New year, new tax reforms

New year, new tax reforms

Nebraska lawmakers begin 2023 in the midst of a wave of state tax cuts. Most importantly for local families and firms, Nebraska’s individual income tax rate dropped from 6.84% to 6.64% on January 1, and the corporate rate fell from 7.5% to 7.25%.

Nebraskans should have more to cheer about in 2023, as influential lawmakers have suggested an accelerated plan for income tax cuts that are currently scheduled to phase in over the next five years. Revenue Committee Chair Lou Ann Linehan suggested state surpluses should be returned to taxpayers by accelerating the income tax rate cuts that were enacted in LB 873, which would ultimately bring both the individual and corporate rates down to 5.84%. That means the 2023 legislative session could bring more rapid relief for income taxpayers.

State tax reform has become a highly competitive field, and Nebraska is joined by 10 other states that had income tax rate cuts take effect on January 1. Arizona, Idaho, Indiana, Iowa, Kentucky, Mississippi, Missouri, New Hampshire, New York and North Carolina all had rate cuts take effect on New Year’s Day. Arizona, Idaho, and Mississippi’s cuts were a part of broader tax reforms that include discarding progressive tax structures in favor of flat taxes.

Yet more state tax reforms will undoubtedly be enacted in 2023, and Kentucky could be the first mover of the new year. The Bluegrass State began a series of tax reforms in 2019 by implementing a 5.0% flat tax in a reform that included an expansion of the sales tax base. Then Kentucky lawmakers passed HB 8 in 2022, which lowered the state’s income tax rate from 5.0% to 4.5%, effective on January 1, 2023. HB 8 included an additional expansion of Kentucky’s sales tax base to include still more services. Governor Andy Beshear vetoed HB 8, but was overridden by wide margins. Notably, Kentucky only requires a simple majority to override a gubernatorial veto, meaning that when the supermajority Republican legislature is unified, they can override the state’s Democratic governor with ease.

Kentucky’s legislature appears intent on pushing their income tax rate even lower. House Bill 1 was introduced on January 3 and breezed through Kentucky’s House with a 79-19 vote on January 5. The bill would lower the state’s income tax rate from 4.5% to 4.0%, effective January 1, 2024. Kentucky’s state senate will consider the bill when the legislature reconvenes in early February.

Nebraska lawmakers have taken a similar approach to Kentucky’s by enacting iterative rate cuts in the context of strong tax revenue growth. Indeed, Kentucky’s ongoing rate reductions are contingent upon certain revenue goals being met. However, one lesson Nebraska lawmakers can draw from Kentucky is the Bluegrass State’s use of sales tax base expansion to generate revenues to pay for strategic tax relief.

State sales taxes across the country are generally too narrow. As an accident of history, states began to create their sales taxes when their economies were largely based upon the consumption of goods rather than services, and when taxation of services would have been more administratively difficult. As a result, state sales taxation has generally exempted services, and this uneven treatment of consumption continues in most states, including Nebraska.

Nebraska can correct this tax imbalance by imposing the sales tax on a wider range of consumption, including more consumer services. Such a reform often proves politically challenging because businesses and consumers are rightfully skeptical of new taxation. Nonetheless, Nebraska policymakers can make clear that any sales tax base expansion will be used to help fuel even greater reductions in property and income taxes. Kentucky correctly deployed their new sales tax revenues to reduce income tax rates, and Nebraska could similarly use new revenues to reduce property tax burdens and income tax rates.

Nebraska is positioned in a highly competitive region for state tax policy. While competition could threaten to lure away families and businesses, it also can inspire bold policy changes to make Nebraska more attractive. Policymakers have the opportunity to achieve a more attractive state in 2023 by accelerating tax cuts enacted in 2022, deploying strong revenues towards additional rate cuts, and using revenues from a sales tax expansion to make Nebraska’s tax code even more competitive.

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