Legislature(2001 - 2002)
02/19/2002 08:05 AM STA
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HB 413-INCOME TAX: INDIVIDUAL/TRUST/ESTATE/CORP [Contains discussion of SSHB 199 and HB 10] CHAIR COGHILL announced that the first order of business would be HOUSE BILL NO. 413, "An Act relating to the imposition of an income tax on individuals, estates, and trusts; relating to the administration of revenue laws; relating to the Alaska Net Income Tax Act; and providing for an effective date." Number 0220 LARRY PERSILY, Deputy Commissioner, Office of the Commissioner, Department of Revenue, explained that HB 413 uses as a tax base [an individual's] federal tax liability, rather than gross or taxable income. It assigns a flat tax of 20 percent. This legislation allows Alaskans to take all credits allowed under federal law - such as child care credits, business credits, and so forth - before calculating their Alaska income tax. This is a flat tax. Because it's a percentage of an individual's federal tax liability, however, "it picks up the graduated federal tax rates." The more one makes, therefore, the higher percentage that individual pays to the state. MR. PERSILY pointed out that HB 413 has a trigger designed to prevent the [state] government from accumulating more cash than it needs in the Constitutional Budget Reserve (CBR). If there is new development in Alaska, increased tax revenues, or spending reductions, and if the CBR grows to $2 billion, then the effective tax rate would drop from 20 percent to 10 percent for the next calendar year only. Then the CBR balance would be reviewed again. If the CBR balance reaches $2.5 billion, the tax rate would be 5 percent for the next calendar year. MR. PERSILY pointed out that HB 413 also provides a $25 rebate for electronic filing. He noted that there is a comparative analysis with hypothetical tax returns under each proposal. Number 0614 REPRESENTATIVE JAMES inquired as to the total amount [the state] owes the CBR now. MR. PERSILY answered that approximately $4.3 billion has been borrowed from the CBR, although he noted that he may be off a hundred million dollars one way or the other. He specified that [HB 413] doesn't address that issue. REPRESENTATIVE JAMES related her belief that either the CBR should be eliminated and a new method of saving money should be developed, or the CBR should be filled before "we stop." CHAIR COGHILL highlighted that this is the only bill that addresses [returning money to the CBR]. Therefore, a mechanism of doing so may be worthy of consideration. MR. PERSILY acknowledged that a trigger could be incorporated into any of the income tax bills. That way, if the state is more economically healthy, the tax rate could be lowered. CHAIR COGHILL asked how [HB 413] taxes earned income on residents versus nonresidents. He specified that he was interested in what "part-time residents" have to [report] to the state. Number 0827 CHUCK HARLAMERT, Juneau Section Chief, Tax Division, Department of Revenue, answered that in that regard, all three bills [HB 413, SSHB 199, and HB 10] are essentially the same. In almost every individual income tax bill he was aware of, residents of the state are taxed on their worldwide income, which is the same as the federal tax liability. If a resident has a business operation or income from another state and the income is taxable in that state, then a credit is allowed based upon the taxes paid to the other state. That provision is found in all the [individual income tax] bills. MR. HARLAMERT reported that nonresidents [in Alaska], by contrast, report all their worldwide income to their state of residency and claim a credit for taxes paid to Alaska. Under HB 413, a nonresident calculates his/her tax in Alaska by taking the entire taxable income and then apportioning it to Alaska based on the individual's business activity in Alaska. Basically, HB 413 takes the income on lines 7-20 of the tax return - total income - and applies the ratio of income generated in Alaska to income generated everywhere, and then multiples it times the tax base in order to determine Alaska's tax. Essentially, a nonresident's tax would be calculated as if he/she were a resident; the person would then apply a numerator - the income earned in Alaska - over the denominator - the income earned everywhere. Thus the amount of the tax paid to Alaska is determined. MR. HARLAMERT pointed out that HB 413 avoids including modifications from total income. Items excluded from determining that ratio are alimony, living expenses, and other nonbusiness items that don't really reflect where individuals made their money. Number 1084 REPRESENTATIVE JAMES asked whether part-time residents' [income for tax purposes] would be based on the time spent in Alaska. MR. HARLAMERT answered that part-time residents would be treated as nonresidents under [HB 413]. REPRESENTATIVE JAMES asked how [part-time residents] allocate their personal exemptions and/or itemized deductions if part- time residents and nonresidents are treated the same. The nonresident's [tax] is based on the amount of money earned, she said, while the part-time resident's [tax] is usually based on the amount of time in the state. MR. HARLAMERT clarified that the difference is only in the ratio applied. He pointed out that this [discussion] is in regard to the