Michael Lucci on the Future of Nebraska’s Tax Policy
Nebraska ranks 39th in the country for property tax competitiveness. How do we modernize our tax policy to keep and attract more people?
Today, we’re talking about the future of Nebraska’s tax policy and how we compare to other states. Given the changes in the economy, states are competing to keep their current population and attract new people to move in. One way to stay competitive is by modernizing the tax code.
On this episode of Nebraskanomics, I am joined by Michael Lucci, The Platte Institute’s Senior Policy Advisor. Michael has a deep knowledge of state tax policy from his experience as the vice president of state projects at The Tax Foundation, the vice president of policy at The Illinois Policy Institute, and the deputy chief of staff for policy to the governor of Illinois.
Jim: Since you joined us here at The Platte Institute, you have focused your efforts on Nebraska’s tax environment and how we compete in the national and regional picture.
Why don’t we start off by explaining why state competitiveness is so important right now?
Michael: State competitiveness has always been an important factor because you want people to choose your state when families choose where to live, and then when firms choose where to invest and expand their workforce. That’s always been the case.
We have had two recent changes in the last five years that make it even more important. I would describe them as structural changes.
The first change came from the federal government when they made changes to the tax code in 2017. They reduced the ability of federal taxpayers to deduct their state and local taxes against their federal tax return.
That increased what we would call the felt cost of state and local taxation. You’re no longer able to deduct state and local taxes, so you really feel it more. And if your state and local taxes are high, you now have more of an incentive to move to other states.
The second big change, of course, was the pandemic itself and then the result rise in remote work. When people are able to work remotely, they can choose where they want to live.
On the one hand, in 2017, you have a change that makes state and local taxes more acutely felt by taxpayers. Then in 2020 – 2021 with the pandemic, you have a whole class of workers that are unleashed from a physical workplace.
They’re able to live where they want and keep their job. Maybe that’s 20% of the population, and tend to be some higher earners who are likely service sector workers that can relocate to other places.
So, these two big changes happening in the last five years make state competitiveness more important. That’s why Nebraska and a lot of other states are looking to become more competitive.
Jim: Michael, let’s take it a step further. How is state competitiveness measured, and how does Nebraska rank as compared to our neighboring states?
Michael: There are two key factors that I look at in state tax competitiveness. One is the burden. How much are people having to pay in tax in your state? And two is the structure. How competitive is the tax code structure? So, I’ll go through each of those.
For the tax burden, you add up your income tax, property tax, sales tax, excise taxes, and all these different taxes that most states levy. When you add it all up, what percent of state income is the total tax burden?
For Nebraska, that’s about 11.5%, which ranks Nebraska 38th amongst states for tax burden, with one being the lowest tax burden. So, Nebraska is a relatively high tax burden state. It’s especially high within its region.
The second way to look at state tax competitiveness is the structure of a state’s tax code. That basically asks: for each dollar of taxes raised, how much economic distortions are you creating by raising those?
The Tax Foundation ranks states on this measure, and new rankings actually just came out this week. Nebraska’s ranked 29th out of 50 states, with one being the most competitive tax structure and 50 being the least competitive.
Nebraska’s corporate income tax is 30th, the individual income tax is 32nd, and the property tax is 39th most competitive. Nebraska’s sales tax is actually a more competitive factor ranking the 9th most competitive in the country.
Jim: Michael, we talk a lot about tax modernization here at The Platte Institute. Can you take us through the main changes we need to make here in our state to our tax policy to improve our competitiveness?
Michael: Well, as I just mentioned, the less competitive components are on the income tax side and on the property tax side. Sales tax is pretty good in Nebraska, although some improvements could be made there.
So, I’ll start with the income tax. Nebraska has a progressive income tax structure for both its individual income tax and corporate income tax. And despite good changes in 2022 to the income tax, the rate structure is still high. Nebraska’s top rates for corporations and for individuals will remain above average.
Nebraska currently has a progressive tax structure, but we’re seeing states move away from a progressive tax to a flat tax structure. A flat tax structure means you have one rate.
Say you have a 5% income tax rate, and that’s what everybody pays. With a flat tax structure, states often increase what’s called the standard deduction. That’s kind of a zero/zero income tax bracket.
Tax free at the federal level, for example, standard deduction is about $25,000. So you have $25,000 earnings before you get taxed, and then an income tax is applied. What states are moving towards, is just applying a flat tax so that there’s no change in income related incentives as you make more income.
On the corporate side, the argument for a progressive tax structure is an equity argument. If people make more, maybe you want them to pay more at higher income. But, that logic actually doesn’t apply to the corporate income tax.
The wealth of the corporate owners varies because all sorts of people own stock, whether it’s a mom and pop, pension fund, or a hedge fund. So you have people at all sorts of different income levels owning the same corporation, and you actually don’t want to apply a progressive tax to corporations. There’s no real reason to.
