Like most states, Mississippi realized a significant budget surplus in 2021 and projects continued revenue growth over the coming years. As policymakers in Jackson continue to determine how to best invest these funds, they must also reconcile the state’s position in an increasingly competitive 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. environment.
Over the last two years, many of Mississippi’s neighbors have enacted notable 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. reforms. Lawmakers have the incentive and the resources to implement income tax reductions in the Magnolia State. They may even be able to achieve full repeal over time. But to realize the benefits of reform, it will be important to get the details right and to ensure that revenue reductions are sustainable. Both the House and Senate agree that Mississippi would benefit from reforms, but significant work must still be done to reconcile the chambers’ distinct approaches to that end.
Under the House plan (HB 531), the first $37,700 of taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. for single filers, or $75,400 for joint filers, would be exempt from taxation beginning in calendar year 2023. The size of the exemption would increase each year, subject to revenue availability, until the income tax is fully repealed. This phaseout would be partially offset by increasing the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate from 7 percent to 8.5 percent. To diminish the impact of the higher sales tax rate, the bill also introduces a reduced tax rate on groceries, which would be taxed at 4.5 percent, down from the current ordinary rate of 7 percent. Under the House-passed legislation, however, revenue triggers could easily implement cuts which exceed 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. -adjusted revenue growth and reduce the state’s purchasing power in the long term.
The Senate’s plan (SB 3164) would reduce the 4 percent marginal tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. by 1 percentage point each year for four years beginning in calendar year 2023. When coupled with the 3 percent marginal rate repeal, which was fully eliminated at the start of 2022, the Senate’s bill would result in Mississippi levying no tax on the first $10,0000 of taxable income by calendar year 2026. In subsequent years, the Magnolia State would effectively impose a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. of 5 percent on all taxable income over $10,000.
The scope of the Senate bill is narrower than that of the House, due in part to reservations regarding repeal of the second-largest source of state revenue and the impact that activity could have on long-term fiscal sustainability. Senate Bill 3164 would return a portion of state revenue growth to taxpayers while mitigating three concerns related to HB 531.
First, SB 3164 allows the general fund to keep pace with inflation. General fund growth limits are not fundamentally bad, but HB 531 includes a mechanism that would restrict growth to no more than 1.5 percent per year. To put that rate in perspective, at the end of January the 12-month change in inflation was 7.5 percent, the highest rate since 1982. Considerable uncertainty exists over how long it will take for inflation to return to the Federal Reserve’s target rate of 2 percent, but it is not unreasonable to assume that rates could remain somewhere above the target rate for several years. If that occurs, a 1.5 percent cap on revenue growth will significantly diminish the purchasing power of Mississippi’s general fund.
Second, SB 3164 reduces the sales tax on groceries by only 2 percentage points, compared to 2.5 percent under HB 531. Although it is preferable to include groceries in the regular sales 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. in exchange for a lower sales tax rate on all finished goods, policymakers appear to see a rate reduction for groceries as a progressive reform to pair with income tax rate reductions. The limited research that has been conducted on this question, however, casts doubt on whether exempting groceries from the sales tax has the intended distributional effect.
Third, SB 3164 returns surplus revenue to taxpayers through a simpler delivery mechanism. Phasing out the 4 percent marginal rate generates a moderate amount of tax relief without the potential for an unwieldly income tax if comprehensive repeal were to stall. The downside to the House’s escalating exemption approach may manifest if policymakers are unable to completely repeal the income tax due to changing revenue requirements or the loss of political will. Mississippi’s tax landscape would then be dominated by five-figure exemptions and status quo rates. A narrow tax base bent toward high-income earners is not a system that retains investment, nor one that attracts new capital to the state.
The Senate’s reform bill blunts several sharp edges of the House’s total repeal bill, but SB 3164 is not without room for improvement. As with HB 531, the Senate plan does not reduce the top marginal rate. That is the rate that matters if the goal of income tax reform is ultimately to attract new residents and investment into the state.
When making decisions about future productivity and income, taxpayers in general care about what could happen to their next dollar more than they care about what has happened to their last dollar. Therefore, if the benefits of working an additional term outweigh the cost of giving up that time to do something else (e.g., leisure), people will choose to work. Small business owners, most of whom operate pass-through entities taxed under the individual income tax system, make decisions about investment and hiring while considering whether the net income from the added productivity will be worth the additional tax liability.
In states that have intermediate brackets affected by relatively high rates (like California, Connecticut, or Minnesota), lowering the intermediate rates could have a significant impact on the productivity and upward mobility of many low- and middle-income earners. But for purposes of attracting new businesses and residents to Mississippi, lowering the top marginal rate is preferred.
Eliminating the 4 percent bracket is unlikely to impact people’s marginal decision-making in a meaningful way. In Mississippi, the 4 percent bracket applies to workers earning approximately $13,300—already a very large portion of the labor force. Additionally, the 4 percent bracket includes $5,000 of taxable income, meaning potential savings would amount to a maximum of $200 per year for single and joint filers. That may increase consumption in the short run, but it is unlikely to affect investment or in-migration over the long term. Thus, decisions affecting whether to work more, whether to invest in machinery or employees, or whether to relocate to Mississippi are made with greater consideration for the top marginal rate than the lower rate.
Without a reduction to its top marginal rate, Mississippi is on track to lose ground to its neighbors on tax competitiveness. Next year, the median top marginal individual income tax rate in the United States will be at or below Mississippi’s top rate of 5 percent. Additionally, over the past two years several neighboring states have enacted or implemented income tax changes that will result in lower top marginal rates than the Magnolia State. Arkansas set a course to lower its top marginal rate from 5.9 percent in 2021 to 4.9 percent by 2025. Louisiana cut its top rate from 6 percent to 4.25 percent effective January 1, 2022. Tennessee eliminated its tax on interest and dividends in 2021 and is one of seven states to levy no tax on any individual income.
Over the past decade, states which forgo individual income taxes have seen their populations grow at twice the national rate. Competitive rates are an important reason for this growth, but they are not the only reason, and any tax relief in Mississippi must also ensure that the state has the resources to provide essential services.
The ongoing migration from high- to low-tax states, and particularly states with low income taxes, is likely to accelerate with the growing viability of telework. Increasingly, many people will be able to live wherever they wish. Those who are highly sensitive to taxes will find it easier than ever to relocate to jurisdictions with lower tax burdens, regardless of where their employer may be located. Employers themselves will have more location flexibility as geography becomes less of a constraint on their workforces. Mississippi has an opportunity to set the conditions necessary to attract these workers.
Returning a portion of state revenue growth to taxpayers is an investment worth making. Lawmakers know this, which is why HB 531 and SB 3164 passed their respective chambers with strong bipartisan support. But before declaring victory, it is imperative to get the details right. House Bill 531 improved on a previous version introduced in 2021, and SB 3164 takes a more modest approach and improves on aspects of HB 531.
Mississippi is close to making meaningful reforms, but there is still more work to be done if the Magnolia State is to sustain the intended transformation.
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