Targeted Income Tax Increase Would Raise Revenue, Make Tax System Fairer
HARRISBURG, PA (July 23, 2009) - Pennsylvania lawmakers can raise new revenue to resolve a multi-billion-dollar state budget shortfall and make the tax system fairer by targeting a personal income tax increase to affluent earners who can best afford to pay.
In a paper released today, the Pennsylvania Budget and Policy Center and Keystone Research Center explain that this can be achieved by setting a higher income tax rate on investment income while expanding the state's tax forgiveness program for working families. The plan also incorporates a modest increase in the tax rate on earned income.
"The increases in income taxes would be paid in large part by taxpayers at the very top that have enjoyed very rapid increases in income in recent years," said Stephen Herzenberg, Ph.D., Executive Director of the Keystone Research Center and author of the paper. "People in lower-income rural regions and city neighborhoods would pay relatively little. Tens of thousands of working families would receive an income tax decrease."
During the economic boom that followed the 2001 recession, nearly 80% of income growth went to the richest 1% of Pennsylvanians. Meanwhile, nine out of every 10 Pennsylvanians saw their income drop during that time. Because Pennsylvania has a flat income tax rate, and sales and property taxes fall more heavily on lower-income earners, top earners pay substantially less of their income overall in state and local taxes than middle- and lower-income workers.
Dr. Herzenberg said lawmakers should target revenue increases as much as possible to top earners in order to balance the state budget and preserve investments in education, children's programs, senior services and health care.
The paper recommends three changes to the personal income tax:
1. An increase in the rate on earned income (wages and salaries) and interest income from the current 3.07% to 3.4%.
2. A higher income tax rate on investment income (dividends, capital gains, net profits but not interest) to 4%, still far below the top income tax rate of any of our neighboring states.
3. An expansion of the state's tax forgiveness program that exempts families from paying income tax (complete tax forgiveness for a family of three with two children earning up to $27,500, up from the current $25,500).
This proposal, in addition to making the tax system fairer, would resolve the state budget stalemate without increasing job losses as much as steep budget cuts or a sales tax increase, the paper notes.
Steep budget cuts would reduce state economic activity dollar for dollar since government spends every dollar it takes in. By contrast, a tax increase, especially one targeted to affluent earners, would reduce private sector spending by less than a dollar. That's because more affluent earners would have saved a substantial part of that dollar and not used it to increase their spending.
Additionally, a higher state income tax, unlike with a higher sales tax, lowers federal income taxes for Pennsylvania taxpayers who itemize federal deductions. On average, 20 cents of every dollar paid by Pennsylvanians in higher state income taxes comes back to the state in the form of lower federal income taxes.
The greatest share of the increased revenue under this proposal - 36% - would come from the five-county Philadelphia region, while Allegheny County would pay 10% of it, the paper notes. Pennsylvania's 48 rural counties, which account for 28% of the state's population, would pay 18% of the tax increase.
Dr. Herzenberg said these changes can be enacted without running afoul of the "uniformity" clause in Pennsylvania's constitution, which prevents the state from enacting a graduated income tax. State law recognizes interest, dividends, and other unearned income as different income "classes," opening the door to taxing it at a higher rate than earnings and interest income.
Dr. Herzenberg said a better long-term approach would be to repeal the uniformity clause and enact a graduated income tax.
"Even with the changes proposed in this paper, the state's overall state and local tax system would remain highly regressive because middle- and lower-income families pay a much higher fraction of their income in state sales and local property taxes than do upper income earners," he said.
If lawmakers voted to repeal the uniformity clause this legislative session and again next session, it could go before state voters in a referendum as early as the spring 2011 primary, less than two years from now.
