Tax Reform Framework Would Improve Nebraska’s Competitiveness

March 10, 2022

The Nebraska Revenue Committee recently heard LB1264, a bill to modernize Nebraska’s tax structure by reducing income tax rates, repealing the inheritance tax, modernizing the sales tax base, and eliminating most incentives.

These reforms, promoted by various Nebraska stakeholders through the Blueprint Nebraska initiative, would substantially improve tax structure and competitiveness. Once fully phased in, Nebraska would rank 16th overall on our State Business Tax Climate Index, up from 35th today.

Nebraska’s State Business Tax Climate Index Rankings, Current and Proposed (LB1264)
  Current LB1264
Overall 35 16
Corporate Taxes 32 12
Individual Taxes 29 18
Sales Taxes 14 11
Property Taxes 40 35
Unemployment Insurance Taxes 13 13

Source: Tax Foundation.

While some details continue to evolve, these reforms represent a solid framework for tax modernization. As these ideas are debated in the Unicameral, policymakers should consider how some details could be further refined to best achieve structural soundness while promoting economic growth.

Individual Income Tax Reductions

LB1264 would overhaul Nebraska’s individual income tax by replacing the four-bracket, graduated-rate structure with a large zero percent bracket plus a single tax rate on income exceeding the specified threshold (see the following table). In the first year, this proposal would reduce individual income tax collections by roughly 64 percent compared to the most recent revenue projections.

This “zero rate” would apply to the first $49,999 in income for single filers and $99,999 for joint filers, replacing Nebraska’s standard and itemized deductions and removing many Nebraskans from the tax rolls altogether. This would be the most generous zero rate among all states that tax wage income, exempting nearly four times the income that is exempt in states that conform to the federal standard deduction. Currently, approximately 93 percent of potential taxpayers file a return (or are included on a joint return), but under this proposal, only about 35 percent of potential taxpayers would pay state income taxes.

While a large zero rate may seem appealing, it is important to consider the effects of substantially narrowing the tax base. Leaving a small subset of taxpayers to generate the entirety of Nebraska’s income tax revenue would detract from horizontal equity, as some Nebraskans would face substantial burdens while many would not file at all. This could increase the likelihood of future rate increases since a minority of voters would be affected by a rate increase.

A large zero rate would also inject additional volatility into the revenue system, since the income of high earners is more volatile than that of Nebraskans as a whole. One reason for this is the income of pass-through businesses is taxed under the individual income tax code, with business earnings flowing through to owners’ individual income tax returns. Business income tends to fluctuate more from year to year than wage and salary income, and business owners comprise a substantial share of Nebraskans whose income would continue to be exposed to taxation were LB1264 adopted. Additionally, investment income is inherently more volatile than wage income, and investment income comprises a substantial share of high earners’ income.

Furthermore, considering two scenarios—one in which a large zero rate is paired with a relatively higher tax rate and another in which a modest zero rate or standard deduction is paired with a relatively lower tax rate—the latter is more likely to spur in-state investment and economic growth, all else being equal.

Under the first scenario, the zero rate’s benefits are limited; once a taxpayer earns enough income to have any exposed to taxation, all income above the specified threshold is taxed at a relatively higher rate. Under the second scenario, most income is subject to taxation, but when a relatively lower rate is applied, there is less of a tax disincentive associated with earning each additional dollar of income. The lower overall rate would therefore be more likely to promote additional labor and investment on the margin.

Without the proposed zero rate, Nebraska could achieve a flat individual income tax rate of approximately 2.4 percent—the lowest in the country—for the same cost. A significant rate reduction would help Nebraska compete with neighboring Iowa—which is moving to a flat 3.9 percent rate by 2026—as well as many other states that are prioritizing reducing top rates.

Regardless of whether policymakers pursue a robust zero rate or a more typical-sized zero rate or standard deduction, inflation indexing is important. Nebraska’s current brackets, standard deduction, and personal exemption credit are adjusted annually for inflation, but under LB1264, the $50,000/$100,000 threshold would remain static. Over time, failure to adjust the threshold would cause “bracket creep,” where increases in a taxpayer’s nominal income would put more Nebraskans back on the tax rolls and expose more of their income to taxation over time, even if the real purchasing power of that income does not increase.

Nebraska’s Income Tax Rates, Current and Proposed (LB1264)
  Current   Proposed (LB1264)
  Tax Year 2022   Tax Years 2022-24   Tax Years 2025-27   Tax Year 2028 and on
Individual Income Tax
Single 2.46% $0   0% $0   0% $0   $0 $0
3.51% $3,440   5.60% $49,999   5.30% $49,999   4.99% $49,999
5.01% $20,590                        
6.84% $33,180                        
Married Filing Jointly 2.46% $0   0% $0   0% $0   $0 $0
3.51% $6,860   5.60% $99,999   5.30% $99,999   4.99% $99,999
5.01% $41,190                        
6.84% $66,360                        
Corporate Income Tax
  5.58% $0   4% $0   4% $0   4% $0
  7.50% $100,000   5.60% $100,000   5.30% $100,000   4.99% $100,000

Source: Nebraska Department of Revenue; LB1264 (2022).

