Fundamental State Tax Reform: Eliminating the Income Tax in Wisconsin

Noah Williams

Executive Summary:

The state of Wisconsin has the oldest continuously operating state income tax in the United States. In this report I develop and analyze a plan to dramatically change that history. I first document that, even though the state has seen income tax reductions over the past decade, the state income tax remains one of the highest in the country. By contrast, the state’s sales tax is among the lowest. Therefore, I consider a tax reform to eliminate the state income tax and make up some of the lost revenue by increasing the sales tax. I discuss how Wisconsin’s progressive income tax compounds the distortions in the federal tax code. I also highlight that the vast majority of Wisconsin businesses, covering the majority of employment in the state, pay under the personal rather than the corporate income tax. Thus, in addition to distorting household decisions on working and saving, the personal income tax is a tax on small businesses in the state. While I consider a variety of policies, my baseline reform eliminates the income tax and increases the sales tax rate from 5% to 8%. To evaluate the impact of the reform, I develop a structural dynamic general equilibrium model of the Wisconsin state economy. While official state revenue estimates include no behavioral response to taxation, my model incorporates the responses of workers, consumers, and businesses to the tax reform. I find that the tax reform is strongly pro-growth. The reform leads to 7.9% higher output and 6.9% higher employment in the long-run, with a long-run net tax cut of 12.6% of state tax revenue. I also analyze the transitional dynamics in response to two implementations of the reform plan: an immediate elimination and a phased-in plan. Phasing in the reform reduces some of the near-term revenue losses, at the cost of delaying the positive economic growth impact.

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