Strong Roots Nebraska and LB357: Growing Nebraska with Sensible Tax Relief


An Independent Analysis of LB357’s Income Tax Reforms

 

By David G. Tuerck, Michael Head, and Frank Conte
The Beacon Hill Institute at Suffolk University
 

 

Executive Summary

To remain competitive in the interstate race for new jobs and investment, the state of Nebraska should examine the strengths and weakness of its current tax system.  Addressing the state’s high marginal income tax rate and its steep corporate tax is one way to improve the economic outlook. An initiative by the Platte Institute for Economic Research named “Strong Roots Nebraska” proposes an incremental tax reform plan that will cut both the personal income tax rate and the corporate income tax rate.[1]

 

Specifically, the proposed tax changes would eliminate income taxes on the first $6,000 of income for a married couple filing jointly, and would ultimately trim Nebraska’s top personal income tax rate from 6.84 percent to 5 percent. Meanwhile, the top corporate income tax rate would drop from 7.81 percent to 5 percent. The plan freezes property tax rates at current levels.

 

Economic modeling is one method to simulate the effects of a proposed change in tax policy on a state’s economy.  Robust models are able to capture the dynamism of an economy rather than a static picture where lower or higher tax revenue is assumed to have no effect on the decisions of consumers and businesses.

 

The Nebraska State Tax Analysis Modeling Program (NE-STAMP®) is a dynamic model, which captures the effects on economic activity of tax rate changes.  NE-STAMP allows The Beacon Hill Institute (BHI) to provide estimates of the effects of changes in state tax law on the state economy.  

 

BHI evaluated the Strong Roots Nebraska plan.   NE-STAMP generated the following results:

 

  • private employment would increase by 600 jobs in 2016, 1,920 in 2019 and 4,050 in 2023;
     
  • state population would increase by 300 people in 2016, 970 in 2019 and 2,000 in 2023;
     
  • an increase in investment of $55 million in 2016, $153 million in 2019 and $528 million in 2023;
     
  • real disposable income would increase by $52 million in 2016, $198 million in 2019 and $500 million in 2023: and
     
  • tax revenues would drop by $33 million in 2016, $125 million in 2019 and $320 million in 2023.

 

Introduction  

 

Endowed with natural beauty, productive farmland, a highly educated workforce and reasonably efficient government, Nebraska should continue to capitalize on its low cost-of-living, low unemployment and low energy costs.  Overall, Nebraska has the basic policies and endowments in place to grow in the future. 

 

According to the Beacon Hill Institute’s State Competitiveness Index, Nebraska ranks 7th in the nation in its ability to promote economic growth and increase personal income.[2] But the sustainability of this position going forward is not certain.  In a global economy, keeping any advantage will be more difficult as other states and nations compete for labor and investment capital. Today, some government and industry experts worry about Nebraska’s business climate, suggesting that the state is not welcoming to new firms.[3]  

 

Nebraska’s educational system does a good job preparing its students to enter the work force (a large portion of its workforce has more than a high school education and graduates a significant number of science and engineering students).  However, the benefits of those efforts are realized elsewhere. Policymakers are worried about the ability to retain and attract a younger workforce that is now drawn to higher paying jobs in other states.

 

Conceivably, there are several solutions to the problem,  but getting tax policy right is a critical component.  A viable state tax system must be able to raise the revenue that government needs in order to provide public services, while imposing the smallest possible burden on work, saving and investment.  The balancing act between taxation and spending becomes more difficult if other states deploy lower tax regimes combined with some other institutional or natural endowment. Compared to its neighbors, Nebraska has high marginal personal income tax rates. It also heavily relies more on income taxes as a percentage of its own source of revenue compared to the national average.[4] In addition, the corporate tax in Nebraska is among the steepest in the nation.[5]

 

Competition between states for new capital investment is one of the main drivers of tax reform.  Competition is no longer only between states but also between states and foreign nations. Improving the business climate, specifically by raising the return to capital investment, is viewed as the key to economic development.  Over the last 20 years, a variety of state reforms have been adopted, including tax and expenditure limitations and targeted tax cuts. On one side of the policy spectrum, states have also considered tax swaps, under which they would eliminate income taxes and raise sales taxes.  On the other side of the spectrum, some states have earmarked new taxes for education and transportation on the belief that human capital and infrastructure “investment” enable growth. While they are but one determinant of a state’s ability to generate jobs and investments, high taxes can exert a negative influence on growth.  A growing body of literature suggests that taxes and economic growth are more closely related than originally thought.[6]

 

