What’s Wrong With This Picture?

One of the last-minute changes to the budget agreement substituted a 0.25 percentage point increase in each of the state’s basic income tax rates in place of a 5.0 percent income tax surtax. The enacted change would increase each of the tax rates for two or four years, depending on whether the spending cap that will appear on the May special election ballot is approved by the voters. For example, the 4 percent tax rate would be 4.25 percent under the new law and the 9.3 percent rate would go to 9.55 percent. As discussed in yesterday’s blog post, the increase would be cut in half – to 0.125 percentage points – if the Treasurer and Director of Finance certify that the state will receive at least $10.0 billion in “flexible” funds from the federal economic recovery bill. In contrast, the proposal under consideration until the final night of budget negotiations would have required all personal income taxpayers to add an amount equal to 5.0 percent of their tax liability for the two- or four-year period.

Because of this seemingly minor change, lower-income households will experience a much larger tax increase than under the previously considered proposal. The tax liability of a married couple with a taxable income of $40,000 will rise by 12.9 percent under the enacted policy, as opposed to 5.0 percent under the proposal previously under consideration. In contrast, the tax liability of a married couple with a taxable income of $150,000 will rise by 4.0 percent under the final agreement, instead of 5.0 percent under the original surcharge proposal. High-income earners will experience the most significant change – their tax liability will only rise by 2.9 percent under the enacted policy.

The bottom line: this late night change dramatically shifted the impact of the personal income tax increase downward on to low- and middle-income taxpayers, in contrast to a previously considered proposal that would have had a flat impact across the income distribution.

— Jean Ross

2 Responses to What’s Wrong With This Picture?

  1. David says:

    I don’t understand how you arrived at these numbers. I believe they are correct, but how did you do it? How does a .25 in increase = 12.9 for 40K and only 2.9 for 750K. And doesn’t this then mean that the current tax system results in the same backwardness?

  2. cbporg says:

    David, Thanks for your question. The recently approved change in 0.25 percentage point increase in personal income tax rates would increase the taxes owed by a married couple with a taxable income of $40,000 from $777 to $877, a 12.9 percent increase. In contrast, the personal income tax liability of a married couple with a taxable income of $150,000 would rise from $9,341 to $9,716, a 4.0 percent increase. (Both examples exclude the impact of any tax credits to which the hypothetical couple might be entitled). The disparity results from simple algebra – the $100 increase in the tax liability of the lower-income example represents a larger percentage increase than does the larger dollar increase represents for the higher-income example. Moreover, the higher-income couple are more likely to itemize their deductions and thus benefit from the fact that state income taxes can be deducted for federal tax purposes.