A Glide Path To A 3 Percent Flat Tax

伀䌀吀伀䈀䔀刀 ㈀ ㄀㜀

A Glide Path to a 3 Percent Flat Income Tax

Page 2

A Glide Path To a 3% Flat Income Tax Rate Comprehensive Tax Reform for a More Competitive Wisconsin

The John K. MacIver Institute for Public Policy 44 East Mifflin Street, Ste. 201 Madison, WI 53703 www.maciverinstitute.com | @MacIverWisc

A Glide Path to a 3 Percent Flat Income Tax

Executive Summary

S

ince the beginning of his tenure, Governor Scott Walker has made tax reform a priority for Wisconsin. Walker has said he hopes to lower the tax burden every year of his term. Thus far, he has stuck to his pledge, having lowered taxes by $4.76 billion in under six years - and by the end of 2019, taxes are expected to have fallen by over $8.7 billion.1 Both the amount of taxes and the different types of taxes that Governor Walker has cut since he took office is impressive.

It should not be simply glossed over how much progress Wisconsin has made reducing taxes in recent years. In 1994, less than 25 years ago, Wisconsin ranked 3rd nationally in overall tax burden and our taxes were 16 percent above the national average.

Today, property taxes are at the smallest percentage of personal income since 1945, 3.6 percent.2 The average homeowner in Wisconsin, in 2016, paid $116 less in property taxes than he or she paid in 2010.3 According to the Department of Revenue, the typical family in Wisconsin has seen their income taxes cut by $1,159.⁴ Wisconsin’s state and local tax burden, as reported in December 2016 Census Bureau data, fell to 10.8 percent of personal income, the 16th highest among the states.⁵ By comparison, the year prior, Wisconsin’s tax burden ranked the 15th highest at 10.9 percent of personal income.⁶ While Walker and the Republican Legislature should be lauded for all the taxes they have cut, these tax cuts have done little to improve Wisconsin's overall tax ranking.

Similar to the Census Bureau data mentioned above, the nonpartisan Tax Foundation’s most recent ranking of state and local tax burdens puts Wisconsin at the fourth highest in the nation and highest in the Midwest.⁷ In the same study, the Tax Foundation found that state and local taxes take up 11

Wisconsin's top rate of 7.65 percent is the 9th highest top rate among the 43 states with an income tax.

The bottom rate of 4 percent is the 4th highest among the 33 states with a progressive income tax. percent of all personal income in Wisconsin every year.

These tax cuts have also done little to stop or even contain the never-ending and seemingly inevitable growth of the state budget. The 2011-2013 state budget spent over $66 billion from all funding sources.⁸ The 2015-17 state budget spent nearly $74 billion.⁹ Clearly, it is time to think about the next big and bold reform that will transform our state and make Wisconsin an economic powerhouse for generations to come. It is time for a flat tax in Wisconsin.

Wisconsin’s reputation as a high-tax state has a significant impact on the state’s ability not only to attract newcomers, but also to retain those who are already residents. Annually, Wisconsin loses an estimated $136 million in adjusted gross income to tax migration.10 The high tax burden drives individuals to leave for those Figure 1 states with lower tax burdens or no income tax at all, such as Florida and Texas. One study, which examined Internal Revenue Service data from 1992 through 2015, showed that Wisconsin lost $3.40 billion in wealth to Florida, $1.08 billion to Arizona, and $769 million to Texas during the 23-year period.11 In that time, almost 93,000 people migrated from Wisconsin - that's more than the entire population of Racine, the state's 5th largest city.12 The loss of so many individuals, their businesses, and their economic activity does not bode well for the economic future of

Page i

www.maciverinstitute.com the state. Lower, flatter income taxes are one way to help stem the tide of emigration from Wisconsin.

corporate taxation, but are instead taxed under the individual income tax.17 Profits are passed through to the shareholders or partners of these companies and become part of their income. More than half of Wisconsin’s workforce is now employed by pass-through businesses, giving the individual income tax even greater importance to the livelihoods of Wisconsinites and the success of their businesses.18 In Wisconsin, passthrough businesses pay a top marginal income tax rate of over 48 percent - the 8th highest rate in the country.19

Figure 2

Low, flat state income tax rates are actually common throughout the country. Seven states levy no individual income tax at all.13 New Hampshire and Tennessee currently tax dividend and interest income, though recent reforms in Tennessee have set a glide path to total elimination of the income tax in 2022.14 Eight states have flat individual income tax structures, and 33 states, including Wisconsin, levy progressive tax rates based on income level.15 In today’s mobile economy, every state must compete for new residents and new businesses or risk losing them to other states. While climate and the local job market are big factors in a person’s decision to move, a state’s tax burden plays an important role in keeping recent graduates, people looking for a better life, and retirees from moving to a state with a lower tax burden.

