Independent public policy organization highlights Utah's 2006 flat tax legislation
Gov. Jon Huntsman recently signed legislation allowing Utahns to choose between the existing bracketed income tax or a flat tax of 5.35 percent with no deductions or exemptions, with two basic exceptions.
The basic exceptions include deductions or exemptions for state refunds and United States requirements such as interest on federal bonds.
State economists estimate that 4 percent to 5 percent of Utah wage earners will opt for the 5.35 percent flat rate, resulting in a tax cut of approximately $36 million.
Huntsman and key state legislators have publicly noted that the tax reform efforts in Utah is not finished. In fact, the current legislation is just the first step in the process.
The Utah Taxpayers Association advocates for the creation of means-tested credits in the flat rate system.
Since the credits would be phased out as household income increases, the benefit would be targeted to middle and lower income households and the impact on state finances would not be significant, points out the independent public policy organization.
The means-tested credits would mean that the flat tax system would not be a pure flat tax, explains the independent watchdog association.
But flat tax would still have a broader base and a lower rate than Utah's traditional system.
Along with the flat tax option, the Utah lawmakers approved legislation in the recent special session that will annually index individual income brackets for inflation.
Huntsman immediately signed the annual income tax bracketing bill into law, notes the independent public policy organization.
In addition to the annual inflationary increases, the guideline approved by the Utah Legislature implements a one-time increase in tax brackets.
The one-time hike and the ongoing increase in tax brackets mean that less individual income will be assessed at the highest rate, explains the association.
The top marginal tax rate was also lowered from 7 percent to 6.98 percent.
The reduction in the top marginal rate and the bracket increase will reduce the state's income taxes by $42 million.
Without bracket adjustments, the effective tax rates climb because, as wages increase due to inflation, more income is assessed at the highest marginal rate, continues the independent public policy organization.
While lack of indexing harms nearly all taxpayers, low and middle wage earners are impacted the most as a percent of income.
However, Utahns with zero, near zero or exceptionally low taxable income typically do not benefit from indexing.
For example, a typical two parent, two child Utah household with an adjusted gross income of $40,000 in 2005 had an effective tax rate of 2.97 percent.
Had the state's brackets been indexed for inflation since 1973, the effective tax rate would have been 1.7 percent, representing a 43 percent reduction.
The same two parent, two child household configuration with an adjusted gross income of $200,000 in 2005 had an effective tax rate of 5.12 percent.
Had Utah's brackets been indexed, the effective tax rate would have been 4.78 percent, representing a 7 percent reduction.
All Utahns would shoulder decreased financial burdens if the state's income tax brackets had been indexed annually since 1973.
However, lower and middle income households would have received the largest tax breaks in percent terms, notes the independent public policy organization.
In the 1970s, "bracket creep" was a household term in the nation because the U.S. government did not automatically index federal tax levels for inflation, continues the association.
As a result, effective tax rates increased, especially during periods of high inflation.
The term is no longer widely used because the federal government started indexing tax brackets more than 20 years ago.
However, prior to the actions taken during last month's special legislative session, Utah lawmakers had made only one adjustment to the state's income tax brackets since 1973, enacting a 15 percent increase in 2001.
In 1973, the state's top marginal rate kicked in at taxable income of $7,500.
Prior to last month's legislative change, Utah's top rate kicked in at taxable income of $8,626.
If the state's brackets had been adjusted continuously for inflation since 1973, the top rate in 2005 would apply to taxable income in excess of $32,990.
The annual income tax increase resulting from the state not indexing brackets is not very large. But the small per year increases add up significantly during extended periods of time, concluded the taxpayers association.