“The state’s income tax should be reduced … Consider an across-the-board cut, reduce the marginal rates, exempt taxpayers below a certain income level from filing, and expedite the process of indexing for inflation (Improving Productivity by Reducing Taxes and Taxes and Savings in Arkansas, Murphy Commission, 1998)
Summary: Individual income tax brackets, in response to inflation should be retroactively indexed to the Consumer Price Index as part of a multi-year plan that would reduce the tax burden on Arkansas’s middle class, and provide further reductions in the state grocery tax.
(May 2008) Freshman Gov. Mike Beebe’s 50 percent reduction in the state sales tax on groceries helped a large group: more than 500,000 middle class Arkansas households (1). These Arkansas households earned between $25,000 and $74,999, and numbered 511,431, according to U.S. Census Bureau data (2005). The 2007 grocery tax cut, the largest tax cut in state history followed a policy debate on the issue that lasted more than a decade (2). It is worth about $250 million to taxpayers over a two-year period. The tax cut provided much-needed tax relief, returning an estimated $234 annually to the average four-person Arkansas household that spends $150 per week on groceries. But these gains are threatened by an increase in CPI.
CPI increased 0.6 percent in April, a level that is 3.9 percent higher than in April 2007. Rising energy and food costs are placing economic pressure on the budgets of middle class households. According to the most recent CPI release (May 14) from the Bureau of Labor Statistics: “Gasoline prices rose 5.6 percent in April. Compared to a year ago, these prices were up 20.9 percent.” The food index has increased at a 6.9 percent seasonally adjusted annual rate thus far this year, following a 4.9 percent rise in 2007. The Minneapolis Federal Reserve Bank is estimating 4.0 percent CPI (2008), an annual rate that has been exceeded only five times (1984, 1988-91) in the last quarter-century (http://www.minneapolisfed.org/Research/data/us/calc/hist1913.cfm).
‘Bracket Creep’ and Arkansas’s Middle Class
Inflation also pushes Arkansans into higher tax brackets, a phenomenon known as ‘bracket creep.’ Democratic Gov. Dale Bumpers and the General Assembly raised the state’s top income tax rate in 1971 but failed to adjust the measure for CPI (3). A 1996 chart (4) produced by the Office of Economic and Tax Research, Bureau of Legislative Research, illustrates the effect of this policy on taxpayers:
Arkansas Personal Income Tax Rates
(Adjusted for Inflation, 1971-1996)
Marginal Rate Income Level Level Adjusted for Inflation
1.0% First $2,999 First $10,828
2.5% $3,000-$5,999 $10,833-$21,661
3.5% $6,000-$8,999 $21,664-$32,493
4.5% $9,000-$14,999 $82,497-$54,158
6.0% $15,000-$24,999 $54,161-$90,265
7.0% Over $25,000 Over $90,269
A measure passed in the late 1990s allows the state Department of Finance to make modest adjustments in response to CPI. Arkansas has six brackets, with rates still ranging from one to seven percent, and income level ranges ($3,699 to $31,000), the Federation of Tax Administrators notes. Retroactively indexing the 1971 income tax hike using the BLS CPI Inflation Calculator produces the following results:
Marginal Rate Income Level Level Adjusted for Inflation
1.0% First $2,999 First $15,908
2.5% $3,000-$5,999 $15,913-$31,820
3.5% $6,000-$8,999 $31,826-$47,733
4.5% $9,000-$14,999 $47,738-$79,559
6.0% $15,000-$24,999 $79,564-$132,601
7.0% Over $25,000 Over $132,607
Middle class households would receive a significant tax cut under this proposal. The plan, coupled with continued reductions in the grocery tax would provide the biggest middle class tax cut in Arkansas history.
Paying for the Proposal
State Rep. Ed Garner, R-Maumelle, proposed a quarter-percent reduction in the Arkansas income tax rate to a state budget surplus and revenue growth. The measure passed the state House in March 2007 but was defeated in a Senate committee. The proposal would have cut the top rate from seven to 6.75 percent and lower taxes “until the maximum tax rate for any tax bracket ” reached three percent.
Another approach to pay for the proposal is to limit state government spending to Arkansas per capita income growth.
Conclusion
Retroactively indexing the 1971 income tax hike to the Consumer Price Index would provide the biggest middle class tax cut in Arkansas history when coupled with continued reductions in the grocery tax.
Next Month: Paying for Tax Cuts
NOTES
- 1. “A Middle Class Tax Cut,” Arkansas Policy Foundation research memo (January 2007)
- 2. Former State Sen. Bud Canada, D-Hot Springs, proposed grocery tax repeal in the 1990s. The Policy Foundation advanced the issue in a 2002 memo, “Free Market Economists and the Sales Tax on Food.”
- 3. Bumpers’ originally proposed increasing the top income tax rate from five to nine percent. The measure fell short of votes in the General Assembly, forcing a compromise that left Arkansas with a top seven percent rate. “Arkansas Per Capita Income Growth Anemic Since 1971 Income Tax Hike,” Policy Foundation research memo (June 2006).
- 4. Reproduced in a 1998 Murphy Commission report, “Improving Productivity by Reducing Taxes.”
- 5. “Income Tax rate Reduction Debated In Legislative Session.” Arkansas Policy Foundation research memo (April 2007).
