Middle Income Tax Reform Options for Wisconsin: Evaluating A Proposal by the Joint Committee on Finance
RESEARCH REPORT: JUNE 22, 2021
BY: JUNJIE GUO and NOAH WILLIAMS
As an amendment to our initial report on June 17 titled “Middle Income Tax Reform Options for Wisconsin”, we evaluate the potential impacts of cutting the third income tax rate from 6.27% to 5.3%, a proposal approved by the Joint Committee on Finance on the same day. We find the JCF proposal would cut annual tax revenue by about $927 million, which is roughly comparable with both the official estimate by the Legislative Fiscal Bureau and the cost of a proposal discussed in our initial report: simultaneously eliminating the phase-out of standard deductions and removing the second income tax bracket. Comparing the two proposals, we find both would cut the net tax and the marginal tax rate significantly for a large group of households. However, relative to the JCF proposal, simultaneously eliminating the phase-out of standard deductions and removing the second income tax bracket would lead to a larger benefit for middle income families, including a larger percentage increase in after-tax income and a larger reduction in the marginal tax rate which would provide them with more work incentive. The exercise illustrates the importance of considering different options to find the best approach to reforming the state’s complicated tax code.
Middle Income Tax Reform Options for Wisconsin
RESEARCH REPORT: JUNE 17, 2021
BY: JUNJIE GUO and NOAH WILLIAMS
The state of Wisconsin has a progressive income tax system with statutory marginal tax rates that increase with income. But the tax code has a number of credits and deductions which phase in and out, meaning that the effective rates that taxpayers face may differ quite sharply from the statutory rate. In fact, we show that under current law families in the middle of the income distribution face the highest marginal income tax rate of 9.83%, well above the state’s top income tax rate of 7.65% on the highest earners. We evaluate two reforms to simplify the tax structure and lower marginal tax rates on middle income households: ending the phase-out of the standard deduction and eliminating the second tax bracket. We show that these reforms, particularly in combination, sharply lower effective tax rates on middle income filers. After these reforms, middle income families would face a marginal tax rate of 6.27%, the statutory rate in the current third tax bracket. We estimate that the combined reforms would cut taxes by $1.1 billion per year, and that nearly 70% of all filers would receive a tax cut, which would average $500. While marginal rates on middle income households would be most affected, higher income households would see larger tax cuts in absolute terms. Households with incomes above the current threshold