calculation of the fraction of the taxpayer's total income assigned to Alaska. The modifications to income and itemized deductions are all in the background. Although those are allocated, those items aren't included in the allocation formula. Therefore, whether someone pays mortgage interest in his/her former residence state or Alaska doesn't matter because it's allocated in the same way. REPRESENTATIVE JAMES posed an example of an individual who moved to Alaska in July and established residency after working elsewhere for the first half of the year. This individual didn't work until November or December, and therefore his/her small amount of income wouldn't be representative of the time they spent in Alaska in relation to the services being received. MR. HARLAMERT agreed, but pointed out that [HB 413] is an income tax bill. Income earned is taxed; it isn't a tax based on time spent in the state. The purpose of the formula is to determine how much of the person's income was earned in the state. Mr. Harlamert also pointed out that the factor takes into account differences in income. He cited as an example someone who moves to Alaska and receives a raise; that increase in wages would be in the numerator and denominator, and thus would increase the factor. If someone moves to Alaska and doesn't take a job immediately, however, that individual isn't earning income subject to tax, and the factor would appropriately reflect that. CHAIR COGHILL said that is the policy call the legislature will make. Number 1391 REPRESENTATIVE FATE inquired as to the rationale for using the computations in HB 413 versus others that are available. MR. PERSILY explained that the process is to tax only the income earned in Alaska. Therefore, if half of an individual's income is earned in Alaska, then that individual will pay the Alaska tax on 50 percent of that individual's federal tax liability. REPRESENTATIVE FATE related his understanding from Mr. Harlamert's testimony that [HB 413] is based upon not just what the individual is paying on the tax, but upon a ratio measuring it against the income "of the average tax in the Lower 48." MR. PERSILY said that isn't correct. Number 1520 MR. HARLAMERT explained that the purpose of the ratio is to determine how much of a taxpayer's total income for the year is properly taxable by the state. "We cannot tax nonresidents or part-year residents on a 100 percent of their worldwide income because they didn't earn it here," he said. "We just don't have the right to do that under the constitution." There has to be a method of attributing to Alaska the appropriate portion of whatever tax base is used. Therefore, the method used by all the proposals before the committee is to take a ratio of the income earned in Alaska over income earned everywhere. That ratio is then applied to the tax base. CHAIR COGHILL identified the difference, saying [HB 413] utilizes a place on the federal tax form that provides for some exemptions. He related his understanding that the formula [HB 413] uses is "to give the federal tax liability the best flexibility in the state." REPRESENTATIVE FATE asked if [the administration] believes this is a fair tax for everyone and believes this tax provides a little more favoritism to those who can't pay taxes. He again asked for the rationale. MR. PERSILY related his understanding that Representative Fate wasn't questioning the computation of how much a nonresident pays, but rather the proposal to tax on federal tax liability, which is a graduated tax. REPRESENTATIVE FATE restated his question, "Why this type of computation? What's the advantage of this to you? Why has the administration done this kind of computation rather than other kind of computations?" Number 1719 MR. PERSILY related the administration's belief that the federal tax system is good in that the graduated rate of the federal tax system has been accepted by most - that is, the more income one has, the better position the individual is to pay a greater portion in taxes because, in theory, that individual can enjoy the benefits of society more and pay more than others who earn less. MR. PERSILY recognized that an individual with a high income would view a graduated tax as unfair, but countered that in fixing the state's fiscal problems, a tax is necessary. Furthermore, Mr. Persily said it would be safe to assume some form of permanent fund earnings would be used to help with the state's fiscal problem, which would likely result in an across- the-board reduction in dividends that some would argue is unfair to those with low income or fixed income. Therefore, two [arguments] of unfairness cancel each other. Number 1865 REPRESENTATIVE JAMES remarked that she still wasn't clear on the intent with a resident versus a nonresident. She related her understanding of the public's general belief that those who come to Alaska to work and take their money home ought to pay something to help the state balance the budget. Representative James posed a situation in which a resident would be expected to pay tax on his/her worldwide income - or will the residents be prorated if they're making money outside the state? She recalled testimony regarding a credit for money earned in another state on which there is a tax, which she said makes sense. She related her understanding that there would only