Arkansas Tax Reform Task Force Approves Final Report and Hears DFA's "2-4-5.9/6.5%" Individual Tax Cuts Plan

The Arkansas Tax Reform and Relief Legislative Task Force met last week on August 22  and 23 to review the draft final report and hear additional testimony.  The final report was approved without issue.  The highlight of the testimony was a thoughtfully designed new plan presented by the Department of Finance and Administration (DFA) that would significantly simplify and cut individual income taxes.

Draft Final Report Approved

On the 22nd, the Bureau of Legislative Research (BLR) presented the draft report that it had prepared based on the Task Force's prior proceedings.  The report basically lists the policy proposals that the Task Force had voted for inclusion in the final report.   The Task Force approved the final report with little discussion.

The policy proposals included in the final report are as follows:

Sales & Use Taxes

  1. Regular, comprehensive cost-benefit review of all sales and use tax exemptions.
  2. Designation of revenue from any sales tax exemption repeals to go toward paying for income tax cuts.
  3. Cap local sales and use taxes at no more than 3% for counties and 4% for municipalities.
  4. Expand the sales tax exemption for self-serve coin-operated car washes to apply to all car washes and instead impose a water usage fee.
  5. Replace the farm equipment sales tax exemption for all-terrain vehicles with a rebate mechanism.
  6. Repeal the various exemptions for specifically named charitable entities and replace them with a more generalized nonprofit or charitable exemption.
  7. Repeal the sales tax exemption for subscription magazines.
  8. Require remote seller sales tax collection, following the South Dakota model.

Income Tax

  1. Regular legislative review of all deductions, exclusions, and credits.
  2. Repeal the throwback rule.
  3. Adopt single sales factor apportionment.
  4. Phase in an NOL carryforward extension from the current five years to twenty years.
  5. Cut individual income tax rates and simplify brackets under one of three options.  These would reduce the top marginal individual rate from 6.9% to 6.5% or even 6.0%.
  6. Reduction of the corporate rate from 6.5% to 5.9%.
  7. Repeal the exclusion from tax for capital gains in excess of $10,000,000.
  8. Repeal the political contribution income tax credit.
  9. Create a Connecticut-style passthrough entity tax as a federal SALT deduction limitation workaround.

Property Tax

  1. Provide a nonrefundable income tax credit for ad valorem tax paid on business inventory.
  2. Streamline the franchise tax and transfer administration to DFA.
  3. Have the Assessment Coordination Department (ACD) establish guidelines for exemption determinations and give ACD enhanced oversight authority.

Excise and Miscellaneous Tax

  1. Index fuel taxes to construction cost inflation, not-to-exceed 3% per year.
  2. Impose annual road user fees for electric and hybrid vehicles of $184 and $90, respectively.

The final report also includes excerpts from the REMI dynamic scoring, which had been the subject of some confusion when presented to the Task Force.

Part IV of the report provides polling of the Task Force on policy priorities.  The top four priorities were (1) adopting single sales factor apportionment and repealing the throwback rule, (2) income tax bracket simplification and cuts, (3) NOL carryforward extension, and (4) reduction of the top rates for corporate and individual income tax.  It also contains a ranking of six revenue raisers.  Online sales tax collection was the first priority; fuel tax indexing was the last.

The Task Force final report is not truly the final word.  The report says that it "is not a static document, but one that is subject to revision or modification by the Task Force as it works to refine its final recommendation."  The Task Force will continue convening this fall to refine its proposals and draft legislation for the 2019 legislative session.

The "2-4-5.9/6.5%" Individual Income Tax Cut Plan

With no surprises on the final report, the most notable development was a new, thoughtfully-designed rate cut proposal from the executive branch.  Assistant Commissioner Paul Gehring from the DFA made the presentation, and he indicated that the plan is supported by the Governor.

The plan would increase the Arkansas standard deduction to $6,800 single / $13,600 joint.  The new rate schedule in "Phase 1" would be 2% for first $8,000, 4% through $18,000, 5.9% through $65,000, and 6.5% for anything in excess of $65,000.  In "Phase 2," the 6.5% bracket would be eliminated leaving the state with a top 5.9% marginal rate.  The net effect is to dramatically simplify and somewhat flatten Arkansas's convoluted income tax bracket schedules.  The initially higher rates at lower income levels also help reduce the revenue impact, making this more affordable than the rate cut plans in the Task Force report.  This would mean more room for other reforms to boost state competitiveness.

While this plan would involve marginal rate increases at the low end of the bracket schedule, the increased standard deduction should ensure that almost all Arkansans do not actually pay more in taxes.  Only lower-income Arkansans with extensive itemized deductions would seem to potentially be a little worse off.  The increased standard deduction would also help harmonize Arkansas's system with federal tax reform's increased standard deduction, thus substantially reducing the recordkeeping burden for most Arkansans.

Responses to the the plan from Task Force members were generally positive.  One member asked why they had not gotten to consider it earlier in the process.  This plan would seem to be the new front-runner for individual income tax reform.

It should be noted that this plan would require a 75% supermajority in both legislative chambers, because some stated income tax rates would increase at lower income levels, even though almost all lower income Arkansans would pay less in tax under the proposal.

Fiscal Impacts and Triggered Tax Cuts

The second day involved discussion of fiscal impacts and tax triggers.

Richard Wilson from the BLR provided testimony about fiscal impacts of proposals.  DFA also testified, including reemphasizing that the fiscal impacts from the combination of multiple proposals (e.g. throwback repeal and single-sales-factor apportionment) could be different from the sum of single-proposal impact estimates.

Nicole Kaeding from the Tax Foundation testified on  designing a package for the 2019 session, including designing triggered tax cuts.  She noted that "phase one" of the new DFA individual income tax cuts proposal could be combined with most of the business tax reforms (single sales factor, throwback repeal, NOL carryforward extension, corporate rate cut) for an approximately $200 million tax cuts and reform package.  To the extent triggers are desired, she also suggested that the be set based on when revenue growth exceeds three percent, and with a mechanism to avoid downward ratcheting if revenues decline in a recession.

ITEP also submitted written testimony responding to legislators prior questions about ITEP modeling and also generally criticizing the Task Force's proposed policy recommendations in its draft report.

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