Arkansas' top individual income tax rate will drop from 6.6% to 5.9% on Jan. 1, 2021, under current state law, and Revenue Division officials have drafted a proposal that would reduce that top rate further to 5.5% over two years.
The proposal would eventually reduce state general revenue by $115.1 million a year.
They also have estimated that general revenue would drop by $86.5 million a year under House Revenue and Taxation Committee Chairman Joe Jett's draft legislation that would exempt earners in the lower-income tax table from paying individual income taxes.
"No decision has been made as to whether any of the tax cut proposals will be an agenda item in the next legislative session," Gov. Asa Hutchinson said Friday.
"I will not be able to properly evaluate these options until after the revenue forecast is set for the next biennium," the Republican governor said in a written statement. "[M]y highest priority has always been to lower the individual income tax rate. It needs to be lowered over time to 5%."
On Nov. 10, state officials are scheduled to release Hutchinson's proposed general revenue budgets for fiscal 2022, which starts July 1 next year, and fiscal 2023, which starts July 1, 2022. The state Department of Finance and Administration's general revenue forecast for those two fiscal years will be released as well.
"One thing that is important to note about the budget is while we have a surplus right now, we have another six months-plus that's left in this fiscal year and there's uncertain times and not confidence that we are going to be able to maintain that surplus every month in the next year, so we're going to continue to conservatively budget and make sure that we have adequate reserves as we go into the session next year," Hutchinson told reporters Thursday.
FISCAL 2021 BUDGET
In the fiscal session in April, the Republican-dominated Legislature enacted a $5.89 billion general revenue budget for fiscal 2021. The finance department's revenue forecast will provide $5.68 billion for that budget and leave $212.2 million unfunded.
On April 2, the department trimmed its original forecast for fiscal 2021 by $205.9 million, citing a projected economic recession triggered by the coronavirus pandemic.
During the first three months of fiscal 2021, the state has accumulated a net surplus of $158.8 million through the end of September.
State lawmakers on Tuesday will begin hearing budget requests from state agencies for the next two fiscal years in advance of the regular session starting Jan. 11. The hearings come against the backdrop of behind-the scenes-discussions about potential tax cuts or possible tax increases.
Because of the pandemic, lawmakers will be separated by Plexiglas during their budget hearings in the Multi-Agency Complex west of the state Capitol.
Joint Budget Committee Co-Chairman Rep. Lane Jean, R-Magnolia, said he's interested to see how much more in state funds that the state Department of Human Services and state Department of Corrections will seek for the next two fiscal years.
The House and Senate Education committees Tuesday recommended an increase of $99.7 million in state funding for public education in fiscal 2022 and another increase of $86.9 million in fiscal 2023.
Jean said he's wary there will be more of an economic downturn amid the coronavirus.
"I don't think we have hit the depths of it, but we'll see," he said.
Senate Democratic leader Keith Ingram of West Memphis said he expects that Hutchinson eventually will be cautious, and propose phasing in individual tax cuts over a number of years.
"There is a lot of concern about the economy going forward," with the prospect of the economy slipping back into a recession, he said.
If the U.S. Supreme Court overturns the federal Patient Protection and Affordable Care Act under which the state operates its Medicaid expansion program called Arkansas Works, that "would have a tremendous impact on our state budget," Ingram said.
In March, the U.S. Supreme Court agreed to consider an appeal by a group of Democratic-led states that are defending the 2010 health care overhaul law, a signature achievement for then-President Barack Obama, against a legal challenge from a group of Republican states.
Arkansas Works provides health coverage to about 285,000 low-income Arkansans. The state pays 10% of the cost with the federal government covering the other 90% of the price tag.
Neither the Department of Finance and Administration nor the Department of Human Services has conducted a financial analysis of the impact on the state budget if the federal law is overturned by the U.S. Supreme Court, according to spokesmen for the two agencies.
INCOME TAX CUTS
The state's top individual income tax rate currently applies to income above $80,800, said Scott Hardin, a spokesman for the state Department of Finance and Administration.
Arkansas Revenue Division officials' draft proposal to cut the state's top individual income rate from 5.9% to 5.5% is projected to reduce state general revenue by $115.1 million over calendar years 2022 and 2023 and its initial impact would be spread over three fiscal years, state Revenue Commissioner Charlie Collins said in an Aug. 14 email to Finance and Administration Secretary Larry Walther.
"Attached is our proposal for your consideration regarding potential income tax reduction legislation," Collins wrote in his email to Walther.
Collins, a former Republican state representative from Fayetteville, has been a staunch advocate for cutting the state's individual income tax rates.
Cutting the top rate from 5.9% to 5.7% in 2022 and to 5.5% in 2023 would "further tax competitiveness with surrounding states," according to the Revenue Division proposal. The document states that the information in it should not be considered the position or views of the agency or the governor.
Two of Arkansas' neighboring states -- Tennessee and Texas -- don't have individual income taxes.
Mississippi and Oklahoma's top individual income tax rate is 5%, while Missouri's top rate is 5.4% and Louisiana's top rate is 6%, based on information compiled by the Federation of Tax Administrators.
Collins said in his email that reducing the top individual income tax rate from 5.9% to 5.5% over three fiscal years is projected to reduce state general revenue by $109.6 million and "adjusting bracket cliffs for tax fairness" is projected to reduce revenue by $5.5 million.
A "bracket cliff" means when an increase in income triggers a tax increase.
