This post originally appeared at https://www.badgerinstitute.org/why-the-badger-institute-opposes-sb-435-2023/

The bill: The Wisconsin Senate now is considering a bill, SB435, that exempts a lot retirement income from the state income tax. Specifically, the bill: 

• Exempts up to $100,000 for an individual ($150,000 for a married couple) of income from tax-sheltered retirement accounts.
• Cuts the marginal rate on the second-highest income tax bracket from 5.3% to 4.4%, making a single bracket of the second- and third-highest brackets. Other brackets are unaffected.

Why we oppose it: The Badger Institute supports substantial tax reform that would cut most Wisconsinites’ income tax by going to a single-rate system. With the Tax Foundation, we offered a set of options that would do this with no increases in any taxpayers’ liability. In other words, we favor tax cuts. But the problems with this proposal are two-fold:

Unfair exemption: Exempting income from a tax-sheltered retirement account means that some wage income that was exempted from tax when savers put it into accounts such as 401(k)s or IRAs would be untaxed entirely — but not income that savers put into a Roth IRA, which is taxed when earned and already is exempt from taxation upon retirement. It means Wisconsin would treat different savers unequally and in a way they could not have anticipated when they chose a Roth IRA over a traditional IRA in their working years.

And, as the Tax Foundation’s Katherine Loughead points out, large income tax base carveouts such as this put upward pressure on the overall rate that applies to all income, including that earned by workers and job creators who drive productivity and economic growth.

Poorly targeted relief: It is far better for lawmakers to push for lower rates for everyone. 

The third-highest bracket covers a broad swath of taxpayers, and it was left unchanged even as Gov. Evers let stand the Legislature’s cuts to two lower brackets. But the second-highest bracket was cut about a percentage point in 2021. What hasn’t been cut is the state’s top rate of 7.65%. 

This matters for all Wisconsinites because the top rate, 8^th highest in the country, falls heavily on Wisconsin businesses. About 95% of businesses in the state are “pass-throughs,” paying taxes on their owners’ personal returns, and about 67% of pass-throughs’ income is exposed to Wisconsin’s top rate. The top bracket “is the most important rate to reduce because it has a far greater negative effect on economic growth than lower rates,” Loughead testified to the Assembly in May — meaning that keeping the rate high means slower growth and fewer opportunities for Wisconsinites in search of better work. 

Economist Don Bruce estimated for the Badger Institute this year that moving to a 5.1% single-rate income tax would mean 24,000 more jobs and $7.2 billion of added growth in Wisconsin over the next five years, mostly because reducing the top rate would mean less suppression of business growth. 

By contrast, cutting the rate for the second-highest bracket, while delivering relief to many taxpayers, does little for every other Wisconsinite by missing most of the growth-encouraging effects of a single-rate tax reform.

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