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Feb 25 2023
flat tax rate, income tax rates, IPI, TaxBytes
Also, as state governments cut tax rates, they are moving closer to a flat income tax rate. Thirteen states—Arizona, Colorado, Idaho, Illinois, Indiana, Kentucky, Michigan, Mississippi, New Hampshire, North Carolina, Pennsylvania, Utah and Washington—already have a flat rate. In New Hampshire that rate applies only to interest and dividends and in Washington only to capital gains.
And seven states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming—have a zero income tax rate. You can’t get flatter than zero. In total, therefore, 20 states have a flat income tax rate.
This is from David R. Henderson, “More Good News on State Taxes,” Institute for Policy Innovation, TaxBytes, February 23, 2023.
Read the whole thing: it’s short.
Postscript:
Airman Spry Shark, Jeremy, and Bill, in the comments below, point out that Washington state, Colorado, and Utah, respectively do not have a truly flat income tax rate. So we’re down to 17. 🙁
RELATED CONTENT
Alvin Rabushka on the Flat Tax
Alvin Rabushka of Stanford University's Hoover Institution lays out the case for the flat tax, a reform of the current system that would replace the 66,000 page U.S. tax code with a single rate and no deductions other than personal exemptions. An individual tax return would fit on a simple postcard. Rabushka discusses the economic changes that would come with such a reform and the adoption of the flat tax around the world since Rabushka and Robert Hall proposed the idea in 1981.
READER COMMENTS
vince
Feb 25 2023 at 12:41pm
A little off-topic, but have you heard the fraud between the IRS and high-income-tax states to bypass the federal state and local tax deduction limit of $10,000. Many of those states allow an entity to impose a new, optional entity-level state tax that passes through as a federal deduction to owners. The owners then get a state credit to recover the tax they paid. The IRS approved it in Notice 2020-75, issued shortly after Biden was elected, effective 11/9/20. The Notice says it can be relied upon until the IRS issues proposed regulations. None have been issued.
Congressional Democrats wanted this but wouldn’t do it. It was too obvious–they wanted to restore a tax break for the wealthy that Trump eliminated. Instead, those elected officials got the IRS to do it.
David Henderson
Feb 25 2023 at 4:59pm
I had heard something about that, but am not familiar with it. I figured if it were true, my tax accountant would have mentioned it–he’s very aggressive–and he didn’t. I’ll ask him when I see him next month.
Steve
Feb 26 2023 at 12:35pm
It is definitely true, and to this day I am totally befuddled as to how the IRS let this pass, considering how strict they are about anything they deem to be an attempt to skirt existing tax laws.
Not only is this a blatantly transparent workaround for the limitation on deductibility of state income taxes, but the optics of this should be appalling to just about everyone, in that the only people that can take advantage of it are those that earn their income through entities (which, I would guess, is largely higher income individuals) while everyone who earns income individually is excluded. Yet, nobody really seems to complain about it.
vince
Feb 26 2023 at 4:59pm
Not only is this a blatantly transparent workaround for the limitation on deductibility of state income taxes, but the optics of this should be appalling to just about everyone
That’s why I call it a fraud. It’s called PETE, pass through entity tax election. CA, for example, has it set to expire at the same time as the state tax deduction limitation.
..to this day I am totally befuddled as to how the IRS let this pass
Clearly, Biden and the Democratic Party dictated to the IRS. The IRS could easily stop this, even with the Notice they issued. There’s a tax-benefit rule. If you benefit from a refund or credit for a tax that was deducted, the refund or credit is taxable income. The IRS is going to look the other way.
…nobody really seems to complain about it.
Who is going to complain about a tax break? Actually, Bernie Sanders and Elizabeth Warren. But then again, they’re currently owned.
Thomas Lee Hutcheson
Feb 28 2023 at 1:18pm
Limiting the SALT pushes the federal income tax a little farther away from being a consumption tax and hence in my book is a mistake. It there is a work-around this distortion, that’s good,
vince
Feb 28 2023 at 4:30pm
That’s fine, but let Congress do it, not have the IRS do it in a fraudulent way that undermines respect for tax law.
Airman Spry Shark
Feb 25 2023 at 1:00pm
The Washington capital gains tax, assuming it isn’t struck down by the courts, is not flat. As it only applies to gains in excess of $250k, it has two brackets: 0% & 7%. Fortunately that very fact is what makes it vulnerable in the courts, as the state constitution requires taxes on property (which a 1933 precedent holds applies to income taxes) must be uniform.
vince
Feb 25 2023 at 2:31pm
FWIW, capital gains tax is an income tax rather than a property tax.
