Thursday, March 29, 2007

Corporate income tax change: single sales factor apportionment

In recent years, states have been slowly reducing corporate income taxes. States have been doing this not by reducing corporate income tax rates but rather by increasing the sales factor weighting in corporate income tax apportionment formulas.

What is apportionment of corporate income?
Apportionment of corporate income is an important issue for multi-state companies. Many decades ago, states agreed to use an evenly weighted three-factor apportionment formula based on a corporation's sales, property, and wages. Each factor was given a 33.3% weighting. This was intended to prevent overtaxation of a corporation's profits. For example, without apportionment, a company doing business in twenty states would have to pay 100% state corporate income tax if each state imposed a 5% corporate income tax rate.

Using the evenly weighted three factor formula, the corporation's income would be apportioned to each state where it did business. The following hypothetical example illustrates how this works

Percent of sales in
Other states: 99%
In-state: 1%

Percent of wages in
Other states: 1%
In-state 99%

Percent of property in
Other states: 1%
In-state: 99%

Other states = (99% + 1% + 1%) / 3 = 33.7%
In-state = (1% + 99% + 99%) / 3 = 66.3%

Why increase sales factor weighting?
States have been increasing the sales factor weighting from 33.3% in order to incentivize and encourage investment by high wage, export-oriented companies that have the option of locating in any state (or country for that matter). A semiconductor manufacturer, for example, pays high wages, brings money into the state by exporting products to other states, and can locate anywhere.

By increasing the sales factor to 100%, a company that employs Utahns and invests in Utah but exports all or most of its product to other states, would pay zero or little Utah corporate income tax (assuming the throwback rule were eliminated, which will talk about at a later time). Companies that produce and employ in other states but sell their products in Utah would not benefit from this change.

Using the above hypothetical example, the Utah-based exporter's apportionment to Utah would be 1% if single sales factor were used instead of 66.3% if evenly weighted three factor were used.

Currently, Utah uses a double-weighted (50%) sales apportionment formula. Only eight states use an evenly weighted formula for all corporations. Thirteen states allow or soon will be allowing some or all corporations to use single sales factor (100% weighting). In addition, three states (Nevada, South Dakota, and Wyoming) do not impose corporate income taxes at all.

What about repealing the state corporate income tax entirely?
Complete repeal of the Utah corporate income tax presents two problems. First, the fiscal impact would be huge. In FY2006, Utah's corporate income tax generated $380 million. (The amount generated each year varies dramatically depending on the state of the economy). Increasing the sales factor weighting would impact revenues by about $30 to $50 million per year.

Second, complete repeal of the state corporate income tax would allow local governments to begin taxing intangible property such as patents, trademarks, and goodwill. The Utah state constitution prevents the taxation of intangible property as long as corporate income tax is imposed ("If any intangible property is taxed under the property tax, the income from that property may not also be taxed." -- Utah Constitution, Article XIII, section 2, part (6))

For example, let's assume a company has a market value based on its stock price of $1 billion and tangible real and personal property of $100 million. Currently, local governments can impose property taxes on $100 million. If the state corporate income tax were repealed without changing the state constitution, then local governments would impose property taxes on $1 billion.

Monday, March 26, 2007

Impact of Utah state income tax changes on federal income taxes

Several people have asked us if the recent Utah income tax changes will impact federal income taxes. For those who itemize deductions on federal income taxes, the answer is yes. Federal taxes will be increasing as a result of state income tax cuts. That's because Utahns who itemize will have have higher federal taxable income because they are deducting less state income tax. Bad news, but that's the way it works.

The state income tax cut will be larger than the federal income tax increase. Most Utahns with full-time jobs are in the 15% federal income tax bracket. The 15% bracket for tax year 2007 begins at $15,650 and ends at $63,700. Remember that this is TAXABLE income, which is adjusted gross income less exemptions and deductions. Therefore, for each dollar reduction in state income taxes, federal income taxes will increase by 15 cents.

Higher income Utahns will see an even higher increase in federal taxes because they are in higher federal income tax brackets. The highest marginal tax rate is 35% and begins at taxable income of $349,700 (tax year 2007). However, since itemized deductions are phased out for higher income taxpayers, these taxpayers will experience a federal tax increase of a little less than 35 cents for every dollar of state income tax reduction. In future years, the itemized deduction phase out will be eliminated at the federal level which means the federal tax increase will be 35 cents for every dollar of state income tax reduction.

In a given year, about 40% of Utahns itemize deductions on their federal and state income taxes. If this sounds low, it's because the other 60% includes

- retirees who have paid off their mortgages and whose combined charitable contributions and state income taxes paid are less than the standard deduction

- young taxpayers who do not own homes and do not currently earn a lot of income.

The percent of Utahns that itemize or will itemize deductions during their lifetime is much higher than 40%.

