HB 124-INCOME TAX ON INDIVIDUALS & FIDUCIARIES CHAIR JAMES announced that the first order of business would be 2d SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 124, "An Act relating to the taxation of income and providing a credit for certain property taxes, and permitting the legislature to use certain income tax proceeds to make appropriations for public schools." CHAIR JAMES, sponsor of HB 124, asked Barbara Cotting to read the sponsor statement. Number 0035 BARBARA COTTING, Legislative Assistant to Representative Jeannette James, Alaska State Legislature, read the following: This bill proposes a two-part income tax. Both taxes are levied only against income earned within the state of Alaska, based on W-2 wages, and federal schedules C, E, and F (business income, rentals, royalties, partnerships, S corporations, trusts, and farming). The taxes will NOT be levied on retirement pay, interest, dividends, capital gains, or other miscellaneous income. (See Federal Tax Return 1040. ONLY lines 7, 12, 17, and 18 are taxed.) A 1/2 percent tax will be levied as a "school tax" - i.e., specifically available for the legislature to allocate toward public schools - allowing a credit only for those who pay property tax for education. For several years, we have been hearing testimony from the public regarding an inequity that exists in Alaska. People who own property in an organized borough pay property taxes, a portion of which funds education. Other Alaskans do not contribute to education, yet they receive the same benefits as those who pay. This bill is intended to remove that inequity. By allowing a credit only for those who do pay property tax, it levels the playing field. In addition, a 3 percent general income tax will be levied on the same net income as above, but ONLY on income in excess of $12,500. This would be a flat tax, which is much more equitable than a percent of federal tax. Number 0247 CHAIR JAMES explained that she thinks HB 124 is important, but feels that some people think it is a joke. She announced that she did not want to move HB 124 out of committee at this time. Her purpose in filing this legislation was to give legislators and the public some information illustrating that a state tax based on a percentage of federal taxes is not the only way to implement a state tax in Alaska. She did not believe any state tax will be approved this year by the legislature; but the subject is out there in front of the public and the public is thinking about it. CHAIR JAMES offered her personal belief that there is no way to balance Alaska's budget over the long term without reducing spending and making government more efficient. Therefore, she felt some broad-based tax and some use of permanent fund earnings would eventually be needed. The purpose of presenting the school tax was strictly as a leveling tool. She has heard many people say, "We could just implement a $100-a-year instead of $10 school tax." However, she believes that idea is not feasible because the government would be taking the tax only from people who work for wages. She argued that wage-earning people are the wrong group to attack because they are not the only people who make money in the state. CHAIR JAMES noted that the $10 school tax levied on everyone in the past functioned because Alaska had an income tax at the time. She indicated that a similar tax today, as suggested by some people, would not be feasible. She believes HB 124 is feasible. One half of one percent is about the same amount that is held out of an employee's pay for unemployment insurance. Furthermore, if an individual paid a property tax allocated to education, that individual would receive a credit not to exceed the amount of the tax. Therefore, Chair James explained, a leveling would occur so that all people who are making a living in the state would be paying that tax. CHAIR JAMES further explained that HB 124 was drafted in order to allow a tax similar to a flat income tax. She alleged there was no easy way to write a fiscal note for this legislation because legislators do not have relevant numbers for the amount of money that is earned according to federal schedules. When she attempted to obtain information from the Institute of Social and Economic Research (ISER) study, someone had mentioned to her that the information was available only on tapes. The legislature could get that information, if necessary, so as to make it easier to calculate what the net taxed income would be. She reiterated that her purpose in drafting HB 124 was to generate comments on this kind of tax as a tax that would be equitable, fair and easy to administer. Number 0594 REPRESENTATIVE GREEN asked if HB 124 would also tax Individual Retirement Account (IRA) cash-ins, which are not salaries. People who are 70-1/2 years old can cash in their IRAs. Although a cash-in would put money into their dossiers, they are not earning it. He wanted to clarify whether that money would be subject to the 3 percent tax. CHAIR JAMES answered no. REPRESENTATIVE GREEN said he understood, then, that only earnings on salaries would be taxed. Number 0671 CHAIR JAMES answered yes. Salaries, profit/loss in business and professions, Schedule E rental income, royalties, partnerships, liability companies in Subchapter S corporations, and fund income are included in the 3 percent tax. Her purpose was to tax only income from people who