Tax Reform Task Force Recommends Individual Cuts First, then Business Tax Reforms

The Arkansas Tax Reform and Relief Legislative Task Force met again on the morning of November 27 to consider structuring and timing of its recommended policy changes.  On the whole, the Task Force is on track to recommend some form of individual income tax cuts followed by several changes to business taxation aimed to make the state more competitive.  Tax triggers would be used to prevent budget shortfalls under this approach, which differs from the incremental biennium-by-biennium changes seemingly preferred by the Governor's Office and the Department of Finance and Administration (DFA).  The Task Force will vote on its legislative package at its next meeting on December 12.

The Governor's Budget Includes the 2%-4%-5.9% Plan

Two weeks ago the governor had announced that the 2%-4%-5.9% plan was a part of his request budget for the 2020 and 2021 fiscal year biennium.  At the Task Force DFA Commissioner Walter Anger (who is back from medical leave) and Assistant Commissioner Paul Gehring testified about the plan.  The plan essentials remain the same and they now have an implementation timeline.  Recall that the core of the plan is to increase the standard deduction from $2,200 to $6,800 and for married taxpayers from $4,400 to $13,600, have an initial rate of 2% on the first $8,000 of income, a 4% rate through $18,000, a 5.9% rate though $65,000, and then a top rate that will decline from 6.5% down to 5.9% as the changes are made.  The overall effect is to flatten and simplify Arkansas's income tax rate structure.  The increased standard deductions also should reduce recordkeeping burdens on individuals, since few taxpayers are itemizing at the federal level after the Tax Cuts and Jobs Act.  The flattening of the tax brackets also results in a smaller revenue impact than the Task Force's "Option A."

The implementation plan phases in the tax cuts over four years.  Only the first two would be enacted this session under the Governor's proposal.  In the first year the overall restructuring is put in place and the top marginal rate drops to 6.5%.  The rate then drops to 6.3% in 2021.  The plan calls for additional 0.2% incremental cuts to 6.1% in 2022 and 5.9% in 2023, but these would not be enacted until the 2021 legislative session.  The total fiscal impact from enacting all four phases is projected to be about $192 million.

The overall reception from the Task Force was positive.  Most of the questions involved revenue raisers and an overall sense that the pace of the tax cuts phase-in was slow.  The DFA presentation included $29 million of revenue raised from federal Tax Cuts and Jobs Act conformity.  In addition the state is expecting $24 million of new general revenue from remote seller sales tax collection.  So an initial cut of $47 million in 2020 might technically be a tax increase once netted out against TCJA conformity and remote seller sales tax collection effects.

The federal TCJA conformity revenue raisers focused on individual tax provisions (charitable contributions, moving expenses, mortgage interest, unreimbursed employee business expenses).  There was no indication of Arkansas conforming to interest deduction limitations, taxation of GILTI income, or other business tax revenue raisers, nor to tax benefits like enhanced accelerated depreciation and expensing, indefinite NOL (net operating loss) carryforwards, the section 199A passthrough deduction, or qualified opportunity zones.  (Although Senator Ingram expressed interest in conforming to the qualified opportunity zone benefits.)  There also were questions and a request for updated information about the impact of the federal SALT deduction cap.

Task Force Leaning Toward Tax Triggers: Individual Cuts Followed by Corporate Reforms

After hearing from DFA, the Task Force reviewed the bills comprising its 104-page legislative package.  The Bureau of Legislative Research (BLR) also provided this more digestible summary and proposed implementation schedule.  In general the provisions seem to be consistent with what we have seen and heard before.  Taxpayers should review BLR's summary and then look to the draft legislation for provisions of particular interest.

The overall structure of the Task Force's package is to immediately adopt some administrative and small-dollar reforms in an omnibus package.  For the large-dollar reforms, the Task Force recommends individual tax cuts first, then apportionment reforms, then NOL extension and rate cuts, and then the inventory property tax credit.  Three-pronged tax triggers would be used based on (1) two percent year-to-year growth in personal income tax collections with the 2019 fiscal year as a baseline, (2) two percent year-to-year growth in the net available revenue distribution with the 2019 fiscal year as a baseline, and (3) no decrease in the long-term reserve fund in comparison with the prior fiscal year.  Especially since we are at a seeming peak of the economic cycle, this means that it could be a decade or more before some of these reforms would be triggered.  The personal income tax growth trigger seems particularly problematic since the 2019 fiscal year would be immediately before the major personal income tax cuts.

On the individual tax cuts, the Task Force is still debating between the 2%-4%-5.9% plan and its own "Option A," which essentially shifts all taxpayers to the steeply progressive current bracket schedule for low-income earners.  At the meeting the Task Force determined that the "Option A" plan should be structured to collapse the bracket schedules into a single rate schedule first and then to work on lowering the top rate to 6.5%.

Most of the administrative or small-fiscal-impact provisions are in an omnibus bill (JLL069).  One oddity of the Task Force's package is the conversion of farm equipment ATVs and eligible charities' purchases to refund mechanisms instead of outright exemptions.  The intentions are to reduce abuse of the exemptions and control revenue costs, but it also means significant paperwork for affected purchasers to track their purchases and submit refund claims.

Among the separate bills, we also saw proposed language for the passthrough entity tax (JLL051), which seems to follow the Connecticut model.  This draft is mandatory but it is likely to be changed to be elective consistent with the recommendation of the Task Force in its final report.  The road user fee (JLL055)has also been changed, with the fees lowered to $100 per year for electric cars, $50 for hybrids, and, in a new addition, $100 for alternative fuel vehicles (that use fuels not subject to current fuel taxes).

On the premium tax home office credit, Co-Chair Hendren has not yet reached a resolution for a compromise with stakeholders to scale back the credit.  Currently he is thinking of a 50% haircut in the credit for health insurance jobs, while leaving life insurance jobs untouched.

The Task Force plans to vote on its legislative package at the next meeting.

Vehicle Advertising Sales Tax Testimony

A sidenote at this Task Force meeting was testimony from Houck Transit Advertising raising the issue of bus or vehicle advertising being subject to sales tax where competitor forms of advertising (billboards, etc.) are not subject to sales tax.  They also provided a 1-pager comparing the fiscal impact of a vehicle advertising exemption to existing billboard and newspaper/magazine advertising exemptions or nontaxation.  Task Force members seemed open to a legislative fix.

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