be two types of individuals: a resident and a nonresident. There would be no part-time resident. MR. HARLAMERT replied yes. REPRESENTATIVE JAMES expressed concern with that because of the existence of the permanent fund dividend (PFD). She asked, if someone moves to Alaska in January and files for residency, whether that individual would pay a [state income] tax just like all other residents. MR. HARLAMERT replied yes. He specified that the income tax doesn't follow the residency definition under the PFD. One can become an Alaska resident by declaration, simply by moving here and obtaining a driver's license. In the first full year of residency, the individual will pay tax as a resident taxpayer. In the first year, the individual will pay as a part-year resident. MR. PERSILY posed an example in which someone lives out of state, works in Alaska's oil fields as a nonresident, and earns no income in the other state. Such individuals would pay income tax on 100 percent of their earnings because 100 percent of their earnings were taken in Alaska. However, an individual who fished in Alaska and earned $50,000 [in the summertime], and who worked in Oregon in the off-season and earned $25,000, would pay tax on half, because of the proportion [of wages earned in Alaska]. Number 2139 REPRESENTATIVE WILSON asked on which line of the [IRS] Form 1040 this would begin. MR. HARLAMERT answered that with HB 413, it starts with line 52. If the taxpayer qualifies, federal credits would be deducted as shown on lines 61A and 63 [of Form 1040]. REPRESENTATIVE HAYES asked whether the administration has reviewed an education credit for areas that pay property taxes for K-12 [education]. If not, Representative Hayes asked why that wasn't reviewed as a state credit. He indicated he was referring to something similar to HB 10. MR. PERSILY responded, "I guess we looked at it and felt that as a policy call, it would be better not to give a property tax credit." He said one could argue that such a credit discriminates against those who don't own a home because they will end up paying the bulk of the taxes. Mr. Persily pointed out that property taxes are deductible on the federal tax return; thus a portion would be returned through a lower state tax return, as opposed to a direct credit. REPRESENTATIVE HAYES restated that he was curious whether any consideration has been given to an education credit for those who pay into the community for K-12 education. He acknowledged that it is mostly property tax. CHAIR COGHILL remarked that perhaps there should be an education tax first, for which there is credit on the [state] income tax. REPRESENTATIVE WILSON noted that in some municipalities, renters pay a sales tax on what is paid in rent. She related her understanding that such a provision wouldn't fit under HB 413 because it doesn't have anything to do with the individual's earnings. Number 2379 SCOTT GOLDSMITH, Professor of Economics, University of Alaska Anchorage, testified via teleconference. Mr. Goldsmith began by stating that if [the legislature] doesn't do something this legislative session to deal with the fiscal gap, in all likelihood the economy will fall into a recession. A $1-billion bite out of an economy Alaska's size is too large to digest in one year. Furthermore, the size of the fiscal gap is large enough that a combination of tools will be required to address it, including some sort of income tax, a broad-based sales tax, and a reduction in the PFD. Consequently, the question becomes when the [state] income tax would be instituted and what it would look like. In comparing an income tax with a sales tax and a dividend, there is much interest in the split between the proportions that residents and nonresidents pay. In terms of that criteria, an income tax looks more attractive than the other two options. MR. GOLDSMITH said based on some basic calculations, he'd calculated that for every $1 collected from an income tax, Alaska residents would pay about $.75 and someone else, a nonresident or the federal government, would pay about $.25. However, a reduction in the size of the PFD would result in Alaskans' [paying] about $.84 per $1; the remainder would be shifted to the federal government and nonresidents. With a broad-based sales tax, about $.93 per $1 would be paid by Alaskan residents, with the remainder paid by nonresidents. Therefore, an income tax seems to be most attractive on those grounds. Although an income tax would create disincentives just as any tax would, he argued that those disincentives would be relatively modest. Under HB 413, the 20 percent on top of an individual's federal rate sounds horrendous. However, it only amounts to approximately a 3 percent increase in tax liability for an individual paying 15 percent in federal taxes. MR. GOLDSMITH remarked that an income tax is a progressive tax, which means that people with higher incomes pay a larger percent of their income in taxes than those with lower incomes. The decision regarding how progressive to make the tax system is a philosophical decision for which an economist can't provide an answer. However, Mr. Goldsmith pointed out that Alaska, with the PFD, has the most progressive tax structure in the nation. MR. GOLDSMITH reported that in regard to overall state and local taxes, low-income Alaskans receive money from