HOUSE BILL NO. 146 "An Act imposing a school tax on net earnings from self-employment and wages; relating to a payment against the school tax from the permanent fund dividend disbursement; and providing for an effective date." 9:41:52 AM REPRESENTATIVE MATT CLAMAN, BILL SPONSOR, read the sponsor statement: Good morning members of the Committee, for the record, my name is Matt Claman, and I am the State Representative for House District 21 in West Anchorage. I would like to thank you all for hearing House Bill 146. Alaska faces major financial challenges. Our goal in proposing House Bill 146, a School Tax, is a responsible action plan to meet those challenges. The Alaska Constitution, Article VII, Sec. 1 requires the legislature to "establish and maintain a system of public school." The public supports a strong public school system, and an investment in our students is an investment in our future. When asked about the possibility of a broad-based school tax, many people wanted to know what such a tax would look like. The School Tax in HB 146 sets a tax based on adjusted gross income on federal tax returns for every person who earns income in Alaska. All Alaskans and out-of-state residents who work in Alaska would help solve our financial challenges. The minimum tax would be $100 a year, for those who make $20,000 or less. In this way, the school tax is similar to the school head tax-everyone contributes. The tax then increases on a graduated scale based on income. Those making between $50,000 and $75,000 a year would pay a school tax of $750. The revenue collected from the school tax would be designated to support public education in Alaska. It is not a dedicated tax fund, which would violate our constitution. (Because it is well below the budget amount, there would be no need to argue the designation as well.) The values of the tax range from 1% in the lowest bracket to 3.4% at the uppermost bracket. There is also a cap on the uppermost level, allowing the highest earners to reinvest in the economy and support a positive investment climate. We based our values off a $1000 permanent fund dividend. Everyone is able to contribute, while individuals who depend on the PFD still receive a reasonable portion. To make payment of the tax simple, the bill includes a provision allowing use of future Permanent Fund Dividends to pay the tax. I would like to close by saying that this school tax bill responds to public concern about the funding of education in challenging times. It is a transparent way to produce new revenue and create a responsible action plan for Alaska. At full implementation, the school tax bill is projected to raise $540 million- approximately one third of the state funding for education. We believe that if the public has a more direct investment in funding education, they will become more involved in the education that we deliver. The school tax is not a proposal to increase education funding. The intent is to raise revenue to help close the budget deficit, designate those funds to support education, and reduce the undesignated general fund appropriation for education on a dollar-for-dollar basis. 9:44:49 AM OWEN PHILLIPS, STAFF, REPRESENTATIVE CLAMAN, noted that the only change between the sponsor substitute and the original bill was in the title. He relayed that the old title did not include out-of-state residents or specify income. Mr. Phillips reviewed the sectional analysis: Section 1: Section 2: AS 43.45.011 School tax imposed; payment by dividend: Adds new chapter: Chapter 45. School Tax. Adds new section AS 43.45.011: a) Tax imposed on adjusted gross income (AGI) of: (1) residents and (2) non-residents with income from in-state source b) Lists tax liability for individuals based on tiered AGI levels c) Stipulates that (1) the AGI of (A) a resident is the total AGI of the resident (B) a nonresident or part-year resident is the amount attributable to a source in the state (2) the DOR shall assess the tax due on the AGI of (A) individuals, for individual returns (B) 2+ individuals for joint filing (including dependents) (C) individual, if return is not filed d) Tasks the DOR with adopting procedures to allow use of PFD to pay the school tax, including refunding amounts exceeding the tax e) Defines regulations for the tax payer f) The department shall adopt regulations: (1) Delinquent payment annual interest rate is 18% (2) Establish fee of up to $2,500 for the cost of collecting delinquent tax (3) Allow for a 90-day extension past due date (at the DOR's discretion) (4) Determine AGI subject to tax for joint filers if one of the filers is not a resident of the state g) Tax penalties shall be deposited into the general fund h) "adjusted gross income" has the meaning given in 26 U.S.C. 62 Section 3: Uncodified Law: Amended: REGULATIONS. DOR may adopt regulations to implement section 2 Section 4: Effective Date: Section 3 - Immediately Section 5: Effective Date: All other sections - Jan 1, 2018 Mr. Phillips delineated that the effective date in Section 5 included the tax component of the bill. 9:48:10 AM Co-Chair Seaton cited page 2, line 26 and read the following: …an individual if the individual does not file a tax return… Co-Chair Seaton wondered how adjusted gross income was determined for someone who did not file a federal tax return. Representative Claman responded that the provision would be subject to Department of Revenue (DOR) regulations. Representative Guttenberg asked what the House Education Committee's feedback or actions were regarding the bill. Representative Claman responded that there were no amendment made in the education committee. 