Friday, March 23, 2007

BYU professor opposes vouchers?

Last week, the Provo Daily Herald published an anti-voucher letter by BYU professor Richard Davis and two others.

Not surprisingly, they falsely claimed that vouchers would financially hurt public education. Click here to see our response to this claim.

However, we can't help but be shocked that a BYU professor would be opposed to vouchers, especially since tens of thousands of BYU students have received vouchers (Pell Grants, GI Bill) over the years. Surely, Professor Davis himself has taught hundreds of students that have received taxpayer funds to attend LDS Church-owned BYU.

Davis dismisses vouchers as a "government subsidy, a handout if you will". Unless of course those receiving the voucher subsidies are BYU students. Then it's OK.

When calling vouchers a subsidy, Davis doesn't mention that K-12 public education itself is a subsidy. The voucher subsidy -- expected to be about $1,900 per student -- is actually smaller than the Utah K-12 subsidy, about $7,500 per student in 2008 (figure includes capital and debt service). When students transfer from public schools to private schools, everyone benefits financially, including those families that keep their children in public schools and those families without children.

Davis also plays the elitism card by saying "Americans rejected a caste system where rich people go to private schools". Is Davis not aware that rich people live in rich neighborhoods and send their kids to neighborhood public schools that are much different/better than the public schools in poor areas? Isn't it common knowledge that schools in Alpine and Highland perform better than the schools in Rose Park and Glendale?

Voucher opponents argue that the Pell Grant-voucher analogy is apples and oranges because K-12 education is an entitlement and is compulsory and higher education is not. Actually, the entitlement argument justifies vouchers for K-12 more than it does for higher education. Since K-12 education is a constitutional entitlement, K-12 students are entitled to government funded education, whether that's through the traditional school system or through vouchers.
Mike Jerman
Andrew Stephenson

Tuesday, March 20, 2007

Impact of tax changes on Utah family of four

The Utah Taxpayers Association has just released its analysis of the impact of recent tax changes on a Utah family of four of various incomes. Click here to read the analysis.

This analysis illustrates the impact of tax changes of the 2006 and 2007 legislative sessions, including the following:

- individual income tax reduction

- 3% reduction in state sales tax on food from 4.75% in 2006 to 2.75% in 2007 to 1.75% in 2008.

- 0.1% reduction in general state sales tax from 4.75% to 4.65%

- 0.6% reduction in "boutique" sales tax on food (ZAP, mass transit).

- 0.25% rails/roads sales tax increase in Salt Lake County (most Wasatch Front counties will eventually adopt the "third quarter" sales tax increase). Food is exempt from this tax.

- 0.05% increase in mass transit sales tax rate

(Note: the above listed "percent changes" are technically percentage point changes, but policy makers generally call them percent changes).

The basis for comparison is the new tax system that will be implemented in 2008 and the old system with 7% top marginal rate kicking in at $8,626 taxable income.

The analysis does not include the impact of business tax changes. While businesses pass on taxes and tax cuts to customers, employees, and shareholders, determining how these tax changes are passed on to families and households of various incomes is problematic.

Click here to read the report.

Mike Jerman
Andrew Stephenson

Thursday, March 15, 2007

Would HB148 repeal hurt taxpayers?

Question: would repeal of HB148 (education vouchers) harm taxpayers? Maybe, maybe not.

We've always supported means-tested education vouchers because they are a good deal for taxpayers, parents, and students.

- Choice allows parents to find education options that are best suited for their children.

- Competition improves the quality of public schools.

- Diverting a portion of public school enrollment to the private sector at a lower cost than taxpayers would have to spend to educate these children in district schools is a benefit for school districts and taxpayers, including those taxpayers whose children stay in public schools and those who don't have any children.

By promoting a referendum to repeal HB148 (education vouchers), the National Education Association's local affiliate is trying to undo the good work that Gov. Huntsman and the Utah Legislature have done for the taxpayers of the state.

However, even though vouchers are good policy, would a repeal of HB148 be a bad thing for taxpayers? That depends. Repealing HB148 would not repeal vouchers because HB174 supersedes HB148. However, some elements of HB148 would be repealed, particularly so-called mitigation funds for school districts. This would actually make the voucher law better.

Are "mitigation" funds justified?
Vouchers will not financially harm public schools which means so-called "mitigation" funds won't be needed. In FY2008, school districts will be spending about $7,500 per student, including capital and debt service. Nearly all of this cost is variable. That is, as enrollment growth is slowed in growing districts or enrollment decreases in declining districts due to vouchers, district costs would be less than they otherwise would be. Growing districts won't have to hire as many teachers or build as many schools as they otherwise would. Clearly, so-called "fixed costs" are not an issue with growing districts. Instead of spending $7,500 per student, taxpayers would be spending on average about $2,000 per voucher student that is diverted to the private sector.

