Missouri tax reform could give the state a competitive edge
Tax reform has become a major focus for state legislatures this session, and Missouri lawmakers are tuned for action: After adjusting personal income tax triggers in 2021, the legislature explores other tax reform options. Senate Bill 739 would create an additional tax trigger for personal income tax, while SB 701 would completely eliminate corporate income tax in the 2023 tax year.
In an increasingly mobile post-pandemic economy, tax policy plays a bigger role in the location decisions of businesses and residents. State legislatures are aware and acting massively to make their states attractive for business. Thirteen states passed tax cuts during the 2021 legislative session, and the trend has continued in 2022, with five states having already passed tax reform bills.
Missouri faces nationwide competition from this rapidly changing tax landscape, but must also be able to compete with its neighbors. While Missouri’s top tax rate is 5.4%, Kentucky and Illinois have lower rates of 5% and 4.95%, respectively, and Tennessee levies no income tax. individual.
Missouri is already tied with Oklahoma for the nation’s second-lowest corporate income tax rate at 4% — behind only North Carolina’s 2.5% — but further cuts or elimination total corporate income tax would really make the state stand out.
Senate Bill 739 creates a tax trigger system that relies on a basic general income of $10.3 billion. Each year that general revenue exceeds this benchmark, the top personal income tax rate would be reduced by at least 0.1 percentage point. Multiple reductions can occur in the same year: for every $145 million of income above this benchmark, the top tax rate would be reduced by an additional 0.1 percentage point. The rate reductions would be permanent and the baseline would increase by $145 million for each reduction triggered.
There is no target rate, which means this trigger mechanism could eventually eliminate personal income tax if the state sees enough growth. However, the loss of income due to possible income tax reductions makes this event unlikely. Lower income tax rates help promote economic growth, which broadens tax bases — for income, consumption and other taxes. As long as income tax remains in place, the loss of revenue from lower rates can be somewhat mitigated by revenue from a broader tax base. With full repeal, however, it does not matter how much economic growth is attributable to the policy: the income is not taxed. (Although other tax revenue should also be higher.)
The bill’s financial report estimates that revenue in fiscal year 2022 would reach $11.2 billion, triggering seven cuts of 0.1 percentage points in tax year 2023 and lowering the top rate to 4.6%. Due to reduced revenue from the lower rate, the report estimates that general revenue would reach $11.1 billion in fiscal 2023, below the new baseline of $11.315 billion.
Notably, the baseline increases with each reduction, but it is not adjusted for inflation, so it is possible that inflation could take the state above the baseline before real growth didn’t do it. The chosen trigger mechanism leaves room for revenue growth – locking in gains – but a better model might trade a lower dollar value on the nominal trigger amount, but tie it to inflation.
It is important to note that Missouri already has a personal income tax trigger in place. The system created in 2014 provided for reductions of 0.1 percentage point of the top rate per year, subject to the availability of revenue, for a total of five reductions. Senate Bill 153, signed into law in 2021, builds on this by authorizing two additional reductions, also subject to revenue triggers. This recent law also provides that the maximum rate will be reduced by 0.1% in the 2024 tax year, without the need for any trigger.
Rate reductions are helpful, but simplicity and predictability are also important features of a good tax code. If lawmakers are considering this new trigger because they are unhappy with the pace at which rate cuts are being triggered, they should consider bypassing them altogether and voting for lower rates immediately. Alternatively, if the objective of this new trigger is an eventual phasing out of income tax, legislators should consider retaining this trigger, adjusting the benchmark for inflation, and integrating more broadly the other triggers in this design. A single, consistent tax trigger system is preferable to an overlapping landscape where triggers can work together or oppose each other. A responsible plan to cut rates would promote economic competitiveness and growth, paving the way for further growth-enhancing tax reforms in the future.
The corporate income tax bill, SB 701, is much more direct and would eliminate corporate income tax beginning with the 2023 tax year. If enacted, Missouri would become one of only three states that levies neither corporate income tax nor a harmful gross receipts tax – a significant competitive advantage between the states. Corporate income taxes are much more volatile than other types of taxes because they are closely tied to the economy and business performance. It is therefore wise to reduce the use of these taxes.
Missouri currently ranks 13and overall on our annual report State Enterprise Tax Climate Index, a comparison of the competitiveness of state tax codes. Without corporate taxes, Missouri’s ranking would drop to fifth.
Of course, this type of competitive change is only truly beneficial if the state can afford it. The bill’s tax report estimates that eliminating the corporate tax would cost the state $280 million in fiscal year 2023 and about $561 million annually in subsequent years. The tax on financial institutions would also necessarily fall to zero with the repeal of the corporate income tax, which would cost the state about $770,000 a year. It would also reduce local revenues by about $38 million a year, according to the report. Overall, local governments have seen significant revenue increases in recent years, outpacing state revenue gains.
While these revenue numbers seem significant at first glance, it’s important to put them into context. In fiscal year 2020, Missouri relied on corporation tax for 0.9% of total revenue, 1.1% of general revenue, and 2.9% of tax revenue.
Missouri is expected to see a state tax revenue surplus of $1 billion this year, not including the influx of one-time federal funds. Although one-time funds (other than ARPA dollars) can be used to absorb transition costs and initial revenue losses, permanent tax reductions must be funded by permanent funding, either by growth in income or through budget adjustments. Fortunately, Missouri is in a solid financial position. The consensus state revenue estimate projects general revenue in fiscal year 2023 to reach $11.4 billion, a 2.1 percent increase from fiscal year 2022. The governor’s office does not released no estimates for subsequent years, but if the state’s economic growth continues, Missouri could absorb the cost of the corporate tax repeal. This would interact with the trigger for personal income tax cuts, allowing the two to be adopted in parallel.
It may be possible to change the design of personal income tax triggers, but policymakers are on the right track in seeking to reduce personal income tax rates. And, even if the legislature fails to completely repeal the corporate income tax, rate reductions would help reduce the state’s reliance on a volatile tax and improve Missouri’s standing among the states.