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More states may raise taxes on "rich"

If other states follow Oregon's lead, federal tax changes could make hikes doubly painful.

By Teresa Mears Feb 4, 2010 12:00PM

This news article comes from Ashlea Ebeling and Janet Novack at partner Forbes:

 

Last week, Oregon voters approved a package of corporate tax hikes and an increase in the state's top individual income tax rate from 9% to 11%, putting the state in a tie with Hawaii for the highest state income tax rate in the nation. (Oregon is listed as second in Forbes’ list, however, because its 11% rate starts at a higher income level.)

 

The Oregon increases were first adopted by the legislature in July to cover a $773 million budget shortfall and then targeted for voter rejection by the referendum. In previous referendums, Oregonians had nixed tax increases that would have affected a majority of the population directly, notes the Washington-based Tax Foundation.

 

But this time the tax hike hit only corporations and 2% of individual income taxpayers -- couples with incomes above $250,000 and individuals earning more than $125,000. So voters blithely ignored the warnings of the state's most successful entrepreneur and its only Forbes 400 member, Nike founder and Chairman Phil Knight. He campaigned against the hikes, dubbing them "Oregon's Assisted Suicide Law II" and predicting that "thousands of our most successful residents will leave the state."

 

Does Oregon's vote mean more income tax hikes targeted at the "rich" are on the way? That's certainly what state employee unions, which backed the Oregon increase, and liberal leaning groups are hoping. And Jamie Yesnowitz, a senior manager in Grant Thornton's state and local tax group in Washington, D.C., thinks such hikes are very possible.

 

Sure, state politicians may be cowed and foreswearing tax hikes now, he says. But as state finances deteriorate further and budget deadlines loom, the better off will again be a tempting target. Consider: States are already projecting a combined budget gap of $102 billion for the upcoming fiscal year beginning July 1, and that gap is likely to grow $180 billion, the Center on Budget and Policy Priorities in Washington, D.C., projects.

Last year, six of the 10 states with the highest income tax rates -- Oregon, California, Hawaii, New York, New Jersey and North Carolina -- raised their levies on high earners, at least temporarily. Connecticut and Delaware also raised rates on high-earners, but their new top rates are still close to the median rate, at 6.5% and 6.95% respectively.

 

Yesnowitz speculates that in 2010, tax hikes for high-income folks could well spread from the West and East Coasts to the middle of the country. "Everything is on the table this year,'' he says.

State tax hikes would hit the wealthy particularly hard if President Barack Obama gets his way. In its FY 2011 budget proposal, released Monday, the Obama administration proposed both allowing the Bush tax cuts for those earning more than $250,000 to expire and reducing the value of deductions (including for state and local taxes) for those earning $250,000 plus. So high-income families would pay a top rate of 39.6%, but would only be able to claim their state and local tax deductions against a 28% rate. In addition, the administration wants to reinstate for high-income folks a separate haircut to itemized deductions that was gradually phased out under the Bush tax cuts. (Plus, some upper-middle- class folks lose all the advantage of state and local income tax deductions to the alternative minimum tax.)

 

Clint Stretch, director of tax policy for Deloitte Tax, suggested Monday that the fact that states have already moved to raise their top individual income tax rates could potentially limit how high the top federal rate can go. Stretch said he's assuming there is a "finite limit" to how much tax can be extracted from the better off. "We have essentially a race to get to the high income taxpayers,'' he observed. (It's a race that for now the states appear to be winning, since the federal rate increases wouldn't take effect until 2011.)

 

Before they pile on, politicians have reason to be wary of tax-weary voters. In November, New Jersey voters ousted Democratic Gov. John Corzine who had pushed through a one-year increase in that state's top rate from 8.97% to 10.75%., replacing him with Republican Chris Christie who ran on a promise of income tax relief. Last May, Californians turned down a tax package that would have extended a 0.25% income tax hike the legislature imposed for 2009 and 2010 into 2011 and 2012. Moreover, Illinois Gov. Pat Quinn, who replaced disgraced Gov. Rod Blagojevich a year ago, could lose in his own Democratic primary tomorrow; it's not helping his popularity that he has been unsuccessfully pushing an increase in the state's top rate to 4.5% from 3%.

 

Note that without any legislative or referendum action, the list of high-tax states will change for the 2010 tax year. New Jersey's hike was for 2009 only; its top rate is set to drop back to 8.97% from 10.75% for 2010. Vermont's top rate will drop slightly for 2010, from 9.4% to 8.95%, keeping it below New Jersey.

 

Maine might drop off the list altogether for 2010; its 8.5% rate for 2009 will be replaced with a flat tax of 6.5% on all income below $250,000, or 6.85% above that. At least that's what is supposed to happen under current law. But voters will have a chance to overturn the new flat tax in a statewide referendum on June 10.

 

Battles over income tax rates are looming in states with lower rates too. In Colorado, Democratic Gov. Bill Ritter in his State of the State address this month called for voters to defeat anti-tax measures on the November ballot, including one that would slowly cut Colorado's 4.63% income tax rate to 3.5% over a decade.

 

Stay tuned.

 

Related reading from Forbes:

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