9:49:26 AM Representative Pruitt mentioned that another revenue measure was being considered in the House. He asked whether the bill would be an addition to an income tax. Representative Claman responded that the legislation was intended as an alternative to an income tax. Representative Pruitt asked whether the bill was another version of an income tax. Representative Claman responded in the negative. He clarified that the school tax combined a capped head tax with graduated rates between the low and high ends of income. He delineated that the tax included a mandatory minimum on the low end and a cap on the maximum payment and was not considered an income tax. Representative Pruitt countered that the tax fell within the definition of an income tax but included the language that the revenue "may" be appropriated for education. Rep. Claman declined to "argue the policy question." Representative Grenn cited page 2, lines 4 through 13 of the bill. He asked what formula was used to create the income brackets. Representative Claman replied that he began with the premise to establish a minimum tax, from the desire that everyone should be part of the solution. He assumed that based on a $1000 PFD (Permanent Fund Dividend) it was reasonable to request a $100 minimum payment. The other brackets were developed similarly; with the consideration that, certain income levels should receive a certain portion of their income and retain the ability to also contribute above the limit. He considered "economic levels of income at which the statistical likelihood that the PFD was critical to their family economics became less important." 9:52:33 AM Representative Wilson asked about using a percentage of income versus a flat fee. She provided an example from the tax brackets. Representative Claman responded that the goal of the bracket fees was to create clarity and make it easier for the public to understand what they were expected to pay versus calculating percentages. He agreed that by using step increments a taxpayer at the lower limits of a higher bracket would pay much more in relation to the previous bracket versus using a percentage of income but at the expense of clarity and a straightforward approach. Representative Wilson asked whether the representative had information regarding the "correlation between the public paying the fee and how it would impact what was happening in the schools." Representative Claman did not understand her question. Representative Wilson wondered if he had accessed information from other states that employed a similar tax on correlation between the tax and educational outcomes. Representative Claman responded that that he concluded from anecdotal information that the community felt that the more they invested in education the more they would become interested in outcomes. Representative Wilson did not agree because the system was not the same for all; not all children go to public school and she doubted the correlation. She asked for further data from other states. Representative Claman remarked that no other state had a school tax similar to the proposal in HB 146 and doubted he could provide any further information. He believed that all segments of the community were concerned about how the state invested in public education. 9:56:26 AM Vice-Chair Gara thanked the sponsor for introducing the bill. He asked whether Rep. Claman supported an alternative way to raise revenue without taxing the PFD as part of income. Representative Claman replied that the PFD was included in adjusted gross income on the federal level. He expressed concerns about complicating the bill for the public as exceptions and "layers" were added. Vice-Chair Gara asked whether the income and tax levels in the bill were adjusted over time. Representative Claman wondered if he was asking about inflation adjustments. Vice-Chair Gara responded affirmatively. Representative Claman answered in the negative. Co-Chair Foster noted Representative Thompson had joined the meeting. Vice-Chair Gara asked whether single and joint tax payers with or without dependents all paid the same tax. Representative Claman responded that the tax was based on the return versus on an individual basis. 