The personal income tax, not just the corporate tax, is also becoming a bigger factor in the financial health and growth of businesses. The number of pass-through entities has nearly tripled since 1980, making passthrough businesses the most common business form in the country.16 Pass-through entities are not subject to typical

“I think it’s a great time to talk about [a flat tax] because Walker and the Republicans now have proven that we have adults running our budget.” - Jay Weber

Taking nearly half of a company’s income is detrimental to success and economic growth. Many states are wising up to the fact that high income taxes hurt competitiveness by punishing success and hard work. Despite the rhetoric that progressive taxation results in a fairer outcome, evidence shows that progressive income taxes are actually associated with higher income inequality.

THE SOLUTION: A 3 PERCENT FLAT TAX This report sets out to explain why Wisconsin should continue to ratchet down its relatively high individual income tax system and many different rates to one flat rate. Evidence from a variety of sources - economic, social, and fiscal health metrics, as well as academic studies demonstrates the benefit of a lower and flatter income tax structure. After examining Wisconsin’s position within the Midwest and considering recent reforms around the country, this report will recommend that Wisconsin transform its progressive income tax to a flat 3 percent tax rate for all taxpayers over an eight year period. In subsequent papers, we will continue to build our case through a comparison with Indiana, a state similar in size and demographics to Wisconsin, and will recommend specific steps that Wisconsin can take to make a flat tax a reality.

Page ii

A Glide Path to a 3 Percent Flat Income Tax A systematic glide path to a 3 percent income tax rate would give Wisconsin the most competitive income tax among Midwestern states while greatly improving the state’s attractiveness on a national level. Such a move would have a significant impact on the incomes of all Wisconsinites and most importantly, would allow working class people to keep more of their income. A 3 percent flat tax would be a tax cut for everyone in Wisconsin. Under the current "progressive" tax code, our lowest tax rate of 4 percent for those who make just $11,120 per year is the 4th highest tax rate among the 33 states with a progressive income tax system.2⠰ Spacing out the rate reductions over a number of years protects the state budget from sudden and steep revenue drops, giving sufficient time to make gradual adjustments so the transition to the new tax system is smooth.

If Wisconsin is serious about becoming a high-performing

States with the most progressive income taxes have the greatest income inequality. States with no income taxes have the lowest levels of income inequality. state in a 21st Century economy, it must continue its recent tax-cutting momentum to fundamentally change the fiscal trajectory of our state and to lighten the tax burden for its hard-working residents.

Our economic future depends on it. v Matt Crumb, former researcher at the MacIver Institute, also contributed to this report.

Figure 3

*Iowa, Ohio, and Wisconsin's brackets are indexed annually for inflation; for simplicity’s sake, this chart does not include those additional values.

All rates listed are for single filers for 2017, or 2016 if the state's Department of Revenue has not yet updated rates at the time of this publication.

Page iii

www.maciverinstitute.com

Glide Path to a 3 Percent Income Tax: Income Taxes in Wisconsin and the Midwest

P

ersonal income in Wisconsin is taxed under a relatively progressive system that applies higher tax rates to higher levels of income. Currently, Wisconsin has four tax brackets which apply different rates at specified income levels and are adjusted annually for inflation.21 Single filers are taxed at a rate of 4 percent for income earned up to $11,120, while the top earners in the state are taxed at a rate of 7.65 percent.22 Married taxpayers filing jointly are taxed at the same rates but at different income levels. Additionally, the dollar amount added to each percentage tax rate is different for married filers than for single filers.

with a progressive tax structure. Illinois, Indiana, and Michigan have flat income taxes, wherein every tax filer is taxed at the same rate regardless of income. v

Wisconsin’s personal income tax has gone through a number of changes in the past six years. Before 2009, the state’s four income brackets had a bottom rate of 4.60 percent and a top rate of 6.75 percent.23 An additional bracket was added in 2009 under former Governor Jim Doyle with a rate of 7.75 percent for income over $225,000.24 In 2013, the Wisconsin Legislature reduced the number of tax brackets back to four and lowered the bottom and top rates to 4.4 percent and 7.65 percent, respectively.25 During the 2014 legislative session, the bottom bracket was again lowered to 4 percent.26 Since then, the top dollar amount threshold for each tax bracket has slightly increased to account for inflation.

Despite recent reforms, Wisconsin’s top rate of 7.65 percent is still among the highest in the nation, ranking 9th among the 43 states that impose an income tax.27 The state’s 4 percent bottom rate is also high, coming in at 4th highest among progressive income tax states.

