Recapping the 2019 Arkansas Tax Reform

April 11, 2019

Nicole Kaeding
Jeremy Horpedahl

Nicole Kaeding, Jeremy Horpedahl

The Arkansas General Assembly  concluded its 2019 session after accomplishing one of its key priorities, tax reform. After two years of intense debate and study, the Natural State has passed a series of tax reforms to improve the competitiveness of the state’s tax code.

Individual Income Tax Reform

The General Assembly pushed through its third phase of individual income tax cuts. Following reductions in 2015 and 2017, the 2019 General Assembly lowered tax rates for individuals with income above $79,300 in income. The top income tax rate will fall from 6.9 percent to 5.9 percent in 2021 and the six brackets will consolidate into three (although the three sets of brackets based on income level will remain).

Corporate Income Tax Reform

Among the biggest changes to the Arkansas tax code are within the corporate income tax. 1) The corporate income tax rate will drop from 6.5 percent to 6.2 percent in 2021, followed by another decrease to 5.9 percent in 2022; 2) the apportionment factor is changing from a double-weighted sales approach to a single-sales factor; and 3) the net operating loss carryforward period is being extended from five years to 10 years. The state seemed poised to repeal its throwback rule, but that was dropped at the last moment due to revenue concerns.

Sales Tax Reform

Arkansas also worked to harmonize its sales tax code with the U.S. Supreme Court’s ruling in South Dakota v. Wayfair. Already a member of the Streamlined Sales Tax Agreement, the state had less work to do than many other states, but Arkansas did codify the remaining components of the Wayfair checklist. The state will now require remote collection by sellers with more than $100,000 in sales or 200 transactions. Arkansas does go beyond South Dakota by also requiring marketplace sellers (such as third-party sellers using the Amazon platform) to also collect sales taxes in some cases. Arkansas also cleaned up several of its sales tax exemptions, ensuring that they are properly targeted on business-to-business transactions and not individual consumption.

Infrastructure Funding

The state also took a big step forward by raising its gas tax. The state created a new wholesale tax on gasoline and diesel at a rate of 1.6 percent and 2.9 percent, respectively. This is equivalent to a 3 cent-per-gallon gas tax increase. The state also created a new fee for electric and hybrid vehicles. Additionally, the state is sending voters a constitutional amendment to permanently extend a temporary sales tax increase to fund infrastructure. Originally passed in 2012, the ½ cent sales tax generates almost $300 million a year in revenue for infrastructure projects. The part to be approved by voters represented about three-quarters of the overall highway-funding package that the governor proposed.

Tax Expenditure Review

One of the least reported, but important, reforms advanced in Arkansas is a now regular process for quantifying and reviewing the state’s tax expenditures. Prior to this legislature, Arkansas reviewed its expenditures on an ad-hoc basis, often going years between updates. Prior to the task force’s work, the most recent list of sales tax exemptions dated to 2012. Now, the Department of Finance and Administration will prepare biennial reports on each tax expenditure, including the information about the costs, distribution, and impact of each expenditure.

Franchise Tax

The state has also made some administrative changes to its franchise tax. The tax will now be administered by the Department of Finance and Administration, instead of the Secretary of State.

Preventing Bad Ideas

Finally, the General Assembly also prevented a few bad items from taking hold. The state briefly debated raising its cigarette tax and creating a new tax on vapor products. It also considered a flawed proposal to create a pass-through entity tax to allow businesses to game the new federal, state, and local taxes paid deduction cap.

Many of these recommendations come directly from our 2016 book on the state’s tax code as well as our frequent testimony to the Arkansas Tax Reform and Relief Task Force. Both authors presented on multiple occasions to guide the thinking of the task force as it considered tax reform proposals in Arkansas. Arkansas’s diligent study of the issue has paid off with comprehensive tax reform in the Natural State.

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Taxing Distributed Profits Makes Business Taxation Simple and Efficient

A 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.

A gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline.

Tax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans.

A Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years’ profits. Businesses thus are taxed on average profitability, making the tax code more neutral. In the U.S., a net operating loss can be carried forward indefinitely but are limited to 80 percent of taxable income.

A tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the IRS, preventing them from having to pay income tax.

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 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.