More States To Join The Flat Tax Club

After lawmakers in nearly 10 states enacted income tax cuts in the first half of 2022, a string of special sessions in the second half of the year is resulting in further income tax relief and strengthening the recent trend of states moving from graduated to flat income taxes. Most recently, Idaho legislators returned to the state capital in Boise on the first day of September for a special session called by Governor Brad Little (R) for the purpose of making Idaho the newest flat tax state.

Governor Little signed the largest income tax cut in Idaho’s history in 2021. Earlier this year he topped that by approving another income tax cut that was even larger than the 2021 reduction. The impetus for the new tax relief package proposed by Governor Little, which was passed the Idaho House and Senate on September 1, is inflation relief.

“The cost of basic fundamentals to live everyday life has skyrocketed, and schools are faced with the burden of rising operating costs,” Governor Little said when announcing his new tax relief proposal on August 23. “Idaho’s powerful economic engine, combined with years of fiscal conservatism in state government, mean tax revenues have outpaced government spending, month after month, year after year. As a result, we are now projecting a new record budget surplus – $2 billion – which is hundreds of millions more than we expected.”

Governor Little’s proposal, which state legislators passed on September 1, moves Idaho to a flat 5.8% personal income tax. Idaho currently has a progressive income tax code with a top rate of 6%, which kicks in at less than $8,000 in annual income. Idaho is one of only 10 graduated income tax states whose top rate kicks in below $20,000 in income. Though progressive on paper, in practice these states already have something very close to a flat tax in place, given most households are already paying the top marginal rate.

Under House Bill 1, the bill to implement Governor Little’s proposal, the first $2,500 in income will be excluded from taxation for single filers and the first $5,000 for joint filers. The new zero tax brackets are inflation adjusted, which will ensure bracket creep doesn’t lead to a higher tax burden in the future for some.

“The fact this legislation includes the inflation adjustment is an important factor, since some taxpayers would otherwise see a tax increase,” explains Miguel Legarreta, president of the Associated Taxpayers of Idaho. HB 1 would also nullify the harm caused by Proposition 1, the controversial ballot measure that Idaho residents will vote on this November.

Proposition 1, if approved, would establish a new top income tax rate of 10.925% assessed on income above $250,000 (single filers) and $500,000 (joint filers). Even if Proposition 1 were to pass, enactment of HB 1 during the September special session will ensure taxpayers are held harmless.

“While the proposed structural reforms are economically beneficial in their own right, the bill’s effective date—January 3, 2023—would ensure these reforms supersede and reverse the effects of a tax increase ballot measure that, if adopted, would take effect on New Year’s Day,” writes Katherine Loughead, senior policy analyst at the Tax Foundation, about the benefits of HB 1.

“In addition to creating the highest income tax rate between New York and California, Prop. 1, through a series of drafting errors, would increase taxes for nearly all Idahoans by reversing the income tax cuts that took effect earlier this year,” Loughead added. “It would also inadvertently create a tax cliff, increasing tax liability by more than $1,300 with one additional dollar of income, and expose an increasing number of Idahoans to the 10.925% top rate each year due to an inverted inflation adjustment formula that would reduce, rather than increase, the income level at which the top rate kicks in each year.”

HB 1, which Little will soon sign into law, will also cut Idaho’s corporate tax rate from 6% to 5.8% and result in the third round of taxpayer rebates in the past two years. This tax package would make Idaho, a state with one of the fastest growing economies and among highest in-migration rates in the nation, even more attractive to individuals, families, employers, and investors.

“In addition to these permanent income tax rate reductions totaling approximately $150 million annually, the legislation proposes an additional individual income tax rebate of approximately 10% of a taxpayer’s 2020 Idaho income tax liability or $300 per single filer and $600 per joint return, whichever amount is greater,” Loughead added. “As Idaho attempts to further solidify its position as a growth-oriented, taxpayer-friendly state this special session, other states should look to its example and pursue similar reforms.”

