Tax analyst says flat-rate system will benefit wealthy at the expense of the majority

By: - January 26, 2023 7:00 am
Dollar bill and coins

(Kenny Eliason | Unsplash)

The wealthiest Wisconsin residents already pay a smaller share of their incomes in state taxes than the rest of the population, and replacing the state’s current graduated-rate income tax structure with a flat tax would increase that disparity, a national tax expert says.

Carl Davis
Carl Davis, Institute on Taxation and Economic Policy research director (Photo courtesy of ITEP)

“The most common way that tax equity is evaluated is looking at how much people are paying compared to their income,” said Carl Davis, research director for Institute on Taxation and Economic Policy (ITEP) in Washington, D.C., in an interview Wednesday. ITEP describes its mission as conducting research and making policy recommendations intended to “shape equitable and sustainable tax systems.”

Research that ITEP produced in 2018 found that Wisconsin families who make $198,000 a year or less pay 10.1% to 10.6% of their incomes in state and local taxes — a figure that includes sales taxes, property taxes, other special taxes as well as income taxes. Those families account for 95% of the state’s population.

Meanwhile, the highest-earning 1% of Wisconsin families, with annual incomes of $512,000 or more, pay 7.7% of their income when all their state and local taxes are added up, ITEP calculated. The total state and local tax bite for the remaining 4%, with incomes between $198,000 and $512,000 a year, is 8.5% of their income.

Davis said ITEP considers a tax system equitable if, whether rich, poor or in between, everyone pays about the same percentage of income for all taxes combined. 

“By that measure, our research has found that high-income folks in Wisconsin are actually paying less overall than either middle or low-income families,” Davis said. “That would be exacerbated quite a bit by a flat tax.”

On average, in states with flat-rate income taxes low- and middle-income earners pay higher state income taxes than their counterparts in states with a graduated income tax. (Graphic courtesy of ITEP)

Republican leaders in the state Legislature have made shifting to a flat state income tax a high priority in the coming legislative session. Senate Majority Leader Devin LeMahieu unveiled a plan earlier this month to phase in a flat tax and reiterated plans to pursue that goal after Gov. Tony Evers’ State of the State address Tuesday night. 

In addition to Wisconsin, state lawmakers in Louisiana, Nebraska, North Dakota and Ohio have floated proposals this year to move from graduated state income tax rates, in which higher earners pay a larger share of their incomes in taxes than lower-income taxpayers, to flat-rate systems, according to a policy brief ITEP released Jan. 17.

“We’re seeing a lot of opportunism in the states right now, where lawmakers feel that they have some breathing room in their budgets and they’re using this moment to pass some long-term tax cuts,” said Davis, who coauthored the brief with ITEP’s state policy analyst, Eli Byerly-Duke.

Over the course of four years, the LeMahieu plan would replace Wisconsin’s current system of state income tax rates. Those range  from 3.54% for the lowest-income earners to 7.65% for the highest earners. Instead, all income taxpayers would pay a single 3.25% tax rate — lower than the current bottom rate.

Evers has declared his firm opposition to a flat tax, advocating instead a 10% income tax cut for single filers with adjusted gross incomes of $100,000 or less and joint filers with incomes of $150,000 or less. 

An analysis by the nonpartisan Wisconsin Legislative Fiscal Bureau of LeMahieu’s proposal pegged its cost at more than $4 billion a year in the first two years of its phase-in to just over $5 billion a year in 2026 and thereafter.

Lawmakers who have signed on to the LeMahieu proposal as well as outside groups pushing the flat tax plan have claimed it was needed for Wisconsin to become economically competitive with flat-tax neighboring states, including Illinois, Michigan, and most recently Iowa. Illinois and Michigan have flat rates enshrined in their state constitutions and Iowa instituted a flat tax effective this year.

Most other state and local taxes, such as property taxes and sales taxes, tend to be regressive, hitting poor and middle-income taxpayers harder than the wealthy, Davis said. Income tax structures that raise rates on higher incomes help offset that.

Davis said that while Illinois and Michigan do have flat tax structures, other provisions in their tax code compare more favorably with Wisconsin when it comes to tax fairness. 

According to calculations from the Institute on Taxation and Economic Policy, for the 95% of Wisconsin residents with incomes below $198,000 a year, state and local taxes combined take from 10.1% to 10.6% of their incomes, while the wealthiest 1% pay 7.7% of their incomes and those in the next wealthiest group pay 8.5%. (Graphic courtesy of ITEP)

Wisconsin allows a deduction of 30% on the income tax levied from long-term capital gains. “That’s a form of income that flows overwhelmingly to high-income people,” Davis said. “I would be especially worried about instituting a flat tax in a state that has that. That’s very different than what we see in Illinois or Michigan.”

Wisconsin also gives tax breaks for charitable contributions and mortgage interest that favor higher-income taxpayers and that aren’t found in Illinois or Michigan, he said. 

The ITEP policy brief asserts that claims a flat tax would boost small business and drive economic growth were unfounded.

Flat taxes “tend to favor those with the highest incomes — including the largest and most profitable businesses rather than the smallest,” the brief states. 

In the brief, Byerly-Duke and Davis write that under a graduated tax rate, small businesses and those that are less profitable are likely to be in lower tax brackets, while the primary beneficiaries of a flat tax will be big, wealthy corporations.

“Very large companies like Koch Industries, Publix Supermarkets, Fidelity Investments, and countless law firms, lobbying shops, and real estate firms are organized as S corporations or partnerships and see their profits taxed under the personal income tax code,” they write. “A well-designed graduated rate tax can tax partners and shareholders at more profitable firms at a higher rate than mom and pop shops.”

In addition, the personal income tax isn’t a large enough expense to influence business decisions, the authors observe. State and local taxes account for 2.3% of all business costs, they write, and state personal income taxes represent 6% of the total state and local tax bill for businesses, according to the accounting firm Ernst and Young. 

“The personal income tax is a small fraction of a small fraction of the expenses paid by business owners, suggesting that even dramatic changes in this area will have minimal impact on businesses’ bottom lines,” the policy brief states.

Besides worsening income and wealth inequality, a flat tax will bring with it trade-offs in the form of pinched resources for government services such as public education and road repair, Davis said. “It’s not going to take long for those trade-offs to make themselves known.”


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Erik Gunn
Erik Gunn

Deputy Editor Erik Gunn reports and writes on work and the economy, health policy and related subjects, for the Wisconsin Examiner. He spent 24 years as a freelance writer for Milwaukee Magazine, Isthmus, The Progressive, BNA Inc., and other publications, winning awards for investigative reporting, feature writing, beat coverage, business writing, and commentary.