Declining districts can also reduce so-called fixed costs by shifting school boundaries and/or consolidating schools (which they are already doing). Also, if enrollment declines, districts won't need as many teachers. Don't worry about teachers losing their jobs. The growing districts will make sure that there will be plenty of jobs for teachers, even if enrollment growth in growing districts is slowed due to vouchers.

Bottom line: by diverting students to the private sector at an average cost of $2,000 per student, districts will have more money to spend per student for those students remaining in the public system.

But didn't the legislative fiscal analyst say this would cost $450 million over thirteen years?
The Legislature's projected fiscal impact included only the costs of providing vouchers, but the projection did not include the other half of the equation: the school districts' reduced costs due to diverting enrollment to the private sector. The legislative fiscal analyst admits that there are significant variable costs but did not include these costs in the model.

But what about students already in private schools? Where are the savings for districts when these students get vouchers?
The ultra worst case scenario would be that only existing private school students would use the voucher, and maybe a small amount of switchers on top of that. Under HB148 and HB174, voucher eligibility for existing private school students is phased in over thirteen years. However, even if all current private school students were immediately eligible for the voucher, the fiscal impact would be small.

According to the Utah State Office of Education, there are currently (FY2007) 16,386 students in private schools. Opponents of vouchers have always argued that private school students come from rich families, which means that they would only be eligible for a $500 voucher. Therefore, 16,386 students multiplied by $500 equals $8.2 million. We'll round this up to $9 million to account for the worst case possibility that a handful of public school students switch but not enough students to allow school districts to reduce costs.

In FY2008, Utah school districts will spend at least $4 billion (again, including capital and debt service). A $9 million reduction in revenues would be 0.22% of total costs, and this is the ultra-worst case scenario.

Realistically, thousands of students will switch to the private sector, and the private sector currently has the capacity to increase their enrollment by several thousand students without having to build more facilities. If 3,000 students switch, taxpayers will save about $5,000 per student, or about $15 million in total, which more than offsets the $8.2 million cost of providing all current existing private school students with a $500 voucher.

As demand for private schools increases, the private school supply will also increase. Expanding private school capacity is not difficult, and much of the expansion will come from existing private school providers.

Fiscal conservatives are in a bind. How do we support the repeal of HB148 -- which improves the voucher law by getting rid of the so-called and unnecessary mitigation funds -- without sounding like we oppose vouchers?

Wednesday, March 14, 2007

Six ways (and counting) to understate government spending growth

Elected officials and spending groups frequently understate government spending and government spending growth. We've identified at least six ways that these groups do this:

1. Increase government funding by increasing "non-mandatory" fees instead of taxes and then exclude fees when calculating tax burdens (sometimes fees are better than taxes, but they should still be counted)

2. Exclude capital and debt service costs when calculating per student spending (that's right, when your local school district asks you to vote for a property tax increase to build new schools, those tax dollars are not included in official statistics on per student spending.)

3. Exclude growth in "below-the-line" items in the Minimum School Program (line items outside the WPU).

4. Earmark state general sales tax dollars for roads and exclude these earmarks from general sales tax revenue and general fund expenditure figures.

5. Compare the pre-supplemental budget for the next fiscal year with the post-supplemental budget for this year.

6. Exclude one-time appropriations

Recently, we've seen an example of items #3 and #6. A local blogger wrote "Instead of a 4 percent increase [for education], lawmakers should have given at least a 10 percent increase".

The actual per student increase in the Minimum School Program -- which accounts for more than 90% of state/local funds for school district operations -- was 15.4% (or about 12.1% adjusted for one year's inflation). This obviously is much higher than 4%.

So where does the 4% figure come from? It comes from WPU growth, which excludes growth in below-the-line items. Frequently, local newspapers have equated WPU growth with spending growth, but this year they avoided that mistake.

Much of the inflation-adjusted 12.1% increase in per student spending is one-time (less than half), which has caused some critics to say education didn't really increase that much. Let's not forget that one-time appropriations are still appropriations and that education budgets have almost always had at least some one-time appropriations. One-time appropriations have contributed to increases in inflation-adjusted per student spending over the years as we've outlined in a previous post. Usually, one-time appropriations either become ongoing appropriations in future years or are replaced with other one-time appropriations.

Monday, March 12, 2007

New state government growth figures

Every year right after the general legislative session, the Legislative Fiscal Analyst releases a State Budget Overview. Here are some sobering numbers from the current year and previous years' State Budget Overview.

- In the past two years, state spending from general sources (excludes federal sources, dedicated credits) has grown 38.8%. Including all sources of revenue, spending has increased 24.3% in two years.

- In the past four years, state spending from general sources has grown 67%, or 13.7% annualized. Total state spending has increased 45.4%, or 9.8% annualized.