the government, in net terms, while high-income Alaskans pay primarily via property taxes. Imposing an income tax such as proposed in HB 413 would add some progressiveness to the system because it would impact higher-income Alaskans more than it would lower-income Alaskans. MR. GOLDSMITH echoed Mr. Persily's earlier testimony that in the long run it's likely the PFD would be reduced, which would have the opposite effect. Therefore, considering the overall tax structure of the state in terms of a progressive income tax, with a reduction in the PFD, could result in the same relative position in terms of the current progressiveness. Number 2666 MR. GOLDSMITH pointed out that when thinking of the tax structure, one has to be careful about comparing Alaskans across all strategies - that is, in regard to the full-time versus part-time resident, the rich versus the poor, the urban versus rural individual, and the young versus the old individual. MR. GOLDSMITH identified one attractive feature of a personal income tax: it solves the problem of the "Alaska disconnect." He explained that the "Alaska disconnect" is the problem that economic growth and development - which would help solve any financial problems in most states - doesn't work in Alaska because Alaska doesn't have a broad-based tax to capture some of the profits generated by new economic activity in order to pay for the public costs that arise. Therefore, a personal income tax would be a method by which to capture some of those profits, which would be positive both fiscally for the state [government] and for Alaska economically. Number 2746 REPRESENTATIVE FATE recalled Mr. Goldsmith's mention of the 15 percent average of federal tax in the state. MR. GOLDSMITH clarified that an individual's lower tax rate on the federal income is 15 percent, the rate at which he believes the majority of Alaskan households pay. However, that isn't the average for all Alaskans because a significant portion of Alaskans pay at a higher rate, 28-30 percent on their "marginal income." REPRESENTATIVE FATE inquired as to the average in the state. MR. GOLDSMITH estimated that the average federal tax on an individual's taxable income is about 20 percent. CHAIR COGHILL mentioned that one of the points of discussion is regarding whether to use the adjusted gross income or the federal tax liability. He requested that Mr. Goldsmith provide his opinion of those options. MR. GOLDSMITH opined that starting with the adjusted gross income provides a bit more flexibility in regard to [allowing] credits or exemptions. On the other hand, by making Alaska's tax a percentage of the federal tax, [the state] is beholden to the federal tax law. However, [tying to the federal tax liability] is a bit more progressive due to the netted-out exemptions, which tend to favor those at the lower end of the income distribution. Number 2857 REPRESENTATIVE JAMES related her conclusion that a three-way fix, including some earnings from the permanent fund, a sales tax, and a moderate income tax, is necessary. However, the dilemma is that an income tax has about double the impact of a [sales] tax, while use of the permanent fund earnings has no cost at all. Therefore, Representative James expressed concern as to the components. She asked Mr. Goldsmith to speak to what he saw as the best advantage. MR. GOLDSMITH responded that the [state] has about three years to phase in a set of policies to address the fiscal gap. Each year there should be about a $350-million bite, the first of which should be through the income tax. Although it will have a negative impact on the economy, it won't be as great as from a sales tax generating the same amount of money because the federal government would "pick up part of the tab." TAPE 02-12, SIDE B Number 2987 MR. GOLDSMITH related his belief that the economy could absorb [the negative impact created by an income tax] without crashing. For the next year, Mr. Goldsmith suggested that perhaps the earnings over and above the PFD and inflation-proofing of the permanent fund should be used. If necessary, Mr. Goldsmith suggested that the third year would look at a sales tax. He reiterated the need to take a phased-in approach in order to avoid hitting the economy all at once. Number 2909 REPRESENTATIVE JAMES agreed with a phased-in approach. However, if $350 million were taken from the earnings reserve of the permanent fund, it wouldn't impact the economy at all because that is excess. She suggested that the income tax would follow. She noted that the effective date [of the implementation of the income tax] could be extended in order to provide more time to prepare. She agreed with looking at a sales tax last. She inquired as to why such a scenario would be wrong. MR. GOLDSMITH answered that largely it's a political choice. If the excess earnings of the permanent fund are used first, the annual amount that could be drawn in subsequent years is [decreased]. "Because we know the economy is going to be doing okay this year, we can afford to take a little bit of a hit," he pointed out. "The future is uncertain." He explained that if the economy softens, the [state] wouldn't want to be forced to impose an income tax on an economy that's already in a weakened condition. Number 2802 REPRESENTATIVE FATE asked Mr. Goldsmith why he felt that a sales tax would