Tax Reform in Vermont: Final Report Senate Finance Committee - - PDF document

Tax Reform in Vermont: Final Report

Senate Finance Committee Testimony Michael Costa, Director January 19, 2011

Commission’s Report

Guiding Principles

• Fairness, Actual and Perceived
• Economic Competitiveness
• Simplicity
• Transparency
• Tax Neutrality
• Sustainability
• Executive and Legislative

Accountability to Tax Payers

• Revenue Neutrality and

Interoperability

Commission Findings

Commission Findings

• Is conventional wisdom wrong?

▫ Certainly more complicated than tax debate or discourse suggest. ▫ Findings address six common tax debates comparing perception and reality.

Commission Findings: Perception Versus Reality

Conventional Wisdom Commission Finding

Commission Findings: Perception Versus Reality

Conventional Wisdom Commission Finding

Finding 1: Do All Vermonters Pay Their Fair Share? Yes.

• Fair share argument is based on fact that 60% of

Vermont’s income tax is paid by top 11% of earners.

▫ Argument ignores rising income inequality. ▫ Argument ignores total tax contribution of each taxpayer.

Total Tax Contribution: Vermont

Source: ITEP

Tax Contribution: New Hampshire

Source: ITEP

Finding 2: Vermont’s Tax Base Promotes High Marginal Rates and Lower Effective Rates

• Vermont is out of step with most states

regarding choice of tax base.

• Taxes smaller base and leaves deduction choices

largely to federal government.

• Creates gap between marginal and effective

rates. Vermont’s Tax Base: Not an Apples to Apples Comparison

• Connecticut (AGI + No Itemized

Deductions) ▫ 3.5% $0-$10,000 ▫ 5% $10,001-$500k ▫ 6.5% $500k+

• Maine (AGI + Capped Itemized

Deductions) ▫ 2% $0-$4,850 ▫ 4.5% $4,851-$9700 ▫ 7% $9,700-$19,450 ▫ 8.5% $19,451+

• Massachusetts (AGI + No

itemized Deductions) ▫ Flat 5.3%

• New Hampshire

▫ No Income Tax

• Rhode Island (AGI + No

itemized Deductions) ▫ 3.75% $0-$55,000 ▫ 4.75% $55,001 - $125k ▫ 5.99% $125,001+

• Vermont (TI + Permissive

Deductions)

• 3.55%: Under $54,399
• 7.00% : $54,400 -$131,450
• 8.00%: $131,450 – $200,300
• 8.90% : $200,300 – $357,700
• 8.95%: Above $357,700

0.005 0.01 0.015 0.02 0.025 0.03 0.035 0.04

1 9 7 6 1 9 7 8 1 9 8 1 9 8 2 1 9 8 4 1 9 8 6 1 9 8 8 1 9 9 1 9 9 2 1 9 9 4 1 9 9 6 1 9 9 8 2 2 2 2 4 2 6 2 8 V e r m

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Source: Vermont Department of Taxes

Effective Vermont Personal Income Tax Rate

32 Year Average = 3.08%

Finding 3: New Hampshire is Only One Factor Impacting Sales Tax Base

• Economy focused on services not goods, opposite of the sales

tax.

• Internet and remote sales reduce sales tax collection by $35-

$40 million annually.

Taxation of Services

• Mainstream approach to taxing services.
• Every service taxed in Vermont is taxed in at least 23 other
• states. Also, Vermont exempts only six services from taxation

that are taxed by a majority of states.

 Tuxedo Rental  Commercial Linen Supply  Tire Repair  Overnight Trailer Park Fees  Service Contracts Sold at the Time of Sale of Tangible Personal Property  Welding Labor

Finding 4: Tax Expenditures Form a Shadow Budget of >$1 Billion

• Tax expenditures, are an exception to the normal

rules of the tax structure that take many forms, including “permanent exclusions from income, deductions, deferrals of tax liabilities, credits against tax, or special rates.”

• These policy preferences provide preferential

treatment for a particular industry, activity, or class

• r persons, and they are found throughout the

personal income tax, corporate income tax, consumption taxes, and the property tax.

Vetted Through Budget Process Pass Through Tax Policy

Residential Fuel: Hard Choices in Tax Expenditure Policy

• The tax expenditure may be duplicative.

▫ Vermont administers the Low-Income Heating Assistance Program (LIHEAP) which will allocate $15.1 million helping Vermonters of modest means with heating fuel this winter.

• The tax expenditure is not targeted or means tested.

▫ The tax expenditure for residential fuel is available to all Vermonters regardless of income level. This drives up the cost

• f the expenditure without furthering the policy’s goal.
• The tax expenditure may contradict other policy choices.

▫ Vermont is investing in green policies, but this tax expenditure subsidizes fossil fuels by more than $50 million.

Finding 5: Data Does Not Support Claims of Tax Flight

• On average, tax filers moving to Vermont earn

18% more than tax filers moving out

• Data demonstrates that Vermont’s “high

income” population is defined by events rather than annual income

▫ Should you design a tax code around 200 filers?

High Income Earners or Events? High Income Earners or Events?

