LB 754 fiscal and economic impact
Nebraska has a once-in-a-generation opportunity to overhaul its tax code in 2023. A successful tax reform will pay dividends for generations.
Nebraska has large revenue surpluses, and the best thing to do with the surplus revenue stream is to return most of it to the productive private economy through thoughtful and sustainable tax reform. This will put money back into Nebraskan pockets and restructure the tax code to allow for more economic success.
Enter Nebraska’s LB 754, which if enacted would be the most significant income tax reform Nebraska has implemented in decades. Nebraska currently has billions in surplus revenue. The tax proposal would reduce taxes by $3.9 billion over the next 6 years relative to prior baselines, according to a new fiscal note for the bill.
Below is a consideration of the economic impact of the tax cuts being considered in the bill.
Full expensing is at once one of the most impactful and least-understood pro-growth tax policies.
The fiscal note for LB 754 projects that making full expensing permanent would reduce revenues by $256 million over 6 years. However, Nebraska had full expensing in law through 2022, so the fiscal note estimate is better understood as a tax increase that is being avoided by preserving full expensing as it existed in Nebraska law until January 1, 2023.
Full expensing means that businesses can immediately write off the cost of capital investments against taxable income in the year the capex expense is incurred. The alternative to full expensing is that a business would need to take deductions spread out over 5-20 years in order to recover its cost of investment, depriving the business of full cost recovery. States lose out without full expensing, especially when inflation is high, because inflation erodes the value of those future deductions.
This reform properly circumscribes the tax base to be revenues minus costs by making a full recognition of costs – arriving at the proper definition of business income. Full expensing is worth more economic growth per dollar of foregone revenue than any other reform in LB 754.
The revenue foregone by enacting full expensing is a tax cut specifically for new investments. By comparison, cutting the corporate income tax rate primarily reduces revenue by reducing the tax rate on income produced by older investments. Tax Foundation modeling shows that full expensing, by focusing its tax relief on new investments rather than old investments, produces twice the economic growth per dollar of foregone revenue compared to a corporate rate cut. In contrast, cutting the corporate rate increases business free cash flow and the incentive for businesses to make new capital investments by changing their return-on-investment calculation, but its impact is not as concentrated on incentivizing new investments per dollar of foregone revenue.
Nebraska has had full expensing in law since 2018. Making full expensing permanent is simply preventing a tax increase. The economic impact of full expensing is compelling. Georgetown researchers found that (state) full expensing boosts business capital expenditures by 21.5% and wages by 5%. A Penn Wharton study found it boosts manufacturing employment by nearly 10%. And Tax Foundation estimated that (federal) full expensing would boost GDP by 2.3% and America’s capital stock by 6%.
For economic growth per dollar of foregone revenue, full expensing is the most important reform Nebraska can make. Time is of the essence
Corporate income tax rate cuts
Only people can pay taxes, which is a key concept to keep in mind when it comes to corporate taxation. Corporations are a stack of legal documents to allow workers, managers, and investors to come together to produce products and services. Corporations remit taxes, but taxes are ultimately paid by individuals.
LB 754 would phase down Nebraska corporate rate to 3.99% over coming years, and the fiscal note for the bill projects that enacting corporate rate cuts would reduce revenues by $439 million over 6 years.
The legal incidence of taxation is upon the stack of legal corporate documents, but the economic incidence of corporate taxation comes in the form of lower worker wages, lower investment returns for shareholders, higher prices for consumers, or some other price impact along the corporate supply chain. After corporate income is taxed at the firm level, it is taxed again when earnings are distributed to shareholders.
The research on the positive impact of a lower corporate tax rate is compelling. A 2014 National Bureau of Economic Research study called Who Benefits from State Corporate Tax Cuts sought to determine the economic beneficiaries of state corporate income tax reductions. The study found that 35% of the benefit went to workers and 40% went to corporate managers and shareholders.
Another study by Cal Berkeley economists published in the American Economic Review found that state taxes impact the geographic location of top earners, star scientists, and innovative companies. Corporate taxes were found to have a slightly greater impact on mobility than individual income taxes. A study published by the National Association of Business Economics found that a reduction in state corporate tax rates is associated with faster job creation, and a 2015 National Tax Journal study called “State Corporate Tax Cuts and Economic Growth” found that lower state corporate income tax rates were associated with higher per capita income growth, increased investment, and increased jobs.