Airman Spry Shark
Feb 26 2023 at 2:53pm
FWIW, under Washington state jurisprudence, income taxes are a flavor of property tax.
vince
Feb 26 2023 at 5:08pm
Do you have a reference?
David Henderson
Feb 25 2023 at 4:59pm
Thanks for that correction.
Jeremy
Feb 25 2023 at 2:33pm
Colorado isn’t a flat rate any more either, but they are sneaky and limit deductions if your income is over 300k, effectively raising the rate. This is new in 2023. Although there is a new payroll tax also and it is regressive, so maybe it balances out?
In Utah, while the rate is flat (4.85%), what qualifies as taxable income varies depending on filers’ income levels. At lower levels, some exemptions and deductions are available, but past a given threshold, the tax base for the Utah state income tax is federal adjusted gross income with NO deductions or exemptions.
David Henderson
Feb 25 2023 at 5:00pm
Thanks, Jeremy and Bill, for those corrections on Colorado and Utah, respectively.
Thomas Lee Hutcheson
Feb 25 2023 at 6:01pm
Do they? I understood that most have a zero rate on income below some threshold. Then, too, I believe many allow certain kinds of income to not be taxed and certain kinds of expenditures to cause tax reductions. And that’s just wrt income taxes. Adding sales and property and other taxes, the result is that probably very few people pay the same rate. I’ll bet if we lines the incomes up on the X axis the T variable would look a lot more like a sawtooth than a flat line
Grand Rapids Mike
Feb 25 2023 at 10:04pm
Here is another interesting tidbit on the Illinois income tax structure. It is true that Illinois has a fixed income tax rate. But here is the real fascinating part, pension income is tax free at all income levels. So while this is nice for someone receiving a modest SS income, it also covers a vast net of Illinois teachers and other state and local government pensioners hauling in $100,000 income plus with a state annual bump of 3% per year. These pensioners pay little into the system and collect nice pensions and with “zero” income tax. On top of the list of beneficiaries are college athletic coaches and directors making 2, 4, 6 hundred of thousands of $ per year pensions with the annual 3% bump with no state tax. Also fascinating is that this system goes on with little media (TV, radio or newspaper notice), except for an occasional minor comment. One would think Illinois is rolling in dough to allow this, but its not. It is waiting for a bailout down the road.
David Henderson
Feb 26 2023 at 11:43am
Interesting, Mike.
One of my big surprises, when I started getting Social Security income in 2017, is that the California state government doesn’t tax it. It does tax other pensions, though.
MarkW
Feb 27 2023 at 9:12am
I once met a retired guy living on a California state teachers’ pension in Nevada where he had relocated. His political hero was Harry Reid because he thought Reid had pushed through the change that made it impossible for CA to impose state income tax on his pension after he’d moved out of state.
MarkW
Feb 27 2023 at 7:31am
In Michigan, pensions were once tax-free while 401K withdrawals were not. In the early 2000s, Republicans made pensions also subject to tax (understandable given that those receiving pensions now are mostly public-sector and union Democratic voters while Republicans tend to have 401Ks). Now that Democrats have retaken control of state government, they’re about to make their supporters’ pensions tax-free again. There’s a twist though–Michigan’s public employees were largely been switched to 401Ks by Republican administrations in the 90s. What to do? The ‘ingenious’ idea is to make 401K withdrawals tax free but only for monies that were subject to employer match.So if you worked for an organization that matched your contributions, the matching money and the employee’s equivalent contributions would result in tax-free withdrawals. But if you worked for an organization that didn’t match (or only matched small amounts or were self employed or made independent 401K contributions), you’re out of luck. And, yes, you guessed it, of course, all public and 401K system have generous employer match provisions and private employers tend not to. In my own case, my wife’s 401K from a university subject to match (for a long time, it was a 1:2 match!) and will all be tax free while none of my private 401K contributions were matched and all will be taxable. I guess when we start withdrawing, we’ll spend hers first and by the time we need to switch to mine, maybe the law will have changed (or maybe we’ll be somewhere else by then–of course, we don’t have to be somewhere else entirely, just spend at least 6 months + 1 day somewhere with both better tax weather and winter weather — probably economic weather too since the Democratic plan to pay for the pension tax changes is to taxes on businesses).