Figure 3 displays how income is taxed in the 7-state Midwest region. Wisconsin joins three other states

Page 1

Figure 4

A Glide Path to a 3 Percent Flat Income Tax

In 2016, Tennessee created a glide path to reduce and eliminate the state's last remaining income tax by 2022. The state's economy is booming.

Recent State Income Tax Reforms Across the Nation

O

ver the last five years, there have been attempts to lower personal income taxes in several states across the country. The most transformative reforms took place in the state of North Carolina.

In 2012, North Carolinians elected their first Republican governor and legislature since the Reconstruction era.28 With control of the governorship and both state houses, conservatives set out to work on reforming the tax code, simplifying income tax brackets and lowering income tax rates while gradually expanding the sales tax base.

In 2013, the state government enacted legislation to switch from a progressive tax structure with three rates - 6, 7, and 7.5 percent - to a single flat income tax of 5.8 percent. The Tax Foundation’s State Business Tax Climate Index gave North Carolina the most dramatic improvement in its history when its ranking changed from 44th to 15th in one year.29 Today, the state is ranked 11th in the nation on that index.30 In 2015, legislators again lowered the income tax to 5.75 percent - the 25th highest in the nation - with additional reductions planned in 2017.31 At the same time, North Carolina drastically reformed the corporate income tax as well as the unemployment insurance program.

Since these reforms, North Carolina has experienced its best stretch of economic growth in 20 years, with ten consecutive quarters of per capita income growth equal to or greater than the national average.32 The

economic growth represents an additional $4 billion in annual income in North Carolina.33 In the words of the UNC-Chapel Hill Center for Competitive Economics director Brent Lane, “ten consecutive quarters is approaching a significant correlation to that policy shift.”34 One October 2016 study found that the income tax reforms increased employment by 8,800 jobs and state GDP by $800 million from 2013 to 2015 alone.35 After ten years, the study projects a $4 billion increase to state GDP, an additional 44,000 jobs, and overall salary increases approaching $1.6 billion.36 In Tennessee, lawmakers voted in 2016 to repeal the state’s last remaining income tax: the Hall income tax on stocks and bonds.37 While the state prides itself on its income tax-free status, this little-known tax was an “asterisk” on that status. The tax affected primarily seniors, entrepreneurs, business owners, and the middle class. More than 40 percent of those who paid the Hall tax made less than $75,000 annually.38 The 6 percent tax will be reduced by 1 percent each year until it is eliminated entirely in 2022, regardless if annual revenue triggers are hit.39 In June, Forbes reported that Tennessee’s revenue came in $800 million over projections.40 Tennessee’s economy is booming, having gained $12.4 billion in net adjusted gross income from 1992 to 2014, according to the Internal Revenue Service.41 Wealth migration, particularly from high-tax states California and Illinois, has contributed a great deal of that growth.42

Since North Carolina moved from a progressive income tax structure to a single flat tax rate of 5.8 percent, the state has experienced its best stretch of economic growth in 20 years, adding 8,800 jobs and increasing state GDP by $800 million in just two years.

Page 2

www.maciverinstitute.com

If just 50 percent of tax migrants stayed in Wisconsin, the state could see almost $70 million a year in additional tax revenue.

Kansas reduced its top two rates of 6.45 percent and 6.25 percent to 4.9 percent and cut its bottom rate of 3.5 percent to 3 percent in 2012.43 Income tax rates will continue to decline thanks to a 2013 legislative package that brings all rates further down, with the top rate sliding down to 3.9 percent by 2018. The legislation includes a provision that will continue to reduce the personal income tax as long as state revenues are still growing from year to year. Any additional general funds over 2 percent growth from the prior year will be put towards rate reduction.44 The state hit a roadblock when it started the new fiscal year with a $12.8 million shortfall.45 Gov. Sam Brownback of Kansas announced $97 million in spending cuts for state agencies, while lawmakers voted to increase the sales tax to help make up the revenue loss.46 However, as the sidebar shows, the state’s budget issues have stemmed from a combination of factors rather than simply having lowered income taxes too much as some have charged. For one, the state increased spending at the same time that it

cut taxes. The state is currently spending at recordbreaking rates. In 2014, Kansas spent 34 percent more per-resident than states without an income tax.47 Between 1995 and 2015, spending increased by 89 percent while tax revenue lagged behind at an increase of 82 percent.48 As Dave Trabert wrote for the Kansas Policy Institute, “you can’t have a conservative tax plan and a liberal spending plan.”49 State lawmakers in Maine50 and Arkansas51 continued their work on tax reforms in the last few years, further lowering rates. Oklahoma has lowered income tax rates since 2011, and lawmakers are gearing up for more reductions in the next few years.52 The District of Columbia is currently phasing in a tax reform package that lowered individual income tax rates for middle-income brackets, in addition to expanding the sales tax base and raising the estate tax exemption.53 After an income tax reduction package was passed in 2014, income taxes in Missouri will also slowly begin to reduce starting in 2017, by 0.1 percent annually depending on a revenue trigger.54 Midwestern states that have recently lowered their income tax rates include Indiana and Ohio. Indiana passed income tax cuts in 2013 which gradually reduce its flat income tax rate of 3.4 percent to 3.23 percent by 2017, with an interim 3.3 percent rate for 2015 and 2016. Indiana’s brand new 3.23 percent rate became effective on January 1st of this year.55