9:59:22 AM Co-Chair Seaton referred to page 2 lines 26 through 30 and read the following: (C) an individual, if the individual does not file a federal income tax return. (d) The department shall adopt regulations establishing procedures for an individual eligible for a dividend under AS 43.23.005 to direct the department to hold all or a part of the amount of the dividend to pay the tax due under this section. Co-Chair Seaton asked whether an individual who did not file income tax had an adjusted gross income and wondered how much money would be generated under the $100 minimum tax from individuals who only get a PFD for income purposes and do not file a federal form. Representative Claman responded that the fiscal note was prepared by the department using proprietary information regarding how many tax returns were filed for each income bracket. He deferred to DOR for additional information. He furthered that the department had information regarding who filed for a PFD. Therefore, it would be known to the department if a person had not filed a tax return but filed for a PFD. 10:01:59 AM Representative Wilson ascertained that the state would take $100 minimum tax from everyone even children. Representative Claman answered that it depended on how the family chose to manage their children's PFD income. He furthered that if parents included their children's PFD income on their return the only school tax due was based on the parent's tax return. Representative Wilson responded that the bill did not reference tax returns; only adjusted gross income. Representative Claman pointed to page 2, lines 24 and 25 and read the following: (B) two or more individuals, including dependents, if those individuals file one federal income tax return together; Representative Claman specified that the language applied to the scenario in question. Representative Wilson referenced page 2, lines 26 and 27 and read the following: (C) an individual, if the individual does not file a federal income tax return. Representative Wilson guessed that most individuals not filing had a disability or incomes so low they were not required to file a return and would be difficult to track if not for the PFD data base. She deemed that individuals who did not file a return or file for a PFD would be "almost impossible" to track. Representative Claman was unfamiliar with the area of tax law she was discussing regarding disability benefits. He agreed that it would be arduous to find people who did not file a return or file for a PFD. 10:05:07 AM Representative Pruitt asked whether the intent was for the PFD to pay the tax or if an individual would "write a check," since there was no withholding of funds. Representative Claman replied that a payroll tax component was not included to minimize the administrative expense. He explained that non-payment of the tax was subject to a high interest rate (18 percent) and fines up to $2.5 thousand to incentivize timely payment for those in the higher income brackets. He wanted the tax collected once a year to provide an easier administrative process for the state. He envisioned that the tax could be paid for with the PFD for tax payers in lower income brackets. The goal was to fashion the tax similar to a property tax. Representative Pruitt thought that the assumption was made that people could manage their money to have enough when the payment was due. He thought a yearly payment was challenging for people who didn't budget their money adequately. 10:08:36 AM Vice-Chair Gara recognized that there were several different policies under consideration. He liked that the bill clearly defined how much people would be taxed versus a tax based on percentages. Representative Claman provided an example from personal experience to illustrate how the fees and penalties would encourage payment compliance. He hoped that the department would graduate the fines so that those that owe more paid higher fines. He voiced that collection issues occurred for any tax. 10:10:34 AM Co-Chair Seaton asked Mr. Alper about the administration of the tax and wondered whether the bill provided enough guidance. 10:10:55 AM KEN ALPER, DIRECTOR, TAX DIVISION, DEPARTMENT OF REVENUE, explained that the bill had a blanket authorization to write regulations. He stated that many technical issues were not addressed in the bill but could be dealt with in regulation. He spoke to the issue of non-resident income generated in the state and requested more definition and additional language should the bill advance in the legislative process. He believed that lawsuits would ensue, if the bill was adopted, regarding what was effectively definable through regulation versus statute. He noted that enough guidance was contained in the bill concerning tax forms, tax rates, and defining tax payers. The department would fill in the details through regulations. Co-Chair Seaton reiterated his question regarding page 2, line 26 of the bill, dealing with an individual who did not file a federal tax return but had adjusted gross income. He asked how the department would administer the tax to Alaskan residents. Mr. Alper guessed that all PFD recipients not included in a filed tax return would owe the $100 minimum tax. The threshold for a larger household exempted from filing a tax return was under $20 thousand; and these households could fall under the higher $250 tax. He surmised that the department would rely on the 1040 form for the administration of the tax and added that a process would be necessary to identify non-filers. 