are actively making a living, as opposed to retirees. She recognized that some people do make a living by investments alone; however, she wanted to encourage investments under HB 124, not discourage them by taxation. Therefore, she exempted Schedule B from HB 124 taxation. Number 0726 REPRESENTATIVE HUDSON asked if HB 124 will tax retirement incomes. CHAIR JAMES replied that retirement incomes are non-taxable. REPRESENTATIVE HUDSON asked if Chair James knew the value amount of tax collected under HB 124. Number 0760 CHAIR JAMES estimated this tax would bring in about $300 million. She surmised that Subchapter S corporations and partnership income might be higher than anticipated. REPRESENTATIVE OGAN noticed that dividends would not be taxable. He sought clarification as to whether the language referred to stock dividends rather than permanent fund dividends. Number 0851 CHAIR JAMES explained that the language referred to all dividends recorded under item 9 of the "income" section of the Internal Revenue Service (IRS) form 1040. Chair James stated that interest dividends, capital gains, or retirement income would be non-taxable. In response to a further question, she specified that permanent fund dividends are not be taxable under HR 124. Number 0887 REPRESENTATIVE GREEN referred to the September 14, 1999 [advisory] vote [regarding use of the permanent fund]. After reading a poll about that vote, he'd surmised that the populace did not want to use permanent fund earnings and did not want new taxes. He asked Chair James if she had taken public opinion into consideration when drafting HB 124. Number 0950 CHAIR JAMES answered with an emphatic yes. In extensive discussions with folks, she'd heard that folks prefer sales tax as opposed to an income tax. She did not believe the public was ready to accept a tax. She reiterated that her purpose in drafting HB 124 was to get people to think about tax alternatives other than a percentage of the federal tax. Also, she surmised that the legislature can draft a tax that excludes retirees since they are not actively making a living in the state. Her purpose in drafting the school tax was to level the playing field so everybody would help pay for education. CHAIR JAMES announced that Representative Moses had joined the committee discussion. Number 1042 REPRESENTATIVE HUDSON commented that he did not view HR 124 as a joke or untimely. He noted that he'd heard that Governor Knowles has expressed the need to tax the thousands of people who work in Alaska on a seasonal basis. Representative Hudson said he himself feels that out-of-state workers should pay for usage of roads and public utilities, just as Alaskans do. He agreed with Chair James about pursuing a broader understanding of tax alternatives by presenting HB 124 and allowing folks to testify. If people believe now is not the time for additional sources of revenue to balance the budget, he said, then those people must think the legislature can exhaust financial reserves and let somebody else deal with the budget deficit later. He did not agree with that reasoning. Number 1209 REPRESENTATIVE KERTTULA asked if one part of HB 124 was a flat tax on anything a worker earned over $12,500. CHAIR JAMES answered yes. REPRESENTATIVE KERTTULA continued, "So it doesn't matter if you are making $13,000 or if you are making $300,000, everybody is going to pay that 3 percent?" CHAIR JAMES answered yes. She further pointed out that HB 124 is an individual tax, and therefore if a husband and wife are both working, each would receive the $12,500 exemption. The tax does not provide any deduction based on marriage or dependent children; it is an individual tax. She did not know whether $12,500 is a good number; it is just a place to start. Therefore, she indicated that the exemption number could be moved up and down, as could the percentage. She surmised that the legislature would want to set the exemption number as low as possible in order to collect sufficient tax revenue. Then later, if a new figure was needed in case of emergencies or disasters, this arrangement would be an easy way to add .25 percent or reduce it by .25 percent. Number 1322 REPRESENTATIVE KERTTULA commented that she had not seen the committee assignments regarding the corporate income tax bills that had just been moved into the House Judiciary Standing Committee. She asked whether the House State Affairs Standing Committee would be hearing those bills. She expressed the need to maintain a balance regarding the tax issue; therefore, the committee needs to review what the larger companies in the state are paying. She deemed perusal of the corporate income tax bills as a valuable exercise in understanding the whole tax picture. Representative Kerttula did not disagree with Chair James in presenting HB 124 as a good place to start. However, she wanted to look at larger corporate individuals first and what they are paying before looking at individual Alaskans. Number 1375 REPRESENTATIVE SMALLEY recalled that Chair James had estimated HB 124 could earn as much as $300 million. He asked if that $300 million included both the .50 percent and the 3 percent tax as outlined in HB 124. CHAIR JAMES answered no; the .50 percent tax would only provide about $35 million. Number 1399 REPRESENTATIVE SMALLEY requested information with regard to cost for additional employees to conduct audits, investigations