WASHINGTON (Reuters) - Colorado voters on Tuesday will decide a ballot proposition that entwines two tax issues currently dominating the U.S. presidential contest: flat rates and increases.
Colorado is one of seven states with a flat income tax, according to the Federation of Tax Administrators. Proposition 103 on its ballot would raise the rate to 5 percent from 4.63 percent of income and hike the sales tax to generate $2.9 billion in revenue over the next five years for education.
Echoing larger national disagreements, educators, state leaders, and activists in the state are fighting over how to find money for basic services while preserving jobs. Some are questioning if they should keep using a flat rate tax at all.
Meanwhile, two of the Republicans competing for the party’s presidential nomination, Herman Cain and Rick Perry, recently questioned the federal graduated tax system and proposed using a flat rate for U.S. taxes.
Opponents estimate the Colorado tax measure will put 119,000 jobs at risk, based on research from Portland State University economist Eric Fruits. Still suffering from the recession and high unemployment, residents simply cannot pay higher taxes.
“There just isn’t the economic vitality there once was. The state cannot afford to increase anyone’s taxes,” said Victor Mitchell, a leading opponent and former state legislator.
Colorado is in a revenue bind. This year, it slashed school spending by $227.5 million to balance its budget. Governor John Hickenlooper will have to close another gap of at least $400 million in his next budget, according to the Denver Post.
Proponents say bringing in more revenue is the only way to prevent deeper damage to Colorado’s public schools.
“Our state is in a situation where we have been reducing spending for vital community services...for so long that we need an infusion of cash,” said Carol Hedges, director of the progressive Colorado Fiscal Policy Institute.
Saying the current system is unfair and part of larger structural budget problems, the institute wants to wipe out the flat rate. In March it withdrew six ballot measures it had proposed for a graduated system because “we were told there would be a huge campaign against us,” Hedges said, and supported Proposition 103 instead.
Colorado is not alone. The housing bust, financial crisis and recession created budget gaps in many states. All states except Vermont must end their fiscal years with balanced budgets, with many being forced to cut spending and hike taxes.
Revenue is generally climbing back, but states with flat rates are “lagging behind,” said Philippa Dunne, editor of the economic newsletter The Liscio Report, who is researching the revenues of flat tax states.
“If we had a healthier jobs creation rate, then the states with the flat tax rates would be seeing a more normal rate in year over year growth of withheld tax receipts,” she said.
In cash-strapped Illinois, lawmakers temporarily boosted the flat personal income tax rate by 67 percent and the corporate income tax rate by 46 percent in January. Fiscal 2011 collections from the two taxes surged $3.5 billion.
But the hike ignited protests from some top Illinois businesses. At the same time, the state’s comptroller said higher revenue was absorbed by rising healthcare and pension costs, and did not help pay bills.
Mitt Romney, a top Republican presidential candidate, says he supports a “flatter tax,” essentially a less complicated code. The former governor of Massachusetts, a flat tax state, opposed the federal flat rate that Steve Forbes proposed in 1996 because it did not include investments. Massachusetts charges the highest flat tax rate among states of 5.3 percent.
The term “flat tax” has “almost become a catchphrase for simplifying the tax code,” Verenda Smith, senior manager of administration and policy for the Federation of Tax Administrators, cautioned.
But under a literal definition, it only means that everyone is taxed the same percentage of income, she said. States can still use complicated methods for calculating income to tax.
Colorado applies its rate on the adjusted income determined by the federal government, for example.
Pennsylvania charges the lowest tax, 3.07 percent, followed by Indiana, 3.4 percent. Michigan charges 4.35 percent.
States with progressive rates line up brackets of income to tax. In that system, higher earners mitigate the tax effects of lower earners or the unemployed, Dunne said.
When Jon Huntsman, also a Republican candidate, was governor of Utah, the state enacted a flat rate. It began the transition in 2007, following a plan similar to Perry’s that allowed taxpayers to choose between progressive and flat rates. Now, it solely uses a 5 percent flat rate.
From fiscal 2006 to fiscal 2007 Utah’s income tax revenue rose 5.6 percent and shot up another 5.4 percent the next year, state records show. But as the recession took hold, they tumbled, dropping 10.7 percent in fiscal 2009. Of late, they are on the mend, rising 6.8 percent last year.
David Stringfellow, senior economist in the governor’s office of planning and budget prefers the term “single rate” because Utah grants credits that change tax liabilities.
“Our income tax system is a little bit more progressive than it was before,” he said. “Part of the initiative of moving to this single rate system was to reduce taxes, but it was a modest tax reduction on the order of $100 million to $200 million.”
Primarily, it cuts volatility, he said, allowing lawmakers to make decisions with a better sense of future funding.
Additional reporting by Karen Pierog in Chicago; Editing by Diane Craft