in the individual income tax portion of our state business tax climate index. Governor Heineman, however, should also consider cutting Nebraska’s 7.81 percent top rate on corporate income, which is the third highest in the region. This high rate significantly contributes to their ranking of 42nd in the corporate tax portion of our index.
The corporate tax rate is important in attracting new business investment, but it’s also important for maintaining neutrality in the tax system. A corporate rate that is higher than the individual rate, like the system in Nebraska, will distort the decision whether to incorporate or not. A sound tax system will treat the decision to incorporate in a neutral fashion, neither encouraging nor discouraging the use of the corporate form.
If Nebraska goes ahead with their individual rate reduction without also reducing their corporate tax rate, they will risk introducing further distortion into the business tax climate. Such distortion will offset the positive gains that will undoubtedly be reaped from the reduction in individual income tax rates.
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