Tax Cuts Signed in Arkansas

Yesterday, Governor Asa Hutchinson (R) signed a $50 million low-income tax cut into law. The tax cut provides relief to individuals with less than $21,000 in income. A small cut that doesn’t fix Arkansas’s underlying individual income tax complexity issues, the bill sets the stage for much larger tax reform in 2019.

Arkansas’s individual income tax is complicated and unlike any other state’s code. Following a tax cut in 2015, the state moved from one set of tax brackets to three tax brackets.

Individuals first calculate their total taxable income, and then use the rate schedule that matches their income level. The expansion to three rate schedules created a number of tax cliffs. Our 2016 book on Arkansas tax policy, Arkansas: The Road Map to Reform, discussed the issue at length:

For example, an individual earning $21,000 in income pays $666.15 in taxes in 2016, compared to $644.40 in taxes for an individual making $20,999. The additional $1 in income resulted in an additional tax liability of $21.75. An individual earning $75,000 pays $3,765.05 in taxes, while an individual earning $75,001 pays $4,265.21, a difference of $500.16.

The tax code includes a bracket adjustment for filers with incomes between $75,000 and $80,000, to offset part of the tax cliff. This is an explicit acknowledgment of the large tax cliffs present within the code.

The tax cut signed by Governor Hutchinson keeps the same basic structure as outlined above, but cuts rates for those with income below $21,000, since they did not benefit from the 2015 changes. The chart below shows the new brackets as adopted, which will take effect in 2019.

The tax on the first $4,299 in income is eliminated and all other rates are lowered. But this structure again created a large tax cliff for an individual going from $20,999 in income to $21,000 in income. The plan mitigates it by lowering the rate for the bottom bracket for those with income between $21,000 and $75,000 in income, but it doesn’t fix the problem. Under the new plan, an individual with $20,999 in income will pay $493.52 in taxes, while an individual with $21,000 in income will pay $659.69. That’s an increase in tax liability of $166.17 for an additional $1 in income. This sort of tax change is far from ideal.

However, the bill signed by Governor Hutchinson has a glimmer of hope. The bill creates a tax reform task force to provide recommendations to the legislature by September 1, 2018. The task force will include 16 legislators picked from the various chambers. The task force will develop recommendations that:

• “Modernize and simply the Arkansas tax code.”
• “Make the Arkansas tax laws competitive with other states in order to attract businesses to the state.”
• “Create jobs for Arkansans.”
• “Ensure fairness to all individuals and entities impacted by the tax laws of the State of Arkansas.

The $50 million tax cut signed in Arkansas sets the stage for much larger tax reform over the next two years. The task force will begin meeting later this year, likely in May or June. Our aforementioned book on Arkansas’s tax code would be great introductory reading for all members of the task force.

For more information on Arkansas, click here.