10:14:42 AM BRANDON S. SPANOS, DEPUTY DIRECTOR, TAX DIVISION, DEPARTMENT OF REVENUE (via teleconference), noted that each year, there were certain individuals that just refused to file a tax return or did not for other reasons. However, employers were required to file a W-2 that would act as documentation of income for the department. The department would use the W-2 information in coordination with the Internal Revenue Service (IRS) to determine assessments. 10:15:49 AM Co-Chair Seaton referenced the following language on page 2, lines 1 and 2 and page 2, lines 20 through 27 of the bill: (1) resident individual; and (2) nonresident and part-year resident individual with income from a source in the state. (2) the department shall assess the tax due on the adjusted gross income of (A) an individual, if the individual files a federal income tax return only on the individual's own behalf; (B) two or more individuals, including dependents, if those individuals file one federal income tax return together; (C) an individual, if the individual does not file a federal income tax return. Co-Chair Seaton queried whether the language ensured that the tax was applied to tax returns and not each individual included in the tax return. Mr. Alper interpreted that the first section allowed a joint filer to pay a single household tax. He surmised that DOR would interpret the language in the same manner. Mr. Spanos added that federal rules required that a child file their own return in some cases. He thought further definitions would be beneficial clarifying when the state would also require a dependent to pay their own school tax. 10:18:56 AM Representative Guttenberg referred to line 2, page 2 and inquired how crew shares fit into the definition of income. He thought that the bill gave the department "a lot of leeway to make decisions and write regulations." Mr. Alper suggested that DOR would have to craft regulations specifically for S Corporations, partnerships, sole proprietorships, and contract work. He furthered that crew shares qualified as a 1099 contractor when received for work done in Alaska or paid by an Alaska owned business. The department would have the non-resident crew member's tax information, apply formulas from regulation to determine the Alaskan portion of the adjusted gross income for tax assessment purposes. He reiterated that the question was whether the regulation language could withstand a court challenge. Representative Guttenberg wondered if the division would have enough authority and guidance to make the decisions required to write the regulations. Mr. Alper replied that enough guidance existed, but he was uncertain whether DOR had the legal authority. He wanted to consult with the state's attorneys. He cautioned that taxes were prohibited from being imposed via regulation and he was uncertain how specific the regulations could be written. 10:22:08 AM Co-Chair Seaton referred to Page 2, lines 12 and 13 of the legislation and read the following: (8) $200,000 or more, but less than $250,000, the tax is $6,500 a year; (9) $250,000 or more, the tax is $8,500 a year. Co-Chair Seaton asked whether someone who made $5 million per year would pay $8.5 thousand in tax. Representative Claman confirmed that the statement was correct. Co-Chair Seaton inquired if an individual with income at $251 thousand would pay $2 thousand more than an individual with income of $248 thousand. Representative Claman answered in the affirmative. Vice-Chair Gara favored the provision that the revenue would be deposited in the Education Fund. He noted that the language in the bill used the word "may" versus "shall" due to the constitutional prohibition on dedicated funds. Representative Claman confirmed that the statement was correct. Co-Chair Foster OPENED Public Testimony. 10:23:42 AM PAUL KENDALL, SELF, ANCHORAGE (via teleconference), provided public testimony. He favored an "open" discussion regarding the bill. He spoke against using property taxes to pay for any public employee's salaries or compensation. He spoke to items and beliefs outside of the context of the legislation. Co-Chair Foster interrupted to clarify that public testimony was being heard on HB 146. Mr. Kendall continued to provide testimony unrelated to HB 146. Co-Chair Foster CLOSED Public Testimony. HB 146 was HEARD and HELD in committee for further consideration.