On Thursday, the Nebraska Unicameral Revenue Committee reported LB 461, an omnibus tax reform bill with support from Gov. Pete Ricketts (R), on a 6-2 vote. As the bill heads to the floor, it’s helpful to take a step back and review the bill’s provisions, including revenue-contingent individual and 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. reductions and agricultural property tax relief.
Individual Income Taxes
Under LB 461, 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 would decline over time subject to revenue availability. The current four-bracket system, with rates ranging from 2.46 to 6.84 percent, would continue through 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. year 2018, with the bottom two brackets consolidated in 2019. Currently, a rate of 2.46 percent applies to the first $3,089 in taxable income, with a rate of 3.51 percent on income between $3,090 and $18,509. This bill would tax all income under $18,509 at a rate of 3.25 percent.
(In the tax code, the second bracket kicks in at $3,000 and the top bracket kicks in at $18,000, but to avoid “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. ,” all brackets are indexed for inflation, hence the unusual numbers. 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. -indexing would continue under LB 461, so by the time 2019 rolls around, we would expect the bracket widths to be slightly greater. For simplicity’s sake, in a subsequent table, I’ll neglect inflation-indexing and use the bracket widths that appear in the code.)
For anyone with 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. of $12,745 or more, this is a tax cut, albeit a very modest one (up to $40), as a standalone provision. Viewed in isolation, however, it could be a very small tax increase for those with lower taxable incomes (up to $24). That is part of why the bill is paired with an increase in the earned income tax credit, which will phase up (over two years) from being worth 10 percent to 12 percent of the federal credit.
After bracket consolidation in 2019, the more meaningful tax-cutting begins—subject to revenue availability. Under LB 461, the top marginal rate (6.84 percent), currently levied on all income above $29,830, will decline by 0.11 percentage points every year after which state revenues grow by at least 3.5 percent. These “triggered” reductions would conclude once the top rate reaches 5.99 percent, which could happen no earlier than 2027.
Finally, the value of the personal exemption credit is phased out for high-income earners. A single filer with 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.” of $150,000 would lose 10 percent of the value of the personal exemption credit, with the amount by which the credit is reduced increasing to 20 percent at $160,000, 30 percent at $170,000, 50 percent at $180,000, and 75 percent at $190,000, with full elimination at $200,000. (The dollar thresholds double for joint filers.)
Here’s what the rate changes would look like once fully phased in (and remember, I’m not including inflation-indexing on bracket widths here):
| Income Bracket | Current | LB 461 |
|---|---|---|
| $0 – $2,099 | 2.46% | 3.25% |
| $3,000 – $17,999 | 3.51% | 3.25% |
| $18,000 – $28,999 | 5.01% | 5.01% |
| $29,000+ | 6.84% | 5.99% |
| EITC | 10% | 12% |
Nebraska’s current top marginal income tax rate is above the national average and stands out regionally. Two neighboring states—South Dakota and Wyoming—forego individual income taxes altogether, while another (Colorado) imposes a single-rate income tax. Iowa, Kansas, and Missouri all impose graduated-rate taxes like Nebraska, but only Iowa imposes a higher top marginal rate (8.98 percent), and the burden of Iowa’s high rate is mitigated somewhat by the state’s atypical allowance of a deduction for federal income taxes paid. One of the last states to even impose an individual income tax, Nebraska now imposes one of the highest rates in the region. The phase-down under LB 461 would bring the state more in line with its regional competitors.
Corporate Income Taxes
Nebraska currently levies a two-rate corporate income tax, with a top rate of 7.81 percent on all corporate income above $100,000. Under LB 461, the top rate would decline to 7.59 percent in 2019, then decline another 0.2 percentage points after each year in which state revenues grow by more than 4 percent. This approach prioritizes individual income tax rate reductions; there has to be enough revenue growth for both sets of rate reductions if the corporate rate is to decline. As with the individual income tax, the rate could continue to decline, subject to revenue availability, until reaching 5.99 percent.
Meanwhile, the New Markets Job Growth Investment Act and the Job Creation and Mainstreet Revitalization Act, which provide tax credits for certain investments and building renovations, would be suspended, broadening the tax base to help pay down rate reductions. Other generous incentives, however, like the Nebraska Advantage, would remain in place.
Tax incentives carve out the corporate 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. , picking winners and losers. Businesses able to take advantage of these preferences face low or even nonexistent corporate income tax liability, while businesses which do not receive such benefits are forced to pay higher taxes to cover the cost of the incentives granted to others. A broader base and lower rate helps address these inequities and limits the degree to which taxes skew economic decision-making.
Property Taxes
If, on the whole, this tax reform proposal pursues greater simplicity, the opposite must be said about the property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. component. Given concerns about rising assessment values of agricultural land squeezing out farmers operating on slim margins, LB 461 offers a new method of land valuation based on agricultural use value. The following explanation is not comprehensive, but does provide at least a brief overview of how this would work.
First, agricultural and horticultural land would be divided into new classes of real property: irrigated cropland, dry cropland, grassland used for grazing, grassland used for haying, wasteland, nurseries, feedlots, and orchards, at a minimum, though the legislation grants local governments leeway to create additional classes as well. Then, each of these classes is further divided into subclasses based on soil classification standards promulgated by the USDA’s Natural Resources Conservation Service (NRCS).
The NRCS is serious about soil taxonomy, with six hierarchical categories, from top-level orders (there are 12 of them) all the way down to series, of which there are more than 19,000. For those of us who can’t distinguish their alfisols from their aridisols, this all gets confusing pretty quickly — but even for property tax administrators with a solid grasp of the issues, and even assuming the adoption of a modest number of soil types, the new system definitely has some complexity built in.
But we’re just getting started: once we know a property’s class (irrigated cropland, say) and subclass (let’s call it Grade A soil quality for now), we still have to assign an agricultural use value based on a capitalized income approach. Every year, county tax officials would take the county’s average yield per acre for every major crop (based on an eight-year rolling average) and multiply those figures by the previous year’s average commodity price for each. Then, these data would be aggregated, weighted according to harvest ratios for the previous year.
Take the gross income that can be expected from the average acre of, say, irrigated cropland with really good soil and multiply that by the acreage, and there you have it: the basis of an agricultural use valuation. Like I said, it’s a little more complex than market value.
It also has its economic shortcomings. After all, there’s a certain logic to valuing a piece of property as the market would, and markets will tend to approximate best and highest uses, which may or may not be agricultural. Nebraska, however, clearly values its agricultural sector a great deal, and this somewhat convoluted approach is designed to keep property taxes from pricing farmers out of their land.
Concluding Thoughts
Nebraska’s LB 461 represents significant tax reform, reducing the state’s above-average individual and corporate income tax rates. It also provides property tax relief for agricultural land, albeit in a nonneutral way. Further analysis will follow, but LB 461, which adopts many of our recommendations from last year, takes great strides in making Nebraska’s tax code more modern, and far more competitive.
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