Missouri’s 2014 Tax Cut: Minimal and Slow with a Small Business Gimmick

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Key Findings

• Missouri’s 2014 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. package cuts income tax rates by 0.1 percentage points each year for five years starting in 2017, provided certain revenue conditions are met.
• The bill’s revenue impact is minimal. Even if the full tax cut were phased in immediately, the budget would still grow by 7.3 percent next year.
• A deduction for pass-through businesses such as S corporations and LLCs lowers effective rates for those entities but misses an opportunity for lowering overall rates in the income tax.
• SB 509 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. adjusts tax brackets to correct for “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. .”

Introduction

Missouri legislators have concluded their two-year effort to enact an income tax cut over opposition from Governor Jay Nixon (D). While the legislature was unable to override the governor’s veto of the tax package passed by the legislature last year, on Tuesday, May 6, it overrode Gov. Nixon’s veto of this year’s bill, SB 509, making it law.[1]

The passage of the bill has been met with great outcries from celebrants and critics of the legislation alike. Americans for Tax Reform President Grover Norquist told reporters, “I think it is very real progress and competitive juices of the neighboring states are going. The race to zero is on,” while Senate Minority Leader Jolie Justus (D) commented, “we’ve done nothing to rein in this tax orgy. We have no clear tax policy in this state. I don’t think this is the right answer.”[2]

Both of these statements miss the mark. While Senator Justus is correct that the bill does not represent clear principles (an issue addressed below), it is a long stretch to classify SB 509 as a “tax orgy.” And while Mr. Norquist is correct that this cut is progress in the sense that Missouri has not cut income tax rates since 1921, Missouri is not “racing” anywhere—we have previously noted that the bill’s phase-in of the legislation moves at a “glacial pace.”[3]

SB 509 Modestly Reduces Income Tax Rates, Inflation Adjusts Brackets, Includes Small Business Gimmick

Major components of SB 509 include:[4]

• A reduction in the top income tax rate by 0.1 percentage points each year that revenue conditions are met, fully phasing in to a total reduction in the top income tax rate of 0.5 percentage points. This will bring the top income tax rate down from 6 percent to 5.5 percent over a minimum of five years (Table 1). This is the first income tax rate reduction in Missouri since 1921 (Table 2)
  • For a cut to go forward, net general revenue collected in the previous fiscal year must exceed the highest amount of net general revenue collected in any of the three prior fiscal years by at least $150 million.
• Inflation indexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. of income tax brackets beginning in 2017.
• A deduction for pass-through entities that will fully phase in to 25 percent of all business income.
  • The deduction will be 5 percent the first year and will increase by 5 percentage points each year the above revenue requirements are met.
• An increase in the 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. from $2,100 to $2,600 for taxpayers with adjusted gross incomes less than $20,000. For joint filers, the increase is from $4,200 to $5,200 if both parties have income below $20,000 each.

Table 1: Projected Phase-in of SB 509 if Revenue Triggers are Met

Bracket	Current Tax System (2014-2016)	Proposed 2017	2018	2019	2020	2021
>$0	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%
>$1,000	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%
>$2,000	2.5%	2.5%	2.5%	2.5%	2.5%	2.5%
>$3,000	3.0%	3.0%	3.0%	3.0%	3.0%	3.0%
>$4,000	3.5%	3.5%	3.5%	3.5%	3.5%	3.5%
>$5,000	4.0%	4.0%	4.0%	4.0%	4.0%	4.0%
>$6,000	4.5%	4.5%	4.5%	4.5%	4.5%	4.5%
>$7,000	5.0%	5.0%	5.0%	5.0%	5.0%	5.0%
>$8,000	5.5%	5.5%	5.5%	5.5%	5.5%	5.5%
>$9,000	6.0%	5.9%	5.8%	5.7%	5.6%

Table 2: Historical Missouri Income Tax Rates[5]

July 1, 1917		May 26, 1919		August 21, 1921		January 1, 1931		January 1, 1971
0.5%		1.5%		1%		1.0%	> $0		1.5%	> $0
						1.5%	> $1,000		2.0%	> $1,000
						2.0%	> $2,000		2.5%	> $2,000
						2.5%	> $3,000		3.0%	> $3,000
						3.0%	> $5,000		3.5%	> $4,000
						3.5%	> $7,000		4.0%	> $5,000
						4.0%	> $9,000		4.5%	> $6,000
									5.0%	> $7,000
									5.5%	> $8,000
									6.0%	> $9,000

Even After Income Tax Cuts, Missouri Budget Will Grow Over 7 Percent Annually

While many media sources have quoted the total revenue impact in the fiscal note of SB 509, many fail to put that number into the context of the total Missouri budget. Even if the total cut were enacted immediately in 2015 (it does not phase in fully until 2021), it would amount to a reduction in the total size of the budget of only 2.2 percent.

Table 3 and Figure 1 show that the size of the Missouri state government is budgeted to grow 9.7 percent over last year already, and subtracting the modest cut[6] would make for a budget that still grows at a hefty 7.3 percent over the previous year.[7]

Table 3: Missouri Budget with “Cuts”

	Total Budget Expenditures	Growth over previous year
FY2013 Expenditures	$ 22,940,887,737
FY2014 Appropriations	$ 25,518,710,400	11.2%
FY2015 Nixon Budget	$ 28,004,472,661	9.7%
FY2015 Nixon Budget with SB 509 phased in immediately	$ 27,383,485,661	7.3%

Source: Missouri Budget FY 2015.

2014 Tax Package is a Missed Opportunity for Reform

SB 509 phases the income tax cut in slowly based on revenue triggers and results in a total cut to the top income 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. of just 0.5 percentage points by 2021. Part of the reason this cut is so minimal is that legislators included a generous new deduction 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. After the provision is fully phased in, businesses such as S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s and LLCs will be able to deduct 25 percent of adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” from taxation. While this provision lowers the effective tax rate of these entities, it limited the amount by which legislators could cut the overall rate.

In addition to this carve-out, the legislation misses an opportunity to broaden income 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 or make significant structural changes to the code, only reducing the state’s ten brackets to nine.

It bears noting that the state has not reformed its income tax bracket structure since the state adopted a progressive scheme in 1931 (Table 2).

Conclusion

Tax reform discussions have been unusually rare in Missouri, so much so that the income tax has not been comprehensively reviewed in decades. A better move this session would have been to consolidate the large number of brackets into a flatter, simpler structure while using the revenue that was put toward the pass-through carve-out to instead lower the overall rate. 2014 represented an opportunity to engage in real tax reform, but the plan that passed was lackluster. Despite fantastical claims by supporters and detractors, these changes will have negligible positive or negative impact.

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