Page 3

A Glide Path to a 3 Percent Flat Income Tax

Ohio, which has a progressive income tax structure, has been gradually cutting income tax rates since 2006.

A 2013 tax cut package worth $2.7 billion features an across-the-board 10 percent income tax cut.56 By 2015, that package was fully phased in, and income tax rates were reduced by 6.3 percent from the 2014 rates.57 As part of the tax package, the sales tax increased from 5.5 to 5.75 percent.58 In 2011, the Illinois Legislature raised Illinois' 3 percent flat tax to 5 percent as part of a "temporary" revenue raiser to help with the state's shaky finances.59 While that rate hike raised $32 billion in additional tax revenue, the state's unpaid bills fell by just $1.3 billion, and pension debt grew by $25 billion.60 In 2014, Illinois' income tax fell back to 3.75 percent until the summer of 2017. As part of the long-overdue

In fact, the evidence suggests that state revenue is positively affected by the lack of an income tax. budget plan, the state raised the income tax rate up to 4.95 percent. That amounted to a 32 percent increase, the largest permanent income tax hike in the state's history. 61 That budget - the Land of Lincoln's first full state budget in two years - raised both the individual and corporate income taxes.

On election day in 2014, voters in Georgia took a historic stand against perennially-increasing taxes. A stunning 96 percent of voters passed a constitutional amendment that prohibits raising the income tax over its current top rate of 6 percent.62 With this move, Georgia became the first state to cap its income tax.63 Even with Wisconsin’s impressive recent efforts to reduce taxes, other states are making greater strides to lower their respective tax burdens.

Wisconsin must do more if it wants to remain competitive. v

High Income Tax States Versus No Income Tax States - Who Wins the Economic Battle?

W

hen examining different options for taxation, one must consider the varied effects that tax structures might have on a state’s economy. Factors such as employment, personal income growth, and net migration tend to vary under different tax schemes, and offer cues as to which types of tax systems are associated with greater prosperity and growth.

In their 2014 book, “An Inquiry into the Nature and Causes of the Wealth of States,” economists Stephen

Page 4

www.maciverinstitute.com

Figure 5

Moore and Arthur Laffer evaluate economic, social, and demographic indicators among the 50 states since the turn of the century. Their resulting work, accomplished with the help of entrepreneur and author Travis Brown and financial expert Rex Sinquefield, is a comprehensive analysis on the effect of state income taxes on overall state well-being.

The authors feature a comparison of the economic and demographic performance, from 2002 to 2012, of the nine states with the highest state and local income taxes versus the nine states with no taxation on personal income.64 As Figure 5 shows, on average, states with no income tax fare better than those with a high income tax when it comes to population growth, personal income growth, private sector employment, and even state and local tax revenue growth - contrary to the notion that a low or no income tax drains state coffers of all revenue. In fact, the evidence suggests that state revenue is positively affected by the lack of an income tax.

U.S. Census Bureau data also show that on average, states with no income tax have more public employees than those with a high income tax - refuting the idea that a lack of state income tax necessarily “guts” public services or that higher income taxes lead to greater numbers of public employees. Figure 6 compares the equal-weighted averages of government employees across the nine states with the highest personal income tax against the states with no income tax. The data

reflect Census of Governments estimates for 2012, the latest year available. The nine states with no income tax do better than or just as well as the nine states with the highest income tax in most categories of full-time public employees.

In other words, when states levy low or no individual income tax, regular life and state output does not grind to a halt. Rather, those states typically enjoy higher levels of growth, employment, and migration.

With a low or no income tax, the incomes of people rise, businesses expand, the economy grows, and state coffers receive more tax revenues. v

Don’t Progressive Income Taxes Reduce Inequality?

P

roponents of progressive income taxation typically argue that it is fair and morally just to ask more of higher earners. In short, progressives argue that individuals should “pay their fair share,” often inferring that richer Americans don’t currently pay enough money towards public services. Modern-day progressives lament the existence of income inequality between the richest and poorest in the country and prefer that richer individuals pay higher taxes to reduce such inequality.

