Tax Policy and the Race for the Governor’s Mansion: Arkansas Edition

Voters in 36 states will be choosing governors this November. Over the next several months, the Tax Justice Digest will be highlighting 2014 gubernatorial races where taxes are proving to be a key issue. Today’s post is about the race for Governor in Arkansas.

No matter who wins the governor’s race in November, income tax cuts are coming to Arkansas. The state finds itself in a unique position this year – because of a law imposing term limits on the governorship, neither of the 2014 gubernatorial candidates is an incumbent, yet both are attempting to fashion themselves in the image of current Democratic Governor Mike Beebe as they push long-term income tax overhauls.

Back in 2006, then-candidate Beebe made slashing the state’s historically unpopular sales tax on groceries the cornerstone of his campaign, a promise he kept as governor as he gradually reduced the rate over the course of his 8-year term from 6% to 1.5%. Beebe was commended both at home and in national policy circles for successfully implementing a common-sense tax cut which lessened the regressivity of the sales tax for low-income Arkansans while also minding the health of the state’s revenue stream – not cutting too deeply too quickly.

In the current gubernatorial race, Republican candidate Asa Hutchinson and Democratic candidate Mike Ross have both invoked Beebe’s duly cautious sales tax reduction strategy as a model for their own income tax cut proposals. But the thing is, the income tax is fundamentally different – state sales taxes are known to be highly regressive, but the income tax is a progressive tax that has the potential to increase the overall fairness of state taxes. As always, the cost of reform to the state should be no small consideration in any evaluation of the candidates’ proposals, but just as important is the extent to which broad income tax cuts would be a loss for progressivity in state taxation.

Arkansas’ current income tax brackets were designed back in 1971 and were left unchanged for 26 years until 1997, when the state legislature first began indexing the brackets to inflation, with a 3% cap. But the legislature declined to apply the indexing retroactively, meaning that bracket boundaries have only risen alongside inflation for 17 of their 43 years of existence (a problem exacerbated by recent low levels of inflation). In real terms, then, the dollar value of the state’s current bracket boundaries are stuck in the 1980s, with the top bracket starting at $34,000. This would be fine if prices and incomes were still at 1980 levels, but inflation inevitably does what it does best – inflates – and has pushed many middle-income Arkansans into unjustifiably high tax brackets.

Mike Ross has proposed a relatively simple, measured hike in the bracket thresholds that retains the tax’s original structure. Ross would lower rates across the board by 0.1% (except the top rate, which is already being lowered by the same amount as part of last year’s tax cut package) and retroactively index the tax brackets to inflation for the 26 years prior to 1997. Applying this type of broad reform, with the adjusted top bracket starting at a more reasonable $75,100, would certainly target relief toward the low- and middle-income taxpayers most affected by inflationary tax hikes under the current structure, but it would also afford unnecessary benefits to the higher end of the income ladder.

Critics have taken issue with the fact that Ross’s timetable for implementation is indeterminate, with the candidate saying only that he will “implement [the proposal] in a gradual, fiscally responsible way — as the state can afford it.” The plan also comes with a $575 million price tag, as projected by the Arkansas Department of Finance and Administration (DFA), once it is fully phased in.

Hutchinson is pushing a more rapid timetable for his own income tax cut plan, which has some worried about unmanageable revenue impacts. The candidate is proposing immediate first-year rate cuts – namely, lowering the rate for those in the $20,400-$33,999 bracket from 6% to 5%, and from 7% to 6% for those earning $34,000 to $75,000. The phased-in portion comes via the implementation of an ill-advised rate cut for those earning more than $75,000 “as surpluses and growth allow.” Extrapolating from Hutchinson’s pledge that no one earning over $75,000 will receive a tax cut under his initial plan, the benefit of the lower rates would likely be phased out over some income range just under $75,000. The plan would target around 500,000 middle-income taxpayers, but would do nothing to lower the taxes paid by the poorest Arkansans – those earning under $20,400.

The campaign estimates the first-year cost at $100 million (the major caveat here is that the cost for the Hutchinson plan cannot be compared to the cost of the Ross plan and should not be taken as an official estimate because the Hutchinson campaign has refused to release plan details to the DFA to model). Hutchinson intends to use surplus funds to cover the cost of the cuts in 2015 and is counting on state revenue growth in future years – a tenuous strategy given the eventual $140 million per year cost of last year’s tax cut package that will be competing for new revenues.

With the price of both plans likely to be a major factor, Hutchinson’s plan at least appears to be preferable in terms of fairness, with high-income taxpayers seeing no cut. But unfortunately, the plan is a red herring. The candidate has made no bones about his end goal – the total elimination of the income tax in Arkansas. Such a move would wipe out a major piece of the state’s tax base and take away the only meaningful mechanism for reducing regressivity, and that outcome has far greater implications for both fiscal health and fairness than Ross’s across-the-board cuts.