The Arkansas Tax Reform and Relief Legislative Task Force has concluded its 20 months of proceedings by approving draft legislation for a roughly $400 million tax reform and relief package that should guide the state's tax policy for the next decade. If implemented, it will provide Arkansas with a fairer and more competitive tax system while maintaining the state's fiscal stability. The next step will be to see the proposals through and further refine them as part of the regular legislative process in 2019.
Votes and Updated Fiscal Impacts at the Final Meeting
The Task Force convened for its final meeting on December 12, 2018. The core of the meeting was two votes: The polled Task Force members chose a 3-year phase-in of the 2-4-5.9% plan as their preferred individual income tax cuts package, followed in preference by a 2-year phase-in of the same plan. So the 2-4-5.9% plan was the clear preference over the "Option A" plan. Then there was a voice vote generally approving the draft bills in the legislative package as reflective of the Task Force's recommendations in its final report from earlier in the year. Discussion followed about the need to find sponsors to introduce the bills.
These votes were preceded by hearing testimony from the Department of Finance and Administration scoring the fiscal impact of the draft bills and addressing several miscellaneous.
JLL072: Individual Income Tax Cuts and Remote Seller Legislation
The individual income tax cuts under the 2-4-5.9% plan are best reflected by JLL072. The first part would be tripling the standard deduction from $2,200 to $6,800 individually or $4,400 to $13,600 for married filing jointly, coupled with a new, single bracket structure of 2% on the first $8,000 of income, 4% on the next $10,000, to $18,000, 5.9% from $18,000 to $65,000, and 6.5% on any excess. That 6.5% top rate then is scheduled to be reduced under a tax trigger until it is down to 5.9% and Arkansas is left with a simple, 3-bracket system with a top marginal rate of 5.9%. These reforms and cuts are projected to cost $192 million. There are three reasons that the Task Force rightly preferred this approach: (1) It raises the standard deduction to get it closer to federal levels, thereby reducing compliance burdens for individuals who no longer have to itemize; (2) it reduces the top rate all the way to 5.9% unlike "Option A" that would only go to 6.5%; and (3) the overall structure flattens the tax so that the revenue cost is not as steep as Option A, $192 million versus $267 million, which leaves more room for reforms to increase Arkansas's tax competitiveness.
As revenue raising partial offsets, JLL072 includes remote seller legislation, repeal of the magazine subscriptions exemption, and repeal of the political contributions credit. The remote seller legislation closely follows the South Dakota model. It is likely to come into effect July 1, 2019 and is projected to raise $35 million annually once fully in effect, including $20 million of general revenue. The bill does not currently contain marketplace collection language, although the DFA fiscal note calls for such requirements to be added in order to hit the projected revenue targets. The magazine subscriptions exemption elimination is scheduled to raise $2.2 million of state revenue, including $1.3 million of general revenue. The political contribution credit repeal, which is also in the standalone JLL031, is projected to raise $500,000 per year.
While the 2-4-5.9% plan is the best of the individual tax cut plans from a policy perspective, it faces a significant political hurdle: The legislation would technically increase rates at some income levels, and therefore it requires a 75% supermajority for enactment. Thus far leaders seem confident that they can reach this threshold.
JLL073: The Major Business Competitiveness Tax Reforms
The significant business tax reforms are provided by JLL073. As drafted, the reforms are in three tranches, but as approved at this meeting there now are four tranches:
- Phase-in of the net operating loss (NOL) carryforward extension from 5 years to 20 years would begin by giving a six-year carryforward to losses generated in 2019 (or perhaps 2020), with the carryforward extending by a year for each subsequent year to effect a 15-year phase-in. This had been scheduled to be part of the corporate rate reduction tranche, but a motion from Rep. Dotson at the meeting carried to begin the NOL phase-in immediately since it has such a long delay until impact anyway. After all, even a one-year extension for 2019 NOLs would not have an effect until 2025. This is projected to have a revenue impact of $97 million once fully phased in.
- Mandatory single sales factor apportionment and throwback repeal are the first triggered tranche of reforms, with an estimated cost of $57 million. As this bill goes through the legislative process, it may be the case that single sales factor on its own moves up to immediate enactment, since on its own it is roughly revenue neutral and would still somewhat improve state tax competitiveness.
- Corporate rate reductions to 5.9%, so as to match the individual rate, are the second tranche. They are projected to cost $39.6 million.
- The final tranche is an inventory tax credit, i.e., a state income tax credit for property tax paid to Arkansas localities. It is projected to cost $70 million.
Tax Trigger Design Is Critical to the Rate Cuts and Business Tax Reforms
As currently drafted, both the second part of the 2-4-5.9% plan as well as the three tranches of triggered business tax reforms are subject to a trigger of satisfying three parts: first, growth in personal income tax collections of 2% year-to-year over a fiscal year 2019 baseline. Second, growth in net available for distribution in excess of 2% year-to-year growth on a 2019 baseline. Third, that the balance of the Long Term Reserve Fund for the most recently completed fiscal year at least equal the balance of the fund for the prior fiscal year. The first trigger raises some concern: If Arkansas significantly cuts individual income taxes then it may be a long time to recover to 2% year-to-year growth against a FY2019 baseline. Having the triggered tax cuts be on the books but unlikely to be triggered until the late 2020's or the 2030's would not provide much of a competitiveness boost to Arkansas.