and appeals if the legislature were to pursue a tax program according to HB 124. Number 1466 CHAIR JAMES answered that she did not have a fiscal note for HB 124 or associated costs. REPRESENTATIVE SMALLEY said he felt that employers would not be elated about being held accountable for collections and submittal of tax revenue raised under HB 124. CHAIR JAMES responded that it is not difficult to collect money under a flat tax arrangement. No W-4 information is required and no dependents are counted when using a flat tax. Employers are already collecting money for unemployment from their employees. She surmised it would be simple just to add another line on the present unemployment form; consequently, a flat tax would be easy to administer. Number 1541 REPRESENTATIVE SMALLEY informed the committee that he'd visited with Kenai Peninsula folks during the September 14, 1999, vote period. He observed that those living on the Kenai Peninsula leaned more toward an income tax than a sales tax, since they already pay a sales tax, although he was not alleging that the majority of Alaskans would support an income tax versus a sales tax. He said although retirees are not earning income in the state, they utilize state services. Therefore, retirees should be included in taxation. He believed the purpose of taxation is to help offset the cost of state services. Number 1612 CHAIR JAMES spoke about forms of taxation that people might prefer. She believes that people who live in communities that do not levy a sales tax would prefer a sales tax [versus an income tax]. Personally, she felt that the imposition of sales tax should be reserved for a community and municipality funding source, instead of using it for a state funding source. She would not object to imposing a 2 percent sales tax statewide and then allowing small communities to "piggyback" on the state sales tax. She saw this as an administrative way to ensure that everybody paid. Her opinion was that if the legislature were to collect all the budget deficit by sales tax, it would be too heavy a burden on Alaskans. Number 1717 REPRESENTATIVE OGAN said he could not support any taxes because he did not believe the state had addressed the fundamental question of what the state should or should not be funding. He asserted that since Alaska had started receiving oil money, the state has funded 500 different programs; as far as he knew, only two had been eliminated as a result of the budget deficit discussion. Number 1761 CHAIR JAMES asked if Representative Ogan believed the budget could be cut by $500 million and, if so, where would the legislature cut? Number 1790 REPRESENTATIVE OGAN said he believed the state budget could be cut by $250 million. He thought the state should narrow its funding scope while striving to perform well on basic programs such as public safety, road maintenance and education. He concluded that the legislature is not getting cooperation from the Administration in cutting excessive programs from the budget. Number 1761 CHAIR JAMES recalled that when she first came to Juneau as a legislator, she expressed the exact same attitude as Representative Ogan has today. She found out within two months that reducing the size of government had to start at the governor's office; there has to be cooperation between the legislature and the governor, or nothing would happen. Number 1901 REPRESENTATIVE WHITAKER concluded that the legislature needs to build agreement regarding the budget deficit, which does not allow the legislature to cut the budget beyond where it is now. He thought the legislature had reached the end of budget-cutting feasibility; he respectfully disagreed with Representative Ogan on that point. Representative Whitaker said he felt that the legislature had reached the point where it needed to consider the programs as proposed by Chair James and discuss them seriously. He acknowledged that some people in the political spectrum will agree with Representative Ogan's opinion. However, he trusted that differences in political opinion would not deter other legislators who believe that cutting of governmental spending has reached its limit. He explained that now it is time to look at alternative revenue sources because ultimately the legislature will have to make a difficult budget decision. Number 1997 REPRESENTATIVE MOSES said he favored HB 124. He'd discerned that in the last decade (1990) Alaskan politicians had campaigned on the platform that they would go to Juneau and cut the budget without adding taxes; that was a promise the politicians made to their constituents. Such campaign promises simply could not be fulfilled without revenue; however, the public was "psyched" into thinking that state business went on as usual, even with cuts to the budget and no taxes. He explained that the school property tax credit was very important, since that kind of income tax affected nonresidents too. A nonresident who decided to become a property owner in the state would be entitled to the credit. Representative Moses said he knew many legislators who complained about areas of the state that do not contribute. In the absence of a local property tax, those Alaskans would contribute revenue to the state, just like a nonresident under HB 124. Number 2097 REPRESENTATIVE GREEN informed the committee that he'd talked with many people, inside and outside the state, who are confused regarding