have more of a negative effect on the state than would an income tax. MR. GOLDSMITH clarified that he was primarily referring to the proportion of each tax that would be paid by nonresidents. The larger the share being paid by nonresidents, the less negative the impact on Alaska's economy because purchasing power would be drawn out of the Alaskan economy [otherwise]. Mr. Goldsmith informed the committee that about 7 percent of sales in Alaska are made to nonresidents, and therefore 93 percent of sales would fall on the shoulders of Alaskan residents if the sales tax were used. With an income tax, however, the tax would be shared by nonresident workers and the income they generate, approximately 10 percent of total wages paid in the state, as well as the federal government, because for many Alaskans the state income taxes would be deductible from their federal income tax. Therefore, the federal liability for some Alaskans would decrease. In that sense, an income tax would have a less detrimental effect on the overall economy. REPRESENTATIVE FATE noted his intention to pursue this further. Number 2670 BOB STILES, President, DRven Corporation, testified via teleconference in favor of reenacting a personal income tax as outlined in HB 413. He emphasized that he is in favor of doing it now. Mr. Stiles remarked that there is a "counter-incentive" to job creation in the state. If jobs are created that result in people moving into the state, the burden on the state has been increased and everyone's prorated share of the PFD has been decreased. The imposition of a personal income tax has the possibility to enhance the development of job creation. MR. STILES related his [support] of tying it to the federal tax because that is the simplest and easiest way to do so. Tailoring a tax to an adjusted gross income versus the federal tax liability creates additional bureaucracy and laws, all requiring additional [employees]. In the end, less overall income from the tax is seen than may have otherwise occurred with a simple [strategy]. Furthermore, the income tax should be done first because it has the longest lead time in regard to the state's seeing any revenues from the tax. For instance, if a tax were instituted during this session, the future liability wouldn't begin to accrue until 2003 and the state wouldn't see any income until 2004. The other mechanisms, a sales tax or use of the permanent fund earnings reserve, can be implemented and produce revenue more quickly than the income tax. Therefore, Mr. Goldsmith said he believes that the approach in HB 413 is preferable. Number 2501 ERIC BRITTEN, Anchorage Chamber of Commerce, testified via teleconference. Mr. Britten informed the committee that the Anchorage Chamber of Commerce has passed a resolution suggesting that an appropriate level of state services be established prior to the institution of any new revenue sources. Additionally, the chamber hasn't supported any spending caps. Once the appropriate level of state services has been established, the first recommendation is to use a portion of the current permanent fund earnings. The next step would be to maintain an appropriate balance in the CBR, using it as a shock absorber against oil-price fluctuations. The third step would be to use debt, as appropriate, to finance the state's infrastructure needs on a long-term, systematic basis. MR. BRITTEN pointed out that the Anchorage Chamber of Commerce has passed resolutions in support of general obligation (GO) and GARVEE [Grant Anticipation Revenue Vehicles] bonding. The final step would be the implementation of broad-based taxes and/or an increase of consumption taxes that are fair and equitable and encourage economic development. MR. BRITTEN remarked that any type of tax discourages economic development to some extent. Obviously, a gross receipts tax is more discouraging to economic development than any of the taxes being discussed now. Targeted business taxes and corporate taxes also discourage economic development. In supporting broad-based taxes, he said, the chamber agrees that [HB 413] or the income tax proposition, as well as a sales tax, fit within that purview. MR. BITTEN noted his personal observation, from discussions with those in the Anchorage Chamber of Commerce, that there does appear to be more support for an income tax than a sales tax. The reasons for that support relate to the ability for [a state income tax] to be deducted from the federal income tax. Furthermore, [a state income tax] fits within a "broad-based" classification. Moreover, there is sort of a property tax deduction in that [HB 413 is linked to] the adjusted gross income on the federal income tax, which allows the property tax to be deducted on the federal income tax. Mr. Bitten highlighted the support and passion for the development of a complete plan. He mentioned that a phased-in approach does make sense, as does having triggers. Number 2266 CHAIR COGHILL asked if a sales tax would be deductible on Schedule A [of the federal tax forms]. MR. PERSILY specified that a sales tax is not deductible on federal income tax returns. CHAIR COGHILL announced that this discussion would continue on Saturday. He also announced that all three of the proposals will be before the committee. Chair Coghill announced that the hearing on HB 413 would be suspended.