However, the evidence suggests that progressive income taxation does not effectively reduce income

Page 5

A Glide Path to a 3 Percent Flat Income Tax

Figure 6

inequality. The Gini coefficient, also known as the Gini index, is a highly regarded measure of income inequality frequently used to gauge inequality across different countries and states. A higher Gini coefficient value indicates higher income inequality, while a number closer to zero indicates more income equality.

In 2014, economist Lyman Stone of the Tax Foundation measured the average Gini coefficient of the nine states with the highest progressive state income taxes, the nine states with flat income taxes, and the nine states with no income tax.65 As Figure 7 shows, the average Gini coefficient of the nine states with the highest progressive tax is slightly higher than the average for flat tax and no income tax states. While many factors affect income inequality, the higher Gini index suggests that contrary to popular belief, states with the most progressive income taxes actually have the greatest income Figure 7 inequality, and that states with no income taxes have the lowest levels of income inequality.

Some may argue that states with progressive income taxes and high income inequality should simply further

increase the top income tax rate in order to see significant changes in income inequality. However, one study by the Brookings Institution showed that an increase in the top individual tax rate, which is directly redistributed to the poorest 20 percent of households, had “exceedingly modest� effects on overall income inequality.66 Researchers used a microsimulation model to measure the impact on income inequality under different scenarios, including an increase in the top individual tax rate by as much as 50 percent.

Such studies demonstrate that progressive income tax structures are not successful in meaningfully reducing income inequality, and by some measures, progressive taxes are correlated with higher inequality.

Focusing on income inequality - the nominal difference in wages between the richest and poorest in society - is a false measure which does not truly reveal how welloff individuals actually are. As researchers Ryan Young and Iain Murphy of the Competitive Enterprise Institute wrote in their 2016 analysis, “People, Not Ratios: Why the Debate Over Income Inequality

Page 6

www.maciverinstitute.com

Asks the Wrong Questions,” those concerned with poverty should consider how the poor are actually doing, whether their economic situation is improving over time, and what policies can make the world’s poor better off over time, rather than focusing on disparities between rich and poor.67 In their paper, Young and Murphy write that:

a flat tax would benefit all Wisconsinites across the board, attract new residents, and help to usher in a new era of economic prosperity. Despite the arguments of detractors, the evidence strongly suggests that a high-rate progressive income tax system, such as Wisconsin’s, does much more to hurt the poor and increase income inequality than a flat tax.

“The mathematical ratio between a society’s highest and lowest income and wealth strata is less important than the actual living standard for people living at the economic bottom. In other words, relative poverty reduction should take a backseat to absolute poverty reduction. People, not ratios, are most important.”68

To be revenue neutral under the current tax structure (retaining all deductions and credits), the flat individual income tax rate would need to be 6.1 percent for all Wisconsinites.71 We propose that Wisconsin institute an eight-year glide path to a 3 percent individual income flat tax by 2025. The estimated "cost" of a 3 percent flat tax while keeping the homestead and earned income tax credits would be $2.60 billion.72

Some progressive writers have argued that a modified flat tax code would actually be the most progressive system of all, given that our current 74,000 page federal tax code has been molded more by carveouts and favors for the special interests than by the principle of tax equity for all.69 A shift to a much simpler code - both at the state and federal levels - would provide assurance that, fiscally, all individuals start out on a level playing field and are being taxed at the same rate with no or few credits or special carveouts for various groups. Such a shift to a flat and broad tax rate would allow us to push the restart button on today's mindnumbingly complicated tax code and the suffocating web of government bureaucracy that enforces the law.

As it stands, Americans spend an estimated $409 billion or 8.9 billion hours complying with the U.S. tax code.70 Moving to a flat individual income tax rate, at least at the state level, would be a solid first step towards putting all Wisconsinites back on the same playing field. v

The Solution: A Glide Path to a 3 Percent Flat Tax

W

isconsin’s history of high government spending and high taxes is a damper on economic growth and makes the state uncompetitive nationally. As evidenced by the research presented in this report,

Gone would be the four different tax rates and the penalty on success and wage growth. All Wisconsinites would pay the same income tax rate - a reasonable 3 percent. A broad, low income tax rate would leapfrog Wisconsin ahead of our Midwestern neighbors in the competition for new residents, recent college graduates, fledgling businesses looking for a home and the struggle to keep our retirees from moving away in their golden years to states with no individual income taxes.

A move to a flat 3 percent income tax rate would also benefit the poorest Wisconsinites, who currently pay 4 percent. For those families and individuals on tight budgets, a lower income tax would go a long way. Further, any sort of sweeping clean of the tax code helps the poorest the most - after all, only those who are well off are able to spend money on lawyers and accountants for the purposes of tax compliance.

