Legislative Testimony for LB432: Change income tax rates

Legislative Testimony for LB432: Change income tax rates

Many tax practitioners and scholars agree that Nebraska’s tax system needs reform.

But reform cannot happen unless the principles of sound tax policy are at the forefront of the discussion. These principles are simplicity, transparency, neutrality, and stability. However, there is wide divergence between academic ideas of sound tax policy and what many groups impacted by taxes prefer.

The Platte Institute takes a principled, pro-growth approach to tax reform that focuses on broad bases and low rates. Here are some ways the current income tax structure departs from that standard, harming Nebraska’s economic growth.

Corporate Income Tax

As I have noted in other testimony, Nebraska’s corporate income tax differs from most states by using high graduated rates, which violates the principles of simplicity and neutrality. It also incentivizes counterproductive activities by corporations and policymakers.

To counter the state’s high corporate tax rates, much of the corporate tax code is filled with deductions, exemptions, credits, and incentives, which ultimately results in higher tax rates for all taxpayers.

Ideally, Nebraska’s corporate income tax should be repealed. The corporate tax is believed to add a measure of progressivity to the tax system, but many studies find the tax falls primarily on workers in lower wages and consumers in higher prices.

However, complete repeal is unlikely given the many priorities facing the committee. A good alternative would be to replace the graduated-rate progressive tax with a flat-rate tax of 5% to become competitive within the region.

Personal Income Tax

Structurally, Nebraska’s personal income tax adheres to many principles of sound taxation, including a relatively broad base. However, taxation of a broad base should result in low statutory rates. Nebraska’s rates are one of the highest in the region. As a result, Nebraska has suffered outmigration and difficulty in attracting higher income residents and young professionals. The top rate also makes the state less attractive to businesses that are organized as pass-through entities.

Our solution is to replace the four-rate progressive income tax that ranges from 2.46% to 6.84% with a flat-rate tax of 5% to become competitive within the region. This low flat rate will modernize the bias against work effort and productivity that plagues progressive rate structures. If a measure of progressivity is needed, a generous expansion of the standard deduction will retain that policy while not harming economic growth.

If a flat tax is not achievable, then every effort should be made to reduce the top marginal personal income tax rate. A number of our neighbors levy a low, flat rate or forego individual income taxes altogether. This creates stiff regional competition on a comparative measure of tax structure. Scholars have found that higher marginal tax rates reduce gross state product growth and that reductions to top marginal rates are beneficial to long-term growth.

Bills this session

In summary, there have been bills filed this session that are steps in the right direction this committee should consider if the more aggressive reforms we outlined are not a political reality.

LB680 proposes to create parity between the corporate and personal income tax rates. This is a step in the right direction towards lowering the high corporate tax rate while also embracing the neutrality principle of taxation.

Another bill worth serious consideration in a reform package for income taxes is LB318 to increase the Earned Income Tax Credit (EITC). Expanding the EITC is a way to add a measure of progressivity to the tax code. For example, if a flat 5% personal income tax were to be adopted, a generous standard deduction can act like an effective 0% tax bracket. If you pair that with an expansion of the EITC, then the state can move to a flat tax without negatively impacting taxpayers who may currently pay only into the lowest brackets.

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