There’s no equity reason to do that because the owners themselves are all sorts of different people. So, moving towards a lower, and then also flat corporate income tax structure is the way to make that more competitive.
On the property tax side, there are a couple things to do, but to make it simple: fix the tax base and lower the tax rate.
Lowering the tax rate is the easier thing to understand. If you think of a property tax as a percentage of your home value, or maybe your manufacturing facilities value, you want to get that lower.
One of the ways we’ve talked about doing this is through the education formula. States provide education aid to local districts, and if more of that money comes in, then property taxes can come down at the local level.
You also want to improve the base. So, Nebraska’s property check base includes the following taxes:
- Inheritance tax. Taxes paid when people receive an inheritance from someone who passed away.
- Capital stock tax. Taxes that apply in Nebraska, which means businesses are taxed based upon their net worth. It’s kind of a throwback from about a hundred years ago, before we knew we could actually tax income.
- Tangible personal property tax. Taxes property that businesses can move around like machinery and equipment.
You want to get those taxes out of the tax base. That would give the state a more modern tax code. But you also want the overall tax burden and the tax rates effectively applied to the property to be lowered sales tax.
It’s just about applying the sales tax evenly to final retail consumption. Nebraska, like many states, doesn’t tax service consumption. Expanding that sales tax to include service consumption would actually generate some of the revenues Nebraska needs to reduce taxes elsewhere, like the property and income tax that we just mentioned.
Jim: And Iowa just made a move to eliminate its inheritance tax, and also move towards a flat tax of 3.9%.
Michael: That’s correct. Missouri made a move to get closer to a flat income tax. They’re nearly there. I wouldn’t be shocked to see Kansas and North Dakota move in that direction. Of course, Wyoming and South Dakota don’t have an income tax. So yes, that’s definitely the move.
Iowa moved to a flat 3.9% income tax rate. They also flattened and lowered their corporate income tax, and we’re seeing that around Nebraska. We’re seeing that around the country, as well.
Jim: So, I’ve been doing this job for a decade now and I hear all the time, opponents down in Lincoln say that there’s no correlation between our taxes and migration. Frequently, Michael, taxes are referred to in terms of the impact on economic decision making. Can you explain that concept a bit more for our listeners?
Michael: There are different ways to apply taxes, and of course taxes are necessary. We have to fund core services. We could debate what to do beyond core services, but we agree that we have to apply taxes.
When taxes distort economic decision making, then those are the types of taxes you want to have less of. When taxes don’t change what economic decisions you’re going to make, those are ones that are going to be more reliable.
I’ll give you an example. If the property tax is applied to real property, which is land and its improvements, you don’t want that tax to be too high. But it’s not going to have a huge distortionary effect on decision making.
Whereas, when you apply the same property tax to things that you can move, such as business inventories, the intangible personal property– the key thing I just said there is, you’re applying it to things that can move.
There are some states, Nebraska’s not one of them, but there are some states that apply a property tax to business inventories. It’s what you have sitting in the warehouse.
Businesses, of course, move those inventories to other states because they don’t want to pay that tax. The tangible personal property tax that Nebraska does have, many states have, gets towards that. Where those things are movable, then you might move some of that business property out of the state, if you can.
On the income tax side, the income tax is just the more distortionary tax of the major taxes. You have income, property, and sales. The income tax is the one that is going to change economic decision making more than the others.
In particular, the corporate income tax will change economic decision making because you want to have income-generating states that tax it less, so people move between states, and businesses move between states.
Because of this, we’ve always seen that. That’s always been picked up in the research. It’s especially coming through now with big moves coming after the pandemic between businesses and families moving between states after the pandemic.
So, the income tax will greatly affect economic decision making. California is an extreme example with 13% and going up. They’re going to be applying more income tax.
You have someone in Silicon Valley who’s making a lot of money, and they can save themselves 13% – 15% just moving to Florida, Tennessee, or Texas. They have massive tax savings just from moving.
Jim: As we wrap up today, Michael, is there a big picture idea that you want to make sure our listeners understand about tax modernization in Nebraska?
Michael: The big thing I’d want folks to understand is that it’s time for Nebraska to do it. For the reasons I laid out. About the near term changes on how state tax competitiveness is more important, those are relevant, but tax modernization is something that states do every couple decades.
There were big changes made in 1967 and 1968 in Nebraska, and then more big changes made in the early ‘90s. So, Nebraska’s just due to make changes to modernize the tax code.
The reason you want to do that is because your economy changes. 30 years later, the tax structure might no longer make sense. Nebraska’s at that point, and you want to have a tax code that applies to the modern economy, rather than the economy from the ‘60s or ‘90s when big changes were made on the tax code.
Jim: Michael, thanks for being with us today on Nebraskanomics. I appreciate your experience and insights into tax modernization, Nebraska.