According to the Wisconsin Taxpayers Alliance, by 2012 Wisconsin had doubled the number of differences between state and federal income tax law and tripled the number of tax credits in only a decade.73 The pages of instruction for taxes increased by more than 20 percent in the same time.74 As the size of government grows, and state and federal laws become evermore complex, the poorest of our society take on

Page 7

A Glide Path to a 3 Percent Flat Income Tax

a greater burden in complying with the convoluted tax structure. By wiping the tax code clean, Wisconsinites will be on the same playing field, with no complicated credits or exemptions.

In 2014, Wisconsin Lieutenant Governor Rebecca Kleefisch toured the state to gather input from the public about tax reform. The top five areas of concern were the property tax burden, personal income tax, the complexity of tax laws, taxes on small business, and the overall cost of government.75 Wisconsinites want lower, flatter income taxes: 23 of 24 times, attendees said they preferred lower and flatter rates without credits, exemptions, or deductions, rather than more credits, exemptions, and deductions to incentivize certain socially beneficial behaviors.76 The glide path to a 3 percent income tax would take place over four budgets, minimizing the impact on the state budget and the need to dramatically reduce government spending in the short term. In a subsequent report, the MacIver Institute will suggest plenty of ways that state government spending could be cut to bring the budget into balance, should normal historic economic growth not cover the rest.

Given that the state of Wisconsin will continue to provide a breadth of services for our residents, we looked at many different factors before deciding on a 3 percent flat tax. In tax year 2014, net income tax liability in Wisconsin amounted to $6,813,380,000 out of $157,770,000,000 in state adjusted gross income, which works out to an average tax rate of 4.3 percent.77 It is important to note that many of Wisconsin's deductions, credits, and exemptions are not available to all. There are exemptions that are used almost exclusively by those in upper tax brackets and there are credits that are targeted to those on the lower end of the income scale.

For example, Wisconsin’s refundable credits added up to $1,392,840,000 in tax year 2014.78 The school property tax/return credit, used by more than 1.7 million Wisconsinites in 2014, added up to over $401 million alone.79 While filers who made less

than $10,000 were unlikely to fully use their credit, those with incomes of $30,000 - $70,000 used over 41 percent, or $164 million, of the credit.80 If all major tax expenditures - the many deductions, exemptions, and credits throughout the tax code - are retained, the "cost" of a flat tax goes up considerably.

A 3 percent flat individual income tax that retains all current deductions and credits, as listed in the tax credit sidebar, would cost $4.4 billion in fiscal year 2016, according to Department of Administration estimates.81 Our proposal, a 3 percent individual income tax rate plus the removal of all major tax expenditures, would "cost" $2.6 billion in 2016, or 1.9 percent of 2014 total adjusted gross income.82 The current Wisconsin budget of 2015-17 spends $73.7 billion, so the cost of MacIver's 3 percent flat tax idea is only 3.5 percent of the total budget. To find 3.5 percent

Page 8

www.maciverinstitute.com

savings in a $74 billion budget should not be difficult.

Under a plan with all major tax expenditures retained, individuals in every single tax bracket would see sizable tax cuts. In 2014, the median household income in Wisconsin was $52,738.83 At a 3 percent income tax, single filers making $25,000 to $30,000 annually would get a tax cut of $406.84 Single filers making $45,000 to $50,000 would keep an estimated $1,174 that is currently taxed away from them.85 Under a 3 percent income tax rate, married joint filers making the median income would receive a $1,142 estimated tax cut.86 For families on tight budgets, such tax cuts go a long way. The median monthly cost of rent in Wisconsin from 2010-2014 was an estimated $772.87 For homeowners with a mortgage, the median monthly owner costs during the same time period was an estimated $1,431.88 While a $2.60 billion cost at the state level is indeed sizeable, tax cuts that average close to the size of rent or a monthly mortgage would indeed make a difference.

Moving to a low, flat income tax would invariably decrease the amount of money coming into state coffers. However, lower tax rates across the board would allow individuals in every single tax bracket to spend more of their own money, further driving economic growth and investment.

As mentioned earlier, a lower tax rate would also attract newcomers to the state and convince some retirees to stay here, bringing in revenue in a multitude of ways. Annually, Wisconsin loses about $136 million in adjusted gross income to tax migration, but how would individuals act if the progressive state income tax was lowered? If just 50 percent of tax migrants stay, the state could see almost $70 million a year in additional tax revenue, significantly offsetting potential costs to state revenue.

