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There has been a recent surge in states swapping tiered income taxes for a flat tax, charging all residents the same tax rate regardless of income.
According to the Tax Foundation, only four states have switched from graduated rates to flat taxes in the last 100 years. Another three states — Iowa, Mississippi, and Georgia — passed legislation this year to make the transition.
Arizona has cleared the way following a recent court decision, and Oklahoma is seeking the move to join nine other unified tax states.
These changes come amid a wave of state-level tax cuts fueled by budget surpluses. Fueled by better-than-expected revenue and billions in state support, the cash rush is expected to continue into fiscal 2022, according to the National Association of State Budget Officers.
“Governments are cashless,” said Jared Walczak, vice president for government projects at the Tax Foundation. “They’ve seen revenue continue to grow and there’s an opportunity for tax reform.”
Many policymakers advocate a flat income tax because they think it’s simpler, more competitive and harder to change, he said. A flat tax rate is more difficult to increase than a graduated rate because it affects everyone and not specific segments of taxpayers.
Walczak said the decision is particularly relevant for small businesses. Owners often have so-called pass-through income, where the income goes into their individual tax returns, and a large portion of their income may be subject to the upper marginal tax rate.
“Given the level of revenue that policymakers are currently seeing in their projections, many see this as a good opportunity to enact the flat tax reforms they may have wanted for years,” he said.
While states like Alabama, Idaho and Missouri aren’t yet required to propose a flat tax, future laws with relatively low income thresholds might make it easier to hit the maximum rate, Walczak said. In Alabama, for example, the top rate of 5% kicks in once income exceeds $3,000.
But critics say the benefit of a flat tax primarily helps the wealthy and may create future revenue challenges.
“It’s not about simplicity,” said Richard Auxier, senior policy associate at the Urban-Brookings Tax Policy Center. “It’s about tax breaks for higher-income households.”
A flat tax could have a long-term negative impact on government revenues, especially in a shaky economy, he said. Fiscal 2022 revenue could be weaker than expected, and some forecasters are projecting a bleaker outlook for 2023, according to the Tax Policy Center.
The phase of inflation, possible changes in monetary policy, the war in Ukraine and other factors could have “really negative effects” on future government tax revenues, Auxier said.
“If you introduce this really low flat tax, you tie the hands of your revenue system,” he said, explaining that it could be difficult to recoup lost revenue during an economic downturn.
https://www.cnbc.com/2022/04/28/critics-call-states-switch-to-flat-income-tax-a-boon-for-the-wealthy.html Critics call the transition of states to a flat income tax a blessing for the rich