Utah would expand its individual income tax and sales tax bases, reduce tax rates, and shift taxes from production to final consumption under a proposal submitted November 22 by outgoing Gov. Olene Walker (R).
Walker’s recommendations are based on the efforts of a group of tax experts she called together one year ago. She promised taxpayers her reform would be revenue-neutral.
“We have a tax structure in Utah that hasn’t been significantly revised for more than three decades,” Walker said in announcing the recommendations. “Tax reform certainly wasn’t the politically correct thing to do, but it was the right thing to do for the future of the state. It was clear the time had come to take action and bring our tax system into the twenty-first century.”
Incoming Governor Mum on Plan
How far her recommendations will advance is anybody’s guess. Walker leaves office January 3, and incoming Gov. Jon Huntsman Jr. (R), who has said tax reform would be his top priority, has declined to comment on her proposal.
“Tax reform is critical to Utah,” Huntsman said in a statement. “As we work to revitalize the economy, we need to revamp our outdated tax codes and close the loopholes of the past.”
Walker said that because of a shifting economy the state’s overall net tax base is declining. Using the sales tax as an example, Walker said as the economy moves from goods-based to service-based, the state is taxing a smaller share of transactions. A similar problem exists with the income tax, she noted.
“To compound the problem, our school enrollment numbers are growing exponentially,” Walker said. “How will this increase be handled by our tax system if our numbers continue to climb and our tax base continues to decline?”
Prospects Remain Uncertain
Reaction to Walker’s plan has been mixed. Legislative leaders have voiced some concerns about the taxes on services. The Utah Taxpayers Association has not officially endorsed the entire package but has indicated the proposed reforms are worthy of debate and should be the basis for ongoing discussions of tax reform in the state.
“The governor’s new tax proposal does not make any adjustments to provide for the education funding of our children that she and so many others have identified that we need to do,” said State Rep. Steve Mascaro (R-West Jordan) on the Utah Policymaker Weblog. “I am impressed with the breadth of the tax reform but extremely disappointed to see a lack of commitment to deal with the education funding issue that we continue to fall further behind on.”
However, former State Rep. Craig Call said on the same Weblog, “A flat tax, reform of redevelopment bonding and zoning for dollars, proper equalization of sales taxes between communities, and a broadening of the base to make the system fairer would all be very good moves and help avoid the ongoing negatives of the current structure.”
Public schools and colleges are guaranteed income tax revenues in the Utah Constitution. The proposal would make them more dependent on property and sales taxes because income tax rates would drop.
“We certainly would not want to give up what we have for the uncertainty” of another funding source, Gary Cameron, executive director of the Utah School Superintendents Association, told the Deseret Morning News. “Unless there is some provision to hold education absolutely harmless, of course … (we’re) nervous.”
Tax Mix Would Change
The proposal would change Utah’s existing income tax system, which has six tax brackets and a current top marginal rate of 7 percent applied to taxable income above $8,626 for a married household. This system would be replaced by a flat tax of 4.9 percent based on federal taxable income.
Because this proposal would generate less revenue than the current state individual income tax, the statewide property tax levy for schools would have to be increased. Walker also has proposed a second option, of taxing federal adjusted gross income at 4.1 percent. At a 4.1 percent tax rate, taxpayers would not be allowed any deductions, including the popular deductions for mortgage interest and charitable contributions.
Both income tax proposals would preclude state-only deductions and credits, which could complicate efforts to allow tuition tax credits for private schools.
Walker also proposes reducing the state sales tax rate from 4.75 percent to 3.75 percent, while expanding the sales tax base to include professional services such as accounting, legal, and medical services. Utah already taxes several types of services, including repair of personal property that is not attached to real property, entertainment, transportation, and cleaning.
Expanding the tax base to include currently untaxed professional services would allow state and local sales tax rates to be reduced by 21 percent.
Would Eliminate Corporate Tax
The governor’s proposal also calls for eliminating the corporate income tax (CIT). Walker cited the volatility of CIT revenues as reason for eliminating the tax. CIT revenues peaked at nearly $190 million at the end of the 1990s’ economic boom and decreased to $119 million during the recent recession. Walker also noted the CIT is slowly being eroded by increased corporate tax sheltering and the increasing popularity of pass-through entities like limited liability corporations and S-corporations, whose incomes are taxed at the individual level.
As a “fallback” proposal, the governor recommends double-weighting the CIT sales factor, as most states already have done. Most states use a three-factor formula–sales, property, and payroll–to determine how much of a multistate corporation’s income should be taxed. Utah still uses an equally weighted formula. Double-weighting the sales factor would shift corporate income taxes from businesses that produce goods and services in Utah to businesses that import goods and services into Utah.
Under Walker’s proposal, the sales tax exemption for purchases of capital equipment currently enjoyed by manufacturers would be extended to all types of businesses. Equipment that can be capitalized under federal income tax law would be exempt from state and local sales taxes.
Exempting business inputs from sales taxes avoids the “pyramiding” effect of imposing taxes on taxes as goods proceed through the production process. Walker noted that taxing business inputs hides the true cost of government by embedding taxes in increased product costs, lower wages and benefits for employees, and reduced rates of return for shareholders. Exempting business inputs also reduces the cost of businesses to improve productivity and expand production.
Protecting School Funding
Walker also proposes allowing school districts to opt out of redevelopment agencies (RDAs). Cities typically use RDAs to offer property tax subsidies, more than half of which are diverted from school districts, to well-connected commercial real estate developers. City officials argue that retail development needs to be subsidized by taxpayers and that RDAs are excellent tools for repairing urban blight, even though such blight is not a serious problem in Utah.
Every year, nearly $40 million in property taxes are diverted from Utah school districts through RDAs, usually to subsidize retail developments, according to Walker’s office.
Mike Jerman ([email protected]) is vice president of the Utah Taxpayers Association.
For more information …
Details of the governor’s proposal are contained in “Governor Olene Walker’s Recommendations on a Tax Structure for Utah’s Future,” available online at http://www.utah.gov/governor.