In terms of the specific glide path to a 3 percent flat tax, we offer two options for consideration:

Option One

The first option would be to divide the difference of the top rate (7.65 percent) and the target rate (3 percent) by eight to determine a yearly percentage drop for all existing tax brackets. That calculation yields a 0.58125% percent drop per year. Under this scenario, those in the lowest bracket (4 percent) would reach the target rate of 3 percent in two years, those in the next bracket (5.84 percent) would reach the target in five years, those in the second highest bracket (6.27 percent) would reach the target in six years, and those in the highest income bracket (7.65 percent) would land at 3 percent in 2023.

Option Two

Alternatively, one could eliminate one tax bracket each budget cycle starting in 2017. First, the middle two brackets (5.84 percent and 6.27 percent) would be combined into one bracket during the 2017-19 biennium. Simultaneously, the lowest bracket (4 percent) would be reduced to the target rate of 3 percent. In the 2019-21 biennium, the new middle income bracket would be combined with the highest income bracket (7.65 percent) at a lower overall rate.

Finally, the 2021-23 biennium would see the high income bracket fall to the 3 percent target rate.

Ideally, the average tax rate would go down by nearly a third in each biennium. A benefit of this scenario is that it gives legislators two years (2017-19) to plan for adjusted spending levels over the next six years.

We believe that the glide path tax reform should not involve any tax swaps that increase other taxes in exchange for lowering the income tax. The hope of this plan is to give all Wisconsinites more freedom and liberty by lowering their overall tax burden. Under the plan, Wisconsin’s individual income tax revenue as a percentage of all state revenue would naturally decrease in the short term. Lowering the prominence of income taxes in Wisconsin’s tax mix would reduce the state’s susceptibility to dramatic downswings in tax revenue during economic recessions that are largely caused by steep income tax revenue drops. v

Page 9

A Glide Path to a 3 Percent Flat Income Tax

Along with transitioning to a 3 percent flat income tax for all Wisconsinites, the MacIver Institute’s plan would eliminate all tax credits and exemptions, except the earned income tax credit and homestead tax credits, which are used primarily by lower-income populations.

W

Conclusion

isconsin has rightly taken steps to address its high tax burden in recent years by reducing its income, corporate, and property taxes. These reforms have improved the state’s competitiveness in the Midwest and across the country. The state’s high individual income tax remains a burden to individuals and businesses. It also affects Wisconsin’s overall attractiveness for potential new residents looking to advance their career and outside businesses who are looking for a state to expand their operations.

We need to think long-term about what is the best strategy for all Wisconsinites and for the state as a whole. We need to think about the next 10 years and the next generation, not just the next budget or the next election. Wisconsin needs a tax code that is simple, straightforward, and an even playing field for all. Wisconsin needs a tax rate that is as low and as broad as possible so that everyone has an equal chance to succeed and everyone has an equal responsibility for our government.

The evidence presented in this report shows that states that do not tax income or tax income at lower rates perform better in many economic and demographic categories.

If Wisconsin is to compete and win the battle for population growth, business expansion, and retiree retainment, Wisconsin needs a flat tax. v

Page 10

www.maciverinstitute.com

A-1: 9 Highest Income Tax States Versus 9 No Income Tax States, 2002-2012 Top Marginal Income Tax Rate