government payments of $1,700 to each individual [the permanent fund dividend] and the legislature's discussion of taxing those same individuals to bring money back to the state coffers. Number 2172 CHAIR JAMES expressed interest in how taxes affect people. She pointed out that nonresidents from Oregon, who come to Alaska to work on the North Slope, pay income tax to their home state. Oregon is actually getting more out of employment taxation than Alaska, even though Alaska's North Slope provides the employment opportunity, because Oregon collects the tax and Alaska does not. It seems strange that people want government cuts, yet still want government services without paying for them. CHAIR JAMES agreed that Alaskans are taxpayers because they do pay taxes to the federal government and the bulk of our state budget is federal funds. Therefore, if state government spends federal funds for programs, then taxpayers can object because some of the money spent is theirs. However, taxpayers do not contribute anything on the state portion of a government-funded program. She believed that is exactly where the budget gap existed: in general state funds. This observation has led her to believe the budget deficit could not be covered by cutting programs only. She noted that the legislature is now into its fifth year of "zero" fund spending; as a consequence, the legislature has found other kinds of fill-in funds. She reiterated that the legislature has cut $220 million over a period of five years. In so doing, the legislature has held the line on budget spending. Chair James felt it was not just a matter of reducing spending each year, but also of holding the line on natural growth. Number 2433 REPRESENTATIVE HUDSON agreed with Chair James regarding the budget reduction over the past five years, although his figures indicated the budget had been reduced by $240 million over the past five years. He believed if the legislature had not reduced the budget, Alaska's constitutional budget reserve - the only publicly acceptable source of funds - would have been depleted entirely. He said one alternative would have been to use the earnings reserve account or some other assets of the permanent fund to fund the budget. He continued by saying other alternatives would have been to establish an income tax, sales tax, or corporate income tax. He argued that it was not easy to cut programs to which the public has become accustomed. Number 2502 REPRESENTATIVE MOSES commented that like no other state, Alaska has tens of thousands of people who come here to make a nest egg - living here five to ten years with no intention of staying, and saving every dollar to take home. Consequently, he felt they were not true residents of Alaska and that the state did not get the benefit of a trickle-down effect in the state economy; that type of resident takes the money and runs. CHAIR JAMES turned to public testimony. Number 2550 SCOTT CALDER testified via teleconference from Fairbanks. Although he liked the idea of HB 124, Mr. Calder said he had a few concerns. He remembered when Alaska used a school tax to collect revenue. The school tax was a simple plan that he thought was fair and equitable. He referred to page 3, Section 5, which includes an extensive rewrite of AS 47.20.030. That section appeared to discuss how a tax is to be collected. He favored collecting the tax through the employer, rather than creating a burden on citizens to submit paperwork to the state. MR. CALDER also noted that on page 7, line 11, the definitions of the words "includes" and "including" were deleted and a definition of the word "individual" was inserted in their place. He did not understand why those changes were made. Generally speaking, he thought HB 124 was a good idea. Number 2721 REPRESENTATIVE GREEN recalled when the legislature passed a tobacco tax, which he had favored. He explained that he favored that tobacco tax because he sincerely thought it was going to be used entirely for education of youth. Unfortunately, the tax has been diverted into several other areas because a tax cannot be dedicated. Therefore, he expressed concern that the same would occur to HB 124. All taxes go into the general fund and are allocated as the legislature sees fit. He said imposing a tax for a specific purpose and then seeing that revenue go straight into the general fund causes him considerable agitation. Number 2784 CHAIR JAMES addressed the issue of constitutionality regarding use of tax revenue. The Alaska State Constitution states that the legislature cannot have a dedicated fund. She explained what had happened regarding the tobacco tax. The legislature does have a dedicated fund for the cigarette tax, not the tobacco tax. The cigarette tax is a dedicated fund set up before Alaska became a state; that money can only be used for the maintenance and construction of school buildings or paying school construction bonds. She said Representative Green was talking about a tax on tobacco and related products, not cigarettes, which tax is being used for things other than educating youth about tobacco. Number 2844 REPRESENTATIVE GREEN replied that the pre-state dedicated cigarette fund and examples like the use of tobacco tax revenue were a subterfuge. He had voted in good faith for the tobacco tax and is now very opposed to how the revenue generated by that law is being used. [HB 124 was held over.]