The top three reasons to cut Wisconsin’s top tax rate

This post originally appeared at https://www.badgerinstitute.org/the-top-three-reasons-to-cut-wisconsins-top-tax-rate/

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Top three reasons to cut Wisconsin’s top tax rate

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The Badger Institute supports a flat-rate individual income tax, a structure increasingly adopted by competing states. We have spent years researching options for reform that includes a single, low rate. But if that is out of the question as budget negotiations proceed, the priority should be Wisconsin’s top rate. Here’s why:

Wisconsin’s top rate is uncompetitive

Wisconsin’s top rate has remained stuck at 7.65% since 2013, when it was cut from 7.75%, even as the three lower rates have been cut three times:

• Most recently, in 2021, the second-highest bracket was cut from 6.27% to 5.3%.

• The third-highest rate was cut in 2019 and 2020, falling from 5.84% to 4.65%, a 20% reduction.

• The lowest rate was cut in 2019 and 2020, falling from 4% to 3.54%, a 12% reduction.

Since 2013, 24 other states have cut their top rates. Wisconsin’s top rate is now the 9th highest in the country.

No other state between New York and California, except for Minnesota, has a higher top rate. Our top rate is:

• 1.65 percentage points higher than Iowa

• 2.7 points higher than Illinois

• 3.6 points higher than Michigan

• 4.42 points higher than Indiana

By standing still, we have fallen farther behind.

Economic benefits of tax reform depend heavily on reducing the top rate

Moving to a single-rate “flat” income tax structure would produce immediate and ongoing economic benefits for all Wisconsinites. Dr. Don Bruce, a nationally known economist, estimated the scope of those benefits in a paper for the Institute.

Moving to a 5.1% flat tax, Bruce estimated, would over the next five years produce:

• $7.2 billion in additional gross domestic product

• $614 million in additional investment

• About 24,000 additional jobs

Bruce noted, however, the economic benefits from the flat-tax structure would be largely driven by reductions for high-income taxpayers, already shown to be most responsive to rate changes. “Indeed, the economic impacts would be smaller if the tax rate reductions were smaller for higher-income taxpayers,” he wrote.

The top rate disproportionately affects most Wisconsin businesses

While the income tax in question is the one on personal income, it also is the tax levied on the earnings of most Wisconsin businesses.

About 95% of Wisconsin businesses are “pass-throughs” — LLCs, partnerships and sole proprietorships that do not pay the corporate income tax. Instead, their earnings are “passed through” to the owners’ personal tax returns and taxed at the owners’ marginal rate.

About 67% of the earnings of Wisconsin pass-through businesses are exposed to Wisconsin’s top rate. The top rate of the personal income tax constitutes, then, the de facto rate of business taxation for many of the most successful Wisconsin businesses, or the rate that businesses expecting to grow will anticipate having to pay.

“The top marginal rate is the most important rate to reduce because it has a far greater negative effect on economic growth than lower rates. That is because business decisions are made at the margin, based on how taxes will affect the next dollar of income earned or invested, not previous dollars of income,” Tax Foundation expert Katherine Loughead testified to the Assembly Ways and Means Committee in May.

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