North Dakota Looks To Follow Lead Of Idaho, Georgia, Arizona, and Mississippi, Becoming Nation’s 24th Flat Tax State

The day after Governor Little called for a special session to convene on September 1, his counterpart in North Dakota, Governor Doug Burgum (R) unveiled a new tax proposal that would also move North Dakota to a flat tax. North Dakota currently has a two-tier income tax with rates of 2.04% and 2.9%. Governor Burgum’s proposal would move to a flat 1.5% income tax.

“Now is the right time to provide meaningful, permanent tax relief to make our state a more attractive place to work and a more affordable place to live,” Governor Burgum said in announcing his proposal. “Under this proposal, almost 60% of taxpayers won’t have to pay state income tax, and those who do will see their income tax liability reduced by roughly one-quarter to one-half, allowing North Dakotans to keep more of their hard-earned money to offset expenses and invest in their families and communities.”

Critics of Burgum’s plan have already begun to paint it as a sop to the rich. Supporters, however, see Burgum’s proposal as a pro-growth reform that will make North Dakota more attractive to job creation and capital formation.

“Income tax is a tax on productivity, it’s a tax on labor. That’s not necessarily the most fair way to do it, in my opinion,” Dustin Gawrylow, president of North Dakota Watchdog, told CBS affiliate KX News. “We want to promote the idea that North Dakota is a place that we’re not going to punish you for making more money. We’re going to tax you when you spend your money.”

North Dakota Democratic-NPL Chairman Patrick Hart has come out against Burgum’s tax relief plan, deriding it as “regressive.” But a flat tax by definition is not regressive. A regressive tax is a levy that consumes a disproportionately greater share of income for low- and middle-income households than it does for higher income filers. That is not the case with a flat income tax, which ensures everyone pays the same share of income.

In fact, contrary to North Dakota Democratic Party Chair’s accusation that a flat tax is regressive, people with higher income levels pay more in taxes under a flat income tax. A individual with $200,000 in taxable income, for example, would owe $10,000 in state income tax under a flat 5% income tax. Meanwhile a person with $75,000 in taxable income would owe $3,750 under the same 5% flat tax. For progressives and others who want upper income households to pay more in taxes than lower- and middle-income filers, a flat tax accomplishes that goal.

“This is the largest income tax relief package in state history and will establish North Dakota as the lowest flat-tax state in the nation, while still retaining a state income tax collection system to fund priorities,” said North Dakota Tax Commissioner Brian Kroshus. “All income earners will see measurable relief, increasing disposable income that can quickly enter the North Dakota economy.”

Governor Burgum’s proposal would also increase the job-creating capacity of small businesses, most of which file under the individual income tax system. According to IRS data, more than 201,000 sole proprietors, partnership owners, and S-corps file under the personal income tax system in North Dakota.

“Because LLCs are taxed under the personal income tax rates, they would benefit from this plan as well, significantly, so an LLC, or North Dakota would become a very friendly place to launch an LLC,” Gawrylow said about the benefits of Burgum’s plan to small businesses.

“This tax policy will keep money in our citizens’ pockets and also includes a removal of state income tax for our state’s lowest income earners,” Senator Scott Meyer said. “This income tax reform is a major step in the right direction as North Dakota works to meet the challenges faced in oil production, agriculture and technology as we further diversify our economy,” Representative Craig Headland added.

There are currently nine states with a flat income tax, 18 when counting the nine no-income-tax states that charge a flat 0%. Four states (Arizona, Iowa, Georgia, and Mississippi) codified laws in 2021 and 2022 that will phase in flat taxes in the coming years. When Governors Little and Burgum enact their tax proposals as is expected, Idaho and North Dakota will become the the fifth and sixth states in past two years alone to adopt a flat tax, bringing the total number of flat or zero tax states to 24. The question in 2023 will then be which state will become number 25, marking the milestone in which half of all states are flat tax states.