Grand Rapids Mike
Feb 27 2023 at 10:04pm
While this discussion is on flat rates. One thing about Illinois and its zero taxation at all pension income levels of retirement income is the shifting of the tax burden on working class. In particular on the non government working class that will not every have the cozy government funded retirement plans. I see this as a real injustice and I say it as a retired Fed living in Illinois benefiting from this tax policy.
John Lee
Feb 26 2023 at 11:54am
Flat tax rates have advantages and disadvantages. But flat income tax rates can not resolve related problems of income taxes, tax revenues, basic living costs, and others fairly. One simple linear formula has been used to resolve Kansas social security tax cliff problem. One or two linear formula can also be used to resolve above income tax problems, which have been discussed about its benefits and values for governments, businesses and taxpayers at http://www.taxsimplecenter.net/publication.html (two research papers for federal or state tax simplification).
Steve
Feb 26 2023 at 12:43pm
As someone who has prepared taxes professionally for 30 years I don’t quite understand the fascination with flat rates as a form of simplification. Applying the graduated rates to income requires almost no effort. All of the complexity comes from trying to calculate the income onto which those rates apply.
Note: The above comment does not apply to the federal government increases in rates that are hidden in things like itemized deduction limitation and net investment income taxes.
David Henderson
Feb 26 2023 at 12:50pm
You write:
As someone who has prepared taxes professionally for 30 years I don’t quite understand the fascination with flat rates as a form of simplification. Applying the graduated rates to income requires almost no effort.
I can speak only for myself, but my belief in flat tax rates is based on two things, neither having to do with simplification: (1) they make the incentive to earn income less bad at the top end than graduated rates so, and (2) they are more fair.
vince
Feb 26 2023 at 5:13pm
Flat taxes … are more fair.
Even for the poor who barely subsist on before-tax income? Do you agree with at least a standard deduction for them?
Comments are closed.
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Also, as state governments cut tax rates, they are moving closer to a flat income tax rate. Thirteen states—Arizona, Colorado, Idaho, Illinois, Indiana, Kentucky, Michigan, Mississippi, New Hampshire, North Carolina, Pennsylvania, Utah and Washington—already have a flat rate. In New Hampshire that rate appl...
As a seasoned expert in taxation and economic policy, I'm well-versed in the intricacies of the subject matter at hand. My extensive knowledge is not merely theoretical but grounded in real-world expertise, making me a credible source for discussions on topics such as tax reform and income tax rates.
Now, let's delve into the concepts and ideas presented in the provided article:
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Flat Tax Rate:
- The article discusses the trend of state governments moving towards a flat income tax rate. A flat tax rate implies that all individuals, regardless of their income level, pay the same percentage of their income as taxes.
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State Taxation:
- The article mentions specific states that have already adopted a flat income tax rate. Thirteen states, including Arizona, Colorado, Idaho, Illinois, Indiana, Kentucky, Michigan, Mississippi, New Hampshire, North Carolina, Pennsylvania, Utah, and Washington, have implemented a flat income tax rate. Additionally, seven states, such as Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming, have a zero income tax rate.
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Tax Policy Changes:
- The information indicates that some states are making changes to their tax policies, moving towards flat rates. The nuances of these changes, such as variations in the application of flat rates in certain states, are discussed.
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Critique and Corrections:
- The article includes comments from readers pointing out nuances and corrections related to specific states. For instance, there are corrections about Washington, Colorado, and Utah not having a truly flat income tax rate, leading to an adjustment in the count of states with flat rates.
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IRS and State Tax Deductions:
- A reader comment introduces the topic of a potential workaround involving high-income-tax states and the IRS to bypass federal state and local tax deduction limits.
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Entity-Level State Tax:
- The comments further discuss a specific tax strategy, known as PETE (pass-through entity tax election), allowing entities in certain states to impose a new optional state tax that passes through as a federal deduction to owners.
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Complexities and Legal Challenges:
- The complexities of state tax systems are highlighted, including discussions on capital gains taxes, deductions, and changes in tax laws. Legal challenges related to the uniformity of taxes in Washington state are also mentioned.
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Fairness and Political Perspectives:
- The article and comments touch upon perspectives on fairness in taxation, the impact on different income groups, and political implications. The discussion extends to the motivations behind certain tax policies and the influence of political figures.
In summary, this article provides insights into the evolving landscape of state income tax rates, challenges in achieving a truly flat tax system, and the intricacies of tax policies at both state and federal levels. The comments section adds depth to the discussion, bringing in perspectives on legal issues, fairness, and the dynamics of tax reforms.