Population Growth

Net Domestic InMigration

Nonfarm Payroll Employment

Personal Income Growth

Gross State Product Growth

State and Local Tax Revenue Growth**

Alaska

0.0%

13.9%

-1.2%

13.8%

60.6%

79.5%

232.8%

Florida

0.0%

15.7%

5.6%

3.4%

53.3%

45%

50.3%

Nevada

0.0%

26.9%

10.3%

8.6%

52%

61.4%

66.7%

South Dakota

0.0%

9.6%

2.1%

9.7%

70.3%

53.8%

50.9%

Texas

0.0%

20.1%

4.3%

15.5%

72%

78.5%

63.3%

Washington

0.0%

14.0%

3.8%

8.0%

56.2%

58.5%

48.6%

Wyoming

0.0%

15.3%

5.3%

16.9%

75.9%

99.5%

121.1%

New Hampshire*

0.0%

4.1%

0.7%

2.4%

39%

38.4%

54.5%

Tennessee*

0.0%

11.4%

4.5%

1.9%

49%

43.5%

50.2%

Equal-Weighted Average of States with No Income Tax

0.0%

14.6%

3.9%

8.9%

58.7%

62%

82%

50-State Equal Weighted Average

5.69%

9.3%

0.9%

4.2%

51.1%

51.7%

56.5%

Equal-Weighted Average of States with Highest Income Tax

10.23%

6.3%

-2.2%

1.7%

46.4%

46.4%

52.2%

Kentucky

8.20%

7.1%

1.8%

2.1%

45.2%

42.8%

38.9%

Ohio

8.43%

1.2%

-3.2%

-5.0%

33.2%

28%

28.2%

Maryland

8.95%

8.2%

-2.2%

3.8%

51.6%

53.7%

52.2%

Vermont

8.95%

1.7%

-1.0%

1.3%

45.8%

39.3%

63.5%

New Jersey

9.97%

3.6%

-5.6%

-2.2%

39.2%

34.8%

57.6%

Oregon

10.61%

11.0%

4.4%

3.3%

44.5%

66.2%

53.3%

Hawaii

11%

12.3%

-2.0%

8.8%

63.6%

61.8%

57.6%

New York

12.7%

2.3%

-8.0%

4.0%

50.3%

46.6%

64.7%

California

13.3%

9.1%

-3.9%

-0.4%

44.1%

44.4%

54%

Source: Laffer, Moore, Brown, SinqueďŹ eld. An Inquiry into The Nature and Causes of the Wealth of States: How Taxes, Energy, and Worker Freedom Change Everything. Wiley Publishing. 2014.

Notes: *NH and TN tax capital gains and dividend income. **Data for 2001-2011 because of data lag.

Marginal tax rates include local income tax of largest city.

Page 11

A Glide Path to a 3 Percent Flat Income Tax

A-2: Public Employees per 10K Residents State

Combined State/Local Income Tax*

K-12

Higher Education

Corrections

Fire Protection

Police Protection

Financial Administration

Alaska

0.0%

281

82

28

11

35

22

Florida

0.0%

183

46

22

15

33

12

New Hampshire

0.0%

276

51

14

15

29

13

Nevada

0.0%

144

34

23

9

29

10

South Dakota

0.0%

236

70

18

5

23

18

Tennessee

0.0%

207

53

19

12

32

12

Texas

0.0%

262

67

26

10

28

9

Washington

0.0%

153

67

20

13

22

11

Wyoming

0.0%

331

109

36

8

35

22

Equal-Weighted Average of States with No Income Tax

0.0%

230.3

64.3

22.9

10.9

29.6

14.3

Equal-Weighted Average of States with Highest Income Tax

10.23%

223.6

69.4

20.9

10.9

30.0

13.2

Kentucky

8.20%

251

88

19

10

23

10

Ohio

8.43%

208

65

18

16

28

13

Maryland

8.95%

211

69

27

12

32

9

Vermont

8.95%

340

91

18

6

28

19

New Jersey

9.97%

254

52

17

9

38

12

Oregon

10.61%

167

82

22

10

23

18

Hawaii

11%

185

80

16

14

27

12

New York

12.7%

239

39

29

12

44

13

California

13.3%

157

59

22

9

27

13

Source: Laffer, Moore, Brown, Sinquefield. An Inquiry into The Nature and Causes of the Wealth of States: How Taxes, Energy, and Worker Freedom Change Everything. Wiley Publishing. 2014.

“States With Most Government Employees: Per Capita Rates By Job Type.” Governing. 2014. (U.S. Census Bureau Data) http://www.governing.com/gov-data/public-workforce-salaries/states-most-government-workerspublic-employees-by-job-type.html

Page 12

www.maciverinstitute.com

A-2 (Continued): Public Employees per 10K Residents State

Combined State/Local Income Tax*

Health

Hospitals

Highways

Judicial and Legal

Public Welfare

Total

Alaska

0.0%

14

14

56

22

28

593

Florida

0.0%

13

29

10

16

8

387

New Hampshire

0.0%

8

4

25

9

31

475

Nevada

0.0%

8

20

10

13

10

310

South Dakota

0.0%

12

17

29

11

24

463

Tennessee

0.0%

20

40

16

11

15

437

Texas

0.0%

21

29

13

10

10

485

Washington

0.0%

14

35

20

11

17

383

Wyoming

0.0%

23

126

46

17

15

768

Equal-Weighted Average of States with No Income Tax

0.0%

14.8

34.9

25.0

13.3

17.6

477.9

Equal-Weighted Average of States with Highest Income Tax

10.23%

14.8

23.9

18.6

15.6

18.6

459.3

Kentucky

8.20%

21

25

17

16

17

497

Ohio

8.43%

16

24

17

16

20

441

Maryland

8.95%

19

6

16

14

19

434

Vermont

8.95%

8

4

40

11

21

586

New Jersey

9.97%

9

22

16

22

20

471

Oregon

10.61%

16

25

18

12

22

415

Hawaii

11%

16

33

13

22

4

422

New York

12.7%

13

47

19

16

25

496

California

13.3%

15

29

11

11

19

372

Page 13

A Glide Path to a 3 Percent Flat Income Tax

Page 14

www.maciverinstitute.com

Page 15

www.maciverinstitute.com

Page 16