The change from one income tax table in 2015 to three tables with different rates created "cliffs" at the beginning of each tax table, and the cliffs have increased significantly in the past four tax seasons, according to the proposal.
Collins said in interview that adjusting the "bracket cliffs" would ensure a smooth transition "so that nobody ends up in a funky situation where between $79,000 and $81,000 in income they wind up worse off on income in their pocket as they earn more money and that's what those cliff adjustments do."
State officials project the top rate cut proposal would reduce state general revenue by $27.4 million in fiscal 2022, $54.8 million more in fiscal 2023 and $27.4 million more in fiscal 2024. About 452,000 taxpayers would be affected by this proposal.
"One addition we could make if you desire is a plan to reduce that top rate further, from 5.5% to 5.0%," Collins wrote in his email to Walther. The Arkansas Democrat-Gazette obtained the document under the state Freedom of Information Act.
Since taking office in 2015, Hutchinson has repeatedly said he eventually would like to reduce the state's top individual income tax rate to 5%.
Reducing the top rate from 5.9% to 5% is projected to reduce general revenue by $246 million a year, Hardin said. They project a $27.4 million reduction in revenue for every 0.10% cut off the top individual income tax rate, he said.
Asked whether the governor plans to propose cutting the individual income tax rate to 5.5% over a two-year period in the 2021 regular session, Walther said in a recent interview, "I guess it's Collins' proposal to start the discussion. The object, I think, would be the 5% if we could."
"But we're anticipating next year might not be as good as the following year, so you're looking at not being able to do it all at one time and what he decided was how we could do it over three years," Walther said.
Act 182 of 2019 -- enacted by the Arkansas General Assembly and the governor in the 2019 regular session -- cut the top individual income tax rate from 6.9% to 6.6% on Jan. 1 of this year and will cut that top rate further to 5.9% on Jan. 1, 2021.
State officials officials projected Act 182 would ultimately reduce general revenue by $97 million a year.
In 2015, the Legislature enacted Hutchinson's individual income tax rate cuts for the middle class that were projected by state officials to reduce state tax revenue by about $100 million a year.
In 2017, an income tax rate cut for low-income Arkansans was enacted that was projected to reduce state tax revenue by about $50 million a year.
Jett, a Republican from Success, said he plans to propose legislation eliminating the state's low-income tax table and exempt taxpayers based on that table.
For tax year 2019, the low-income tables taxed individual net income at up to $22,599 and for 2020 the amount will be up to $22,899, according to Revenue Division officials.
More than 703,000 taxpayers would be affected by this proposed exemption.
According to Revenue Division officials, based on 2019 tax returns:
• About 222,000 Arkansas taxpayers with net taxable income of $80,800 and up paid income taxes of $1.59 billion.
• About 640,000 taxpayers with net income of $22,600 to $80,800 paid income taxes of $919.7 million.
• About 703,00 taxpayers with net income of $22,599 and below paid income taxes of $86.4 million.
"We are going to take a serious look at it," said Jett. "For $80 million, we can eliminate taxes for 700,000 residents. It is a big bang for the buck."
EXEMPTION FOR NEW RESIDENTS
In addition, Revenue Division officials developed a proposal that would create an income tax exemption for every new Arkansas resident for five years.
They projected more than 9,000 new residents a year would be affected by this proposal and it would reduce general revenue by $16.5 million in the first year, $33 million in the second year, $49.5 million in the third year, $66 million in the fourth year, and $82.5 million a year in the fifth year and in the future.
The proposed income tax exemption "could withstand scrutiny under the equal protection clause, if upon legal challenge, the U.S. Supreme Court or Arkansas Supreme Court determined a rational basis for enactment of the exemption for a certain class of taxpayers was identified," according to the proposal.
Collins said through a spokesman that said the proposal was developed because "we've heard about this idea in multiple places, including the Democrat-Gazette, and I wanted to put some research into it to better understand."
SOFT DRINK TAX
Another proposal drafted by the Revenue Division would phase out the soft drink tax over a three-year period, which would ultimately reduce general revenue by $39.4 million a year by fiscal 2025.
Collins said the proposal was developed as "more of a thought starter."
Collins said the Revenue Division developed estimates for increasing the amount of the price of a used vehicle exempt from the sales tax and those estimates are based on "some of the numbers that we have heard or read about in the newspaper."
Increasing the exemption from $4,000 to $7,499 is projected by state officials to reduce general revenue by $12.7 million. Raising the exemption to $19,999 is projected to reduce revenue by $121.5 million a year.
Rep. John Payton, R-Wilburn, said he plans to propose legislation in the 2021 regular session to increase the exemption to $10,000. His legislation that would have increased the exemption to $7,500 failed to clear the Senate Revenue and Taxation Committee in the 2019 regular session.
Arkansas does not have a special excise tax on vapor products or e-cigarettes; about half of the states do not tax vapor products.
Revenue Division officials drafted a proposal to levy a retail-level vape excise tax.
They projected a 7% tax rate would raise $3.2 million a year and a 10% rate would raise $4.6 million a year.
State officials also projected a 15% retail rate would raise $7 million a year and a 20% rate would raise $9.3 million.
Collins said the vape tax proposal "is much more of an exploratory trying to lay out the landscape for how this is being done because this is a new animal."
"What I am strongly recommending to Larry, if the governor chooses to go in a direction like this or if the Legislature does, I think it would be much better from a tax processing standpoint to do it as a retail excise tax, very much like a sales tax," he said.