DFA did provide some modeling of what a phase-in of business tax reforms might look like. It has throwback repeal in 2023, corporate rate cuts in 2024, and inventory tax credit in 2025-26.
JLL051: "SALT Workaround" Passthrough Tax
The Task Force report recommended an elective entity-level passthrough tax, which is intended to provide relief to passthrough business owners affected by the SALT deduction cap. The current draft legislation, JLL051, is modeled on Connecticut's approach and is not elective. Expect this to change to be elective, as specified in the Task Force report, and to provide a partner-level income exclusion rather than an offsetting credit mechanism. The income exclusion approach is simpler and seems more likely to be upheld if challenged by the IRS. The passthrough tax is projected to be revenue-neutral but to cost the state $500,000 annually in additional DFA compliance costs.
JLL069: Administrative Reforms and Sales Tax Changes
A number of proposals, including several administrative proposals of broad significance, are in the omnibus bill JLL069. This contains most of the purely administrative provisions as well as several small sales tax cuts or changes:
- Transfer administration of franchise tax from the Secretary of State to DFA, where it will become part of corporate income tax enforcement.
- Require the Assessment Coordination Department to adopt mandatory guidelines for property tax exemptions and for assessment of business inventory. This is intended to reduce the county-by-county inconsistency in property tax administration.
- Require DFA to report for all exemptions, deductions, credits, or other tax preferences in the income tax or sales and use tax. As drafted this would be an annual report. After hearing DFA's estimate of $875,000 annually in compliance costs, this seems likely to be revised to a four-year evaluation cycle.
- Exempt all car washes from sales tax and impose a water use fee instead. This exemption is projected to cost $2.1 million of state revenue and $700,000 of local revenue, net an uncertain amount of revenue from water use fees.
- Revise the sales tax exemptions for certain named charities or nonprofits to apply to broader categories and to change from an exemption to a refund mechanism, and with caps for various types of organizations. This is projected to be revenue neutral except for an additional $325,000 of DFA compliance costs (and presumably a substantially similar or greater amount of time and expense for affected taxpayers).
- Change the ATVs exclusively for farm use exemption into a refund mechanism. This has an unknown revenue impact: presumably it will curtail abuse of the exemption by dealers and purchasers, but it also means an estimated $675,000 of costs for DFA to administer the rebates (and presumably a substantial amount of taxpayer time and expense as well).
- Cap local sales tax at 3% for counties and 4% for cities.
While not currently part of the bill, at its last meeting the Task Force voted to recommend a proposal from Sen. Elliott to not impose tax on bus advertising. This is projected to have a small fiscal impact of $50,000 per year. Such a proposal would seem to fit in well with the JLL069 omnibus package.
Separately Drafted Revenue Raiser Bills
The revenue raisers other than online (remote seller) sales tax collection generally have been drafted as standalone bills:
JLL031 provides for the repeal of the capital gain exclusion for gain in excess of $10 million. It is projected to raise $7.7 million annually. Capital gain exclusions have been contentious previously (recall the 2015 session), and this proposal may prove to be controversial.
JLL032 would repeal the tax credit for political contributions. It is projected to raise $500,000 annually.
JLL055 would impose annual fees on electric, hybrid, and alternative fuel vehicles. It is projected to raise $600,000 annually.
JLL070 would index fuel taxes for inflation. It is projected to increase receipts by about $11 million for each year of adjustment (e.g. $11 mission in FY2020, $22 million in FY2021, etc.). While this will not solve the highway funding problem, at least it will prevent further erosion of the effective fuel tax funding from inflation.
Qualified Opportunity Zones Conformity?
Early in the meeting the Task Force heard from DFA about the possibility of conforming to the federal tax incentives surrounding qualified opportunity zones (QOZ). DFA was unable to provide a revenue impact due to the uncertain nature of the extent to which taxpayers will use the QOZ program and benefits. Sen. Ingram continued to be strongly in support of conformity. Sen. Elliott questioned whether Arkansas should have a separate program with additional requirements for job creation, wages, etc.
Premium Tax Credits Would Be Capped Under Proposal
Sen. Hendren updated Task Force members about negotiations with insurance industry stakeholders about reducing the home office tax credit, which has been heavily scrutinized in prior meetings. Under the agreement-in-principle, an $18 million per taxpayer cap would be implemented in 2020, and then the credit percentage would phase down to 70% in 2021, 60% in 2022, and 50% in 2023. This should reduce the credit expenditure from $43 million to $27 million once fully phased-in, while giving industry time to price in changes to premiums.
Congratulations and Appreciation
Task Force members were in high spirits after having finished their work. They took time to recognize the extraordinary contributions of Nicole Kaeding from the Tax Foundation and Lisa Christensen Gee from the Institute of Tax and Economic Policy (ITEP). After the dismissal of the independent consultant, these think tank experts took the lead in providing advice to the Task Force. (Not surprisingly given its political makeup, the Task Force has followed the Tax Foundation more than ITEP.) The Task Force also recognized the contributions of the Department of Finance and Administration in supporting the process.
All-in-all, the Task Force should be proud of its work. While not a complete soup-to-nuts overhaul, the Task Force has created a fiscally and politically realistic package that should be a framework for Arkansas to significantly improve its tax system over the next eight to ten years. Current indications are that Task Force bills could proceed quickly once the 2019 legislative session begins.