Like most states, Idaho anticipates increased revenue under the new 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. law, which broadens the state’s 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. . States effectively have three options: (1) do nothing and keep the money; (2) decouple or otherwise tinker with their codes to return the windfall to the taxpayers; or (3) conform with the changes while returning the excess to the taxpayers in the form of rate reductions or structural reforms. Idaho is taking the latter (and superior) route.
In January, the Idaho State Tax Commission estimated that conformity with the new tax law would increase state revenue by $97.4 million, due chiefly to the loss of the personal exemption, worth nearly $412 million in increased revenue. Idaho’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 (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and personal exemption both conform to federal levels, meaning that the state’s standard deduction will be $12,000 for single filers this year, up from an anticipated $6,500 (cost: $340.5 million), but the personal and dependent exemptions are eliminated (savings: $411.8 million). Restrictions on itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s are projected to yield an additional $55.3 million.
Outside the higher standard deduction, Idaho’s largest revenue loser under tax conformity is the new pass-through deduction. Idaho is one of only six states with tax codes written in such a way as to incorporate the new federal deduction, which, as we’ve argued previously, is nonneutral and offers little economic benefit. Implementing this new tax preference for 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. es will cost Idaho an estimated $30.8 million.
Recognizing that doing nothing would result in an unintended tax increase, Idaho policymakers, following the lead of Gov. Butch Otter (R), appear to be coalescing around House Bill 463, a plan which:
- Adopts a 0.475 percentage point across-the-board 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. rate cut;
- Incorporates the new, higher standard deduction;
- Follows the repeal of the personal and dependent exemptions;
- Creates a new $130 per child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. to offset the loss of the personal exemption; and
- Reduces 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. rate by 0.475 percent.
The bill passed the House and reported out of committee in the Senate on a 5-4 vote yesterday.
This plan involves a net tax cut of $104.5 million, as the reforms and rate reductions cost $201.9 million, while the additional revenue anticipated from federal conformity only runs $97.4 million. Not all states will be in a position to adopt a tax cut, but in Idaho, that opportunity exists. These changes would yield an improvement of three places on the corporate tax component of our State Business Tax Climate Index, which measures tax structure, and an improvement of two places on the individual income tax component. The variety of ways that states are likely to respond to federal tax reform makes such projections tenuous, however, because many other states are likely to implement changes as well.
Overall, House Bill 463 would represent an improvement to Idaho’s tax code, as it makes the state’s high tax rates more competitive and avoids an unlegislated tax increase. It could, however, be made even better by decoupling from the pass-through deduction, which confers little economic benefit, and instead conforming, in whole or in part, to a new federal provision called “full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. ,” which removes some of the tax code’s disincentives for domestic investment by allowing the cost of capital investment—like other business costs—to be written down immediately. Unlike the pass-through deduction, full expensing increases tax neutrality—consistent with the idea that the tax code shouldn’t pick winners and losers—and would make the state more competitive.
Tax reform, after all, is at least partly about leveling the playing field. The principle of neutrality represents the understanding that the goal of taxation is to raise revenue, not to engineer particular economic outcomes. At the federal level, tax reform has proven a generational event. At the state level, it need not be—but there is no time like the present to ensure that state tax codes are oriented toward economic growth. That’s something Idaho policymakers appear to recognize.
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