An economic distortion, like a tax, is a state in which economic resources, such as labor, are not allocated efficiently and, as a result, workers and businesses do not maximize their welfare.  For example, suppose we have a labor market with no taxes and the equilibrium wage is $10 per hour, so that businesses pay workers $10 per hour.  If we impose a 10 percent tax on wages, there is now a tax wedge between the pay that businesses make to workers — workers before tax wage — and the wage that worker receive, workers “take home” pay.  Suppose that the tax burden is shared equally between businesses and workers.  Businesses must now pay $10.50 to workers and workers “take home” pay is reduced to $9.50.  Both business and workers are now worse off with the tax.  Moreover, due to the higher wage, some business will not be able hire as many workers, or must reduce employee hours, and some workers will not offer their labor services for $9.50 per hour.  As a result, we have a lower level of employment in the labor market.

 

In addition, because corporations are mobile and attentive to tax rates, states cannot impose exceedingly extractive corporate taxes.  States that limit themselves to a light touch on taxes for all industries believe justifiably that they will be rewarded with jobs and economic development.  Other states which seek to foster specific industries often opt for the targeted tax cut route where certain industries are granted specific “carve outs” from the current code. Sound tax policy must be based on five basic principles: revenue raising ability, neutrality, equity, easy administration and accountability.[7]  Political pressures go against the wisdom of public finance economists who advise against both the opaque exemptions and the targeted tax incentives that pander to special interests. A good tax system introduces a sense of certainty which engenders business confidence and taxpayer fidelity.  The Strong Roots Nebraska plan satisfies the sound principles of tax policy, particularly on efficiency grounds.

 

Compared with recent tax reform measures undertaken by other states, the Strong Roots Nebraska plan is modest.  Table 1 displays these changes.

 

Table 1: Strong Roots Nebraska Tax Plan

 

Personal Income Tax

Corporate Income Tax

 

$0 - $6,000

$58,000 or More

<$100,000

100,000+

Current

2.46%

6.84%

5.58%

7.81%

2016-2018

2.25%

6.69%

5.41%

7.58%

2019

2.04%

6.54%

5.23%

7.35%

2020

1.84%

6.38%

5.07%

7.11%

2021

1.62%

6.24%

4.90%

6.89%

2022

1.43%

6.08%

4.72%

6.65%

2023

1.23%

5.92%

4.54%

6.41%

End Goal

0.00%

5.00%

3.50%

5.00%

 

 

Under the Strong Roots Nebraska plan, the Nebraska personal income tax would fall for the lowest and highest income tax brackets by 2019.  The personal income tax rate would fall from 2.46 percent to 2.04 percent for income $6,000 or less; and the rate would fall from 6.84 percent to 6.54 percent for income of $58,000 and over. The Strong Roots Plan would provide all taxpayers with a 25 percent tax cut at the lowest bracket and a 7 percent tax cut for incomes $58,000 and above.

 

The Strong Roots Nebraska plan also proposes lowering both state corporate income tax rates.  Corporate income tax below $100,000 would drop from 5.58 percent to 5.23 percent and the rate income at $100,000 and above would fall from 7.81 percent to 7.35 percent in 2019. Nebraska’s businesses, both large and small, would receive a tax cut of roughly 9 percent under the plan.    

 

The Strong Roots Nebraska plan would lower tax rates further over a ten year period.  The plan would eliminate the personal income tax bracket for income under $6,000 and drop the rate for highest bracket to 5 percent. The corporate income tax rates would fall to 3.5 percent and 5.0 percent over the same time period.             

 

Initial tax relief would be funded by drawing down on the state’s existing cash reserve for the first two years to the amount of $40 million per year.[8] Future rate reductions will be phased in. Supporters maintain that spending reductions will only amount to one-percent per year.

 

The Strong Roots Nebraska plan poses several questions. 

 

  • What are the economic benefits of reducing corporate income tax and how will doing so affect the state’s competitive position relative to other states?

 

  • What impact on jobs, disposable income, state Gross Domestic Product and other economic indicators would a reform to the state’s personal and corporate income tax regimes have?

 

  • What will happen to property taxes in Nebraska?
     

The NE-STAMP model provides answers to such questions.

 

The Nebraska STAMP Model and Taxes

 

The Platte Institute for Economic Research asked the Beacon Hill Institute at Suffolk University to analyze the Nebraska tax system using BHI’s State Tax Analysis Modeling Program for Nebraska (NE-STAMP).  STAMP is a Computable General Equilibrium (CGE) model that determines the effects of changes in a wide variety of Nebraska taxes on key economic indicators.  The model provides sound economic theory to the determination of the effects of tax changes on employment, investment and incomes.  Robust models, such as NE-STAMP, are able to capture the dynamism of an economy rather than a static picture where lower or higher tax revenue is assumed to have no effect on the decisions of consumers and businesses.

