Nebraska’s 2022 tax cuts: What’s good & what’s not
Nebraska entered the 2022 legislative session with its tax code ranked 35th in structural competitiveness, according to Tax Foundation’s 2022 State Business Tax Climate Index. The state will likely improve its position over the coming years as a result of tax changes made in LB873.
However, projections show the state may only edge closer to being in the middle of the pack, and not even in the top half of states for tax competitiveness. Estimates from the Tax Foundation say that if LB873 were fully implemented today, Nebraska would rank 28th for its state business tax climate.
The bill will be fully implemented over five years through 2027, during which time other states might surpass Nebraska by adopting their own tax reforms. Such is the nature of the current era of interstate tax competition.
The Legislature and governor contributed to Nebraska’s projected improvement primarily by reducing personal and corporate income tax rates. Yet there remains room for significant additional improvements to achieve a highly competitive state tax code.
Gov. Pete Ricketts signed LB873 into law on April 13, ushering in changes to Nebraska’s income tax code and doubling down on the state’s property tax credit program. The two most competitive reforms were phased-in reductions of Nebraska’s personal and corporate income tax rates:
- Nebraska’s top personal income tax rate will be reduced from 6.84% to 5.84% by 2027
- Nebraska’s top corporate income tax rate will be reduced from 7.5% to 5.84% by 2027
In addition to ranking the overall state tax climate, Tax Foundation ranks components of the tax system, such as the individual income tax or property tax. Assuming once again that LB873 was implemented today, Nebraska’s personal income tax ranking would improve from 29th to 25th, and Nebraska’s corporate income tax ranking would improve from 32nd to 24th.
The Tax Foundation’s Index ranks states on the structure of their tax code (i.e. how taxes are collected) rather than the total burden (i.e. how much taxes are collected).
In addition, LB873 accelerated the phase out of state income taxes on Social Security income. Exempting retirement income is a way to address concerns about rising costs for retirees on fixed incomes. However, it’s worth noting that eliminating Social Security income taxation is not targeted to only those on fixed incomes. This change provides tax benefits to Nebraskans whether they have modest means or a rich nest egg and flush retirement account.
Finally, the bill made the following changes to expand the Nebraska Property Tax Incentive, a refundable income tax credit for a portion of property taxes paid:
- Preserves the refundable tax credit worth 25% of school property taxes paid
- Creates a new income tax rebate for property taxes paid to community colleges, which will be worth $50 million in 2022 and increase to $195 million by 2026
These changes do not improve Nebraska’s tax competitiveness, in part, because of the poor structure of the property tax relief program. A property tax credit against income taxes only indirectly addresses the problem of high property taxes, and doesn’t reduce the amount of property taxes collected. Furthermore, this property tax relief is taxpayer-active, meaning that taxpayers need to do work to get tax relief, instead of simply seeing their property taxes directly reduced.
In fact, early evidence from tax year 2020 showed that Nebraskans realized only $3 out of every $5 the state appropriated for the property tax relief program. By any measure, a tax relief program that leaves $2 out of every $5 of tax relief with the government is a poorly-performing program that should be reformed before it is expanded.
Indeed, the new property tax rebate for community colleges makes this point clearly. The rebate is worth $50 million in 2022, but will be worth as much as $195 million by 2026. Nebraska’s entire community college property levy was $250 million in 2021. Instead of creating a tax rebate worth nearly the entire value of property taxes collected for community colleges, lawmakers should simply eliminate the community college property tax and fund community colleges directly. That would give taxpayers direct relief without forcing them to figure out how to get their tax rebates – a process that will inevitably leave tax relief dollars with the state.
Room for Improvement
Nebraska was overdue for income tax rate reform, and LB873 made positive progress in this direction. However, doubling down on a property tax relief program that is already performing poorly is not the ideal way to achieve property tax relief.
Nonetheless, policymakers can build on this framework moving forward. The property tax relief program should be revisited and simplified by providing direct property tax reductions, especially if the tax credit and rebate programs continue to perform poorly.
Comprehensive tax reform means that Nebraska should look at restructuring the bases of both its property and sales taxes, as recommended in the Blueprint Nebraska tax modernization program. Tax Foundation estimated that LB1264, a bill based on the Blueprint plan, would improve Nebraska’s tax competitiveness from 35th to 16th. For reforms to the property tax base, the inheritance tax should be eliminated and tangible personal property taxes should be phased down. For comparison, the Blueprint Nebraska plan would have improved Nebraska’s ranking on every component of the tax code compared to LB873.
Furthermore, the current credit and rebate program could be transformed into direct property tax relief, which could be further advanced each year through education funding reform. Such an approach would continually improve Nebraska’s currently uncompetitive property tax code.
Nebraska’s sales tax base should be expanded, in particular to include more retail consumption. Retail services have been exempted from the sales tax base for historical reasons, yet services continue to grow in terms of total American consumption. Applying the sales tax to retail services would generate revenue to reduce Nebraska’s income and property taxes, which are the areas where Nebraska is least competitive.
LB873 will likely improve Nebraska’s overall tax competitiveness by a certain amount. It made some positive changes to the state income tax code, made other changes that were neutral, and unfortunately expanded a property tax credit program that is too taxpayer-active and is not functioning well. But even under the best circumstances, this legislation will still result in Nebraska remaining behind most states. Building upon this base, however, Nebraska can make more comprehensive reforms, break into the top half of states for tax competition, and target becoming a leader for tax competitiveness among its peers.