Finding 6: The Statewide Education Property Tax

• Two Perception Issues

▫ No agreement on whether the tax should be more income based or property based. ▫ Taxpayers who pay based on income and taxpayers who pay based on property both think that the other side has a better deal.  They’re both right.

The Equity Double Bind

• Taxpayers with an income <$90,000.

▫ Income sensitivity and rebate programs are a better deal than paying full amount of educational property taxes; however, they are still regressive taxes. (Lower income Vermonters pay more of their income for education than households with higher income.)

• Taxpayers with an income >$90,000.

▫ Current system may be better than paying based on income; however, property tax rates are pushed higher due to income sensitivity and circuit breaker.

• Move toward either point of view involves major tax

shift and equity/competitiveness issues.

Recommendation 1

 1A: Shift tax base from federal Taxable Income to federal Adjusted Gross Income.  1B: Eliminate standardized and itemized deductions.  1C: Implement a lower, flatter rate and bracket structure.  1D: Implement a residential credit as a transparent alternative to deductions.  1E: Evaluate all remaining personal income tax expenditures for

• pportunities for removal.

 1F: Reduce the number of filing statuses from four to two, single and joint.

Restructure Personal Income Tax

Recommendation 1

• Move to AGI base
• Eliminate all deductions and exemptions
• Replace with a limited credit for residents only
• $350 per filer, $150 per exemption, $800 max credit
• Credit available until income level of $125,000 AGI.
• Fewer Brackets and Lower and Flatter Rates

Adjusted Gross Income Rates Over But Not Over $ 0 $50,000 3.00% $ 50,000 $ 150,000 4.50% > $ 150,000 6.95%

Recommendation 1

• Addresses perception issue of high rates while substantially

maintaining equity of the system.

• Local Control: AGI base means Vermont reasserts control over

deduction based policy choices.

• Competitiveness: AGI Base means apples to apples comparison

with majority of states and opportunity to broaden base and lower rates.

• Simplicity: AGI base, elimination of deductions, and addition of

credit make code more simple.

Rationale for Restructuring Personal Income Tax

Recommendation 2

 2A: Levy the general sales tax on all consumer-purchased services with limited exceptions for certain health and education services and business-to-business service transactions.  2B: Eliminate all consumer-based sales tax expenditures retaining only the exemptions for food and prescription drugs.  2C: Cut the sales tax rate from 6 percent to 4.5 percent.  2D: Move as aggressively as possible with other states to collect tax revenue due on Internet purchases.  2E: Levy the sales tax on soda by removing its tax exemption as a food product.

Broaden the Sales Tax Base

Recommendation 2

• Addresses perception problem that all sales tax roads lead to New

Hampshire.

• Sustainability: broaden tax base to reflect 21st century with consumer

services and most goods. Only exceptions to rule are Food, RX, and some education and health services.

• Competitiveness: Opportunity to lower sales tax rate to at least 4.5%
• Neutrality: move aggressively to tax internet sales to keep parity for

brick and mortar stores.

• Transparency: Eliminate sale tax expenditure on soda.

Rationale for Broadening the Sales Tax Base

Recommendation 3

 3A: Develop a legislative intent for each tax expenditure.  3B: Report the foregone revenue value of each tax expenditure biennially in the tax expenditure budget and refine the capacity to evaluate these values.  3C: Sunset all tax expenditures that remain in the tax code in a multi-year cycle so that the Legislature evaluates and affirms these policy choices and require a sunset for new tax expenditures as a matter of good, transparent public policy.  3D: Require an evaluation of the valuation of tax exempt properties on the grand list, particularly those that qualify for the public, pious, and charitable exemption from the property tax. Any such mandate ought to be accompanied by a sufficient appropriation from the Legislature to avoid levying an unfunded mandate on local officials.

Enhance Scrutiny of Tax Expenditures

Recommendation 3

• Addresses perception issue that only budget has substantial

spending choices.

• Accountability: legislative intent would help public measure

effectiveness of policy choices.

• Transparency: spending in budget and tax code deserve similar

scrutiny.

• Competitiveness: substantial opportunity to broaden base if

legislature reviews, sunsets, and eliminates tax expenditures.

Rationale for Enhancing Scrutiny of Tax Expenditures

Recommendation 4

• Tax incidence study would demystify public discourse on taxes

and provide policymakers with a powerful tool to assess the intent and impact of tax policy changes.

Invest in Tax Policy Resources

How to Think about Tax Reform

• Tax system is a collection of certain broad rules.

▫ These rules have many, many policy exceptions.

• These policy choices create perception problems for

Vermont’s tax system and tax discourse.

• Broad rules with few exceptions push rates down.

▫ Tax system is simple, competitive, and straightforward to explain/defend.

• Exceptions within the code drive rates up.

▫ Exceptions tend to create complexity, economic distortions, and make system difficult to defend.

Where to Start with Tax Reform? At the Beginning.

• This document is a modified version of the initial

deliberation presentations made by staff before the Commission.

• Slides set forth structural decision points.
• Framework helped Commission stay in its lane,

avoid unnecessary issues, and request most focused information for deliberations.

Income Tax Reform Decision Points

37

Questions?