 

The tax cuts would indeed result in a reduction of revenue.  While that would pose challenges, the money used to pay such taxes does not disappear from the state economy.  Government services would need to be cut at the local or state level and would lead to lower levels of government spending and/or employment.  The NE-STAMP model accounts for the negative impact of lower government revenues that diminish the total economic impact of tax cuts.  Nevertheless, the reduction in income would provide a boost to the state’s private economy leading to an increase in private employment, disposable income and investment.   

 

Static estimates assume that there is no change in underlying economic activity in response to a change in tax law.  For example, a static estimate of a cut in the sales tax, say from 5 percent to 4 percent, would cause revenues to fall by 20 percent (= 5 – 4)/5).  A dynamic estimate would show a smaller drop in revenue because it would capture the positive effect on the tax base of the cut in the sales tax.  The complete elimination of the sales tax would not enable any dynamic revenue effects for the tax itself, since the rate would be zero.  However, businesses would have more money to make profitable investments in Nebraska, thus increasing investment and employment, incomes and retail sales which, in turn, boosts sales and property tax collections.  One of the principal purposes of STAMP is to capture such dynamic effects.

 

In NE-STAMP, taxes are divided into several categories with each category treated differently by the model:  taxes on labor and capital (business property tax and workers compensation tax), sales and excise taxes on the industrial sectors (motor fuels tax), household taxes (residential property tax and license fees) and personal income taxes.  Some taxes are included in more than one category (e.g., the corporate income tax).  All of the taxes enter the standard gross domestic product (GDP) and government income equations.  Here, we trace the taxes through the model and explain how they affect the economy. 

 

Estimates and Results

 

BHI modeled the Strong Roots Nebraska plan using NE-STAMP to identify the effects of tax reduction.  BHI assumes that the plan will be implemented in 2016 and we model the tax changes over the first seven years.  Table 1 displays the results for the years 2016, 2019 and 2023, the last year that the Strong Roots Nebraska plan specifies tax rates.

 

Table 2: The Fiscal and Economic Effects of the Strong Roots Nebraska Plan

Economic Effects

2016

2019

2023

Population Change (people)

300

970

2,000

Private employment (jobs)

600

1,920

4,050

Investment ($ millions)

55

153

528

Real disposable income($ millions)

52

198

500

Fiscal  Effects ($ millions)

 

 

 

Personal Income Tax

(30.5)

(110.1)

(252.2)

Corporate Income Tax

(8.0)

(26.8)

(103.7)

Sales Tax

1.0

3.7

10.5

Other Taxes

0.4

1.3

3.7

Total State Tax Change

(37.1)

(131.9)

(341.7)

Property Tax

1.2

3.5

11.4

Sales Tax

0.3

1.1

3.4

Other Taxes and Fees

0.6

2.3

7.1

Total Local Tax Change

2.1

6.9

21.9

Total State and Local Tax Change

(35)

(125)

(319.8)

 

 

Under the Strong Roots Nebraska proposal, which would gradually lower the personal and corporate income taxes, NE-STAMP showed that private employment would increase by 600 in 2016, 1,920 in 2019 and 4,050 in 2023.  The tax changes also support the population of Nebraska, which would also increase by 350 people in 2016, 1,210 in 2019 and 2,770 in 2023.  The state economy would see an increase in investment of $55 million in 2016, $153 million in 2019 and a higher increase in 2023 of $528 million.

 

The state would lose a net of $37.1 million in 2016, $125 million in 2019 and $319.8 million in 2023.  However, taxpayers would be richer. Real disposable income would increase by more than $52 million in 2016, $198 million in 2019 and $500 million in 2023. 

 

The boost in economic activity would produce a moderate increase in tax revenues for local governments.  Local tax revenues would rise by $2.1 million in 2016, $6.9 million in 2019 and by $21.9 million in 2023.   

 

Conclusion

 

Tax policies matter significantly in the measure of a state’s ability to provide an environment conducive to economic growth.[9]

 

Economists have long maintained that taxes, particularly those that aim to redistribute wealth, impose an excess burden or deadweight loss. Any move toward tax reform must consider the fact that higher tax rates reduce the tax base. The goal of a viable tax system should be to ensure not only fairness but also efficiency.