All of these numbers will most likely be adjusted upward once supplemental appropriations for FY2008 are determined next year.

Defenders of government growth argue that much of the increase in state spending is due to "one-time" expenditures such as roads and buildings, and taxpayers should not be worried about this. However, taxpayers should be concerned about so-called one-time expenditures

- One-time expenditures are still tax dollars.

- Increased expenditures for roads and buildings lead to higher ongoing expenditures since these new roads and buildings require annual appropriations for maintenance and operation.

- This year's "one-time" expenditures will be replaced by new "one-time" expenditures next year. This is especially true for roads. State leaders anticipate spending hundreds of millions of dollars annually on roads, eventually billions of dollars per year. When did "one-time" expenditure evolve into annual expenditure?

While using cash for capital projects such as roads serves as good "working" rainy day (if projected government revenues don't materialize, then government can issue bonds for the project and use the freed-up cash to cover operations in other parts of the budget), let's not pretend that these expenditures aren't growing government.

Wednesday, March 07, 2007

Individual income tax changes

Now that the dust has settled, here's a summary of the individual income tax changes that Gov. Huntsman and the Utah Legislature approved last week. An example of how the new tax system will work is also explained.

1. Utah’s previous top marginal rate of 7% (reduced to 6.98% for one year) will be replaced by a single rate of 5%. This will be the first time in recent memory, if ever, that Utah's individual income tax rate has been lower than the national average (currently 5.3%, non-weighted). However, a broader tax base will ensure that Utah's individual income tax burden as a percent of personal income will remain above the national average.

2. The new system will not have tax brackets.

3. Moderate progressivity will be maintained by offering non-refundable credits that are phased out as income increases.

4. Credits are phased out at a rate of 1.3 cents per dollar of adjusted gross income in excess of $24,000 for married households and $12,000 for singles. Since the credits are completely phased out at high income levels, Utah’s new system will be a 5% flat tax for high income households.

5. Taxpayers will be able to choose a non-refundable credit based on either 6% of the federal standard deduction (approximately $10,900 in TY2008) or 6% of federal itemized deductions (excluding Utah income taxes paid).

6. Taxpayers will be able to claim non-refundable credits for each household member equal to 4.5% of the federal personal exemption (or 6% of 75% of the federal personal exemption). The federal personal exemption will be about $3,500 in TY2008.

7. Existing credits such as historic preservation, renewable energy, and several others that appear on the TC-40S form and are reported on lines 20 and 30 of the TC-40 will not be impacted by these changes.

Here's an example of how the new system will work based on TY2008 assumptions.

  • adjusted gross income: $60,000
  • family size: 4
  • standard credit: $10,900 x 6% = $654
  • personal credits: $3,500 x 4.5% x 4 = $630

1. Total credit prior to phase out would be $654 + $630 = $1,284

2. The phase-out would be ($60,000 - $24,000) x 0.013 = $468

3. Total credit would be $1,284 - $468 = $816

4. Total tax would be 5% x $60,000 less $816 = $2,184.

Under the old system (prior to changes in last year's special session), this household would have paid $2,374 in taxes for tax year 2008. The new system reduces individual income taxes by $190 per year for this household.

Monday, March 05, 2007

Significant increases in education spending?

For the past couple of weeks, Utah Republican leaders have bragged about recent increases in education spending. Others have asked "Have recent increases kept up with inflation and enrollment growth?"

In addition, many have not forgotten the lean recession years in the earlier part of this decade when education spending did not keep up with inflation and population growth. Have recent increases compensated for the lean years?

The answer to both questions is yes.

Everyone seems to have their own way of measuring education spending per student. Some -- particularly the UEA and local newspapers -- focus on the WPU which accounts for less than 50% of total education spending in Utah (and the WPU is not a per student measure anyway although there is a correlation). Others -- like the National Center for Education Statistics -- focus on operations costs, which exclude capital, debt service, and food service. Still others, like the Utah Taxpayers Association, focus on total spending, including capital expenditures and debt service (while excluding bond principal repayment to avoid double counting).

The best way to measure recent increases in per student spending is to look at the Minimum School Program (MSP). Total spending for FY2008 -- which includes capital, debt service, and federal expenditures -- won't be known for another two years. However, the Legislature has released data for the FY2008 MSP, and the MSP accounts for more than 90% of school district operation expenditures from state and local sources.

The Utah Taxpayers Association has calculated annualized inflation-adjusted per student MSP spending growth for three different time periods. The results are as follows.

1993 - 2008 . . .2.6% annualized
1998 - 2008 . . .2.2% annualized
2003 - 2008 . . 3.1% annualized

Keep in mind that these are annualized inflation-adjusted per student spending increases, and these increases are significant, even if some of the increase is so-called one-time revenues (one-time revenues are tax dollars too). We'll talk about one-time revenues in a later post.