A 2012 study in the New England Economic Review called “Corporate Taxes and State Economic Growth” found that lower corporate taxes are associated with higher growth, while a 2013 study called “Do State Corporate Income Taxes Reduce Wages?” in the Journal of Regional Analysis and Policy found that higher corporate rates result in lower wages for low-income workers. Still more studies find a relationship between corporate taxes, job growth, and firm location.
Cutting the corporate income tax rate to 3.99% will benefit Nebraska’ long-term economic trajectory, and is an important tax achievement given that nearby states like neighboring Missouri plans to reduce its corporate rate to 2%.Cuttign the corporate rate is not as impactful as full expensing per dollar of foregone tax revenue, but rate cuts are a key way to attract new investment and growth to Nebraska.
Individual income tax rate cuts
High, progressive tax rates are less competitive for both individuals and businesses. And two recent structural changes make it more important than ever for states to have a competitive individual income tax. LB 754 would give Nebraska a competitive top rate to 3.99%, a change that would reduce revenues by $2.7 billion over the next 6 years.
The first structural change came from the 2017 federal Tax Cuts and Jobs Act. In order to pay for lower income tax rates, the TCJA limited tax deductions. This included limiting the amount of state and local taxes that could be deducted against federal taxable income to only $10,000 per household. Previously, there was no cap on the state and local tax (SALT) deduction against federal income. In effect, the imposition of the “SALT cap” increased the felt cost of state and local taxes. It’s now more important for Nebraska to have lower, more competitive taxes.
The second structural change to occur was the shift to remote work after the pandemic. A significant portion of skilled service sector workers have been untethered from a single work location. As a result, they can choose where to live based upon where they get the best quality of life for cost. Taxes undoubtedly factor into these decisions as one of the larger costs associated with any location. Income taxes in particular are important for relocation decisions, and Nebraska’s top tax rates are high relative to the region and the country.
These two structural changes have put state policymakers in uncharted waters as they navigate the competitiveness of their income tax codes. States are opting en masse to create more competitive tax codes by lowering their individual income tax rates. Nebraska in particular would benefit from a more competitive income tax code, as the Cornhusker State suffers a greater loss of state income due to outmigration than all but 5 other states.
While advocates of highly progressive income taxes make an argument for fairness, it should be considered that the United States federal tax system is the most progressive tax system in the developed world. The impact of federal redistribution and transfer payments make the federal fiscal system even more progressive.
A new study from Tax Foundation shows just how progressive the combined federal and state tax and transfer system is. The first and second quintiles of income earners effectively pay a negative income tax because they are the recipients of significantly more transfer benefits than they pay in taxes. The federal individual income tax is the key driver of overall US tax and transfer progressivity.
Nebraska’s state income tax also drives progressivity. And even if LB 754 is enacted in its current form, Nebraska’s income tax would remain progressive.
Academic research finds that state individual income taxes impact economic growth and migration patterns. And most of that research pre-dates the structural changes that have occurred in the last 5 years that have made state tax competition more important. A 2008 study called State Income Taxes and Economic Growth analyzed all 50 states over 40 years and found that states with lower income tax burdens tend to experience faster economic growth as measured by per capita income, jobs growth, and business formation. The 2012 study titled “The Economic Effects of State Tax Levels” also found that states with lower income taxes tend to have higher economic growth.
The 2012 study “Do High State Taxes Impede Income Growth?” found that higher income taxes are associated with lower economic growth rates and higher rates of out-migration. The 2013 study The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States found that income tax increases lead to significant and persistent out-migration from a state.
Finally, researchers at the University of Wisconsin Center for Research on the Wisconsin Economy found that lowering the top state income tax rate is a key way to stimulate the state economy.
Nebraska lawmakers are rightfully prioritizing a significant income tax cut to a 3.99% top rate to restore Cornhusker state competitiveness. It’s more important than ever to compete for individual talent, and a high income tax is the
LB 754 contains additional tax changes that will impact economic competitiveness in less obvious or less direct ways. Most importantly, the bill would reign in Nebraska’s aggressive taxation of non-resident income, which disincentivizes both businesses and workers from working short-term in Nebraska. Academic scholarship has not addressed this issue in depth, but suffice to say that Nebraska would achieve better inflow of talent and workers if it didn’t punish remote workers for short stays in the state.
Nebraska’s LB 754 would advance the state’s competitiveness more than any tax reform the state has made in decades. Most importantly, the bill reforms income tax rates and the business income tax base. Lawmakers should accomplish as much as possible in LB 754 within the bounds of revenue expectations.