 

The Strong Roots Nebraska proposal evaluated by the NE-STAMP model provides evidence that the gradual reduction in state income taxes would provide a modest boost to the state economy. Reduced income and business tax revenue for the state means more real disposable income for consumers and businesses. Those dollars circulate to purchase goods and services and thus flow into the sales tax revenue stream. 

 

The state of Nebraska would incur modest revenue losses, under the Strong Roots Nebraska plan, as noted above. However, the plan stipulates that the first two years would be funded from the state’s existing cash reserves.  Thereafter, the legislature and the Governor will have to decide whether such gains in the form of long-term economic output are worth the revenue losses projected by NE-STAMP in the out-year of 2023 and beyond.  

 

In the 21st century states face enormous competitive pressures not only from neighboring states but other nations across the globe.  Income tax systems have shown some durability but they continue to impose efficiency costs. 

 

Methodology

 

To identify the economic effects of the tax discounts and understand how they operate through a state’s economy, BHI customized its STAMP® (State Tax Analysis Modeling Program) model for Nebraska (NE-STAMP).[10] NE-STAMP is a five-year dynamic CGE (computable general equilibrium) model that has been programmed to simulate changes in taxes, costs (general and sector specific) and other economic inputs. As such, it provides a mathematical description of the economic relationships among producers, households, governments and the rest of the world.[11]

 

A CGE tax model is a computerized method of accounting for the economic effects of tax policy changes. A CGE model is specified in terms of supply and demand for each economic variable included in the model, where the quantity supplied or demanded of each variable depends on the price of each variable. Tax policy changes are shown to affect economic activity through their effects on the prices of outputs and of the factors of production (principally, labor and capital) that enter into those outputs.

 

A CGE model is in “equilibrium,” in the sense that supply is assumed to equal demand for the individual markets in the model. For this to be true, prices are allowed to adjust within the model (i.e., they are “endogenous”). For instance, if the demand for labor rises, while the supply remains unchanged, then the wage rate must rise to bring the labor market into equilibrium. A CGE model quantifies this effect.

 

Finally, a CGE model is numerically specified (“computable”), which is to say it incorporates parameters that are believed to be descriptive of the actual relationships between quantities and prices. It produces estimates of changes in quantities (such as employment, the capital stock, gross state product and personal consumption expenditures) that result from changes in prices (such as the price of labor or the cost of capital) arising from changes in tax policy (such as the substitution of an income tax for a sales tax).

 

Because it consists of a large number of interrelated equations, a CGE model ordinarily requires the application of a nonlinear computational algorithm, typically some variation on Newton’s method.  STAMP requires the development and application of a sophisticated computer program for the solution of its equations.


[2] The Beacon Hill Institute at Suffolk University, State Competitiveness Report,  13th edition, (March 2014), http://www.beaconhill.org/CompetitivenessHomePage.html.

[3] Clark, Strong Roots Nebraska.

[4] BHI calculations based on U.S. Census, “State Government Tax Collections,” Nebraska and U.S. data from http://www.census.gov/govs/statetax/.

[5] Tax Foundation, “Business Climate Index 2013,” Background Paper 68, (October 2013), http://taxfoundation.org/sites/default/files/docs/2014%20State%20Business%20Tax%20Climate%20Index.pdf.

 

[6] William McBride, “What is the Evidence on Taxes and Growth?” Special Report 207, Tax Foundation, (December 18, 2012), http://taxfoundation.org/sites/taxfoundation.org/files/docs/sr207.pdf.

[7] David Brunori, State Tax Policy: A Political Perspective, (Washington D.C.: Urban Institute Press, 2001)13-29.

[8] Clark, Strong Roots Nebraska

[9] Pavel A. Yakovlev, State Economic Prosperity and Taxation, Working Paper 14-19, Mercatus Center, George Mason University (July 2014) http://mercatus.org/sites/default/files/Yakovlev-State-Economic-Prosperity.pdf.

[11] For a clear introduction to CGE tax models, see John B. Shoven and John Whalley, “Applied General-Equilibrium Models of Taxation and International Trade:  An Introduction and Survey,” Journal of Economic Literature 22 (September, 1984): 1008. Shoven and Whalley have also written a useful book on the practice of CGE modeling entitled Applying General Equilibrium (Cambridge:  Cambridge University Press, 1992). See also Roberta Piermartini and Robert Teh Demystifying Modelling Methods for Trade Policy (Geneva, Switzerland: World Trade Organization, 2005) http://www.wto.org/english/res_e/booksp_e/discussion_papers10_e.pdf  (accessed June 18, 2010).

 
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