Corporate Income Tax Changes

LB1264 would also reduce corporate income tax rates, lowering the 5.58 percent rate to 4 percent and reducing the 7.5 percent rate incrementally to correspond with reductions in the individual income tax rate (see the preceding table).

These changes would build upon the progress made with the 2021 enactment of LB432, which reduced the top rate from 7.81 to 7.5 percent for 2022 and scheduled a further reduction to 7.25 percent for 2023. (That law also expressed the intent of the Unicameral to reduce the rate to 7 percent for 2024 and 6.84 percent for 2025, but LB1264 would reduce rates even further.)

Notably, LB1264 expresses legislative intent to “eliminate tax incentive programs in order to offset the reductions in General Fund revenue,” except remaining credits for research and experimental activities would be doubled.

Nebraska forgoes substantial revenue each year by offering targeted business tax incentives. These incentives mitigate some harmful aspects of Nebraska’s tax code—including high income tax rates—for qualifying firms, but only about two of every 1,000 Nebraska businesses benefit from this relief, while non-qualifying firms experience high tax burdens.

LB1264 rightly recognizes that streamlining incentives would free up substantial revenue to reduce income tax rates for all businesses, leveling the playing field so new and established firms of all industries can succeed in Nebraska. Currently, most new firms eligible for incentives experience below-average tax burdens in Nebraska, but once a business is no longer eligible to claim incentives, tax burdens rise, which can impact in-state retention. Ultimately, a competitive tax code is the most effective “incentive” available, so policymakers should focus on creating a competitive environment for all taxpayers, not just some.

As policymakers discuss reducing the corporate tax rate, they should also consider consolidating two brackets into one. As Jeffrey Kwall, Professor of Law at the Loyola University Chicago School of Law, has noted, “…low-income corporations may be owned by individuals with high incomes, and high-income corporations may be owned by individuals with low incomes.” As such, graduated-rate corporate income tax structures make little sense, as there is no meaningful concept of “ability to pay” that would warrant different rates on different levels of marginal income.

Furthermore, while individual and corporate tax rate parity may seem appealing, policymakers need not prioritize keeping the rates consistent. Given that corporate profits are taxed at both the entity and shareholder levels, individual and corporate income tax rates are not strictly comparable. Face-value rate parity does not achieve parity of tax burdens, so there is little benefit to pursuing it.

Especially for multistate businesses, differences between the corporate and individual income tax rates in any one state are unlikely to affect entrepreneurs’ decisions regarding business structure. When tax policy is a factor in these decisions, the federal tax code will have more bearing on firms’ structuring and restructuring decisions. Significantly more important for state policymakers should be keeping rates and burdens competitive compared to other states.

Sales Tax Modernization

To partially offset income tax reductions, LB1264 would broaden the sales tax base to additional consumer goods and services, including motor fuels, certain event admissions, pet services, repair of real property and motor vehicles, taxi and limousine services, and various professional services, among others. Importantly, LB1264 largely avoids extending the sales tax to business inputs, as that would cause tax pyramiding. Broadening the sales tax base to consumer services promotes neutrality by mitigating the discrepancy between how goods and services are taxed in Nebraska.

Inheritance Tax Repeal

Finally, effective in 2023, LB1264 would repeal Nebraska’s inheritance tax, joining 33 states that forgo taxes on assets transferred after death. Administered at the county level, this tax is paid by those who inherit property from decedents who were residents of Nebraska or who held in Nebraska the property to be transferred.

Compared to alternative local revenue sources, like taxes on real property and consumption, this narrow-based, high-rate tax is highly nonneutral and distortionary and generates an unstable source of revenue. Those in the position to bequeath or inherit property often go to great lengths to minimize inheritance tax burdens, creating dead-weight loss when resources that might otherwise go to beneficiaries are tied up in estate planning.

Policymakers already made commendable progress this year, with enactment of LB310 in February, to reduce Nebraska’s inheritance tax as shown in the following table. But repealing the tax entirely would help Nebraska compete with other states, including Iowa, which is phasing out its inheritance tax by 2025.

Nebraska’s Inheritance Tax Rates
  Current   Enacted (LB310)
  2022   2023
Immediate Relatives 1% $40,000   1% > $100,000
Remote Relatives 13% > $15,000   11% > $40,000
Non-related Individuals 18% > $10,000   15% > $25,000

Source: LB310 (2022).

Conclusion

Nebraska policymakers have recently made commendable progress in reducing corporate income and inheritance tax rates, but more work remains to be done.

If Nebraska is to create a competitive environment and attract in-state investment, comprehensive tax modernization must be a priority. LB1264 provides a solid framework for accomplishing that goal in a manner that would promote opportunity and growth in the Cornhusker State. Now it is up to policymakers to refine the details and advance reforms that will put Nebraska on a better path toward long-term competitiveness and growth.


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A 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.

The 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.

Tax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action.

The 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 as an incentive for taxpayers not to itemize deductions when filing their federal income taxes.

A 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.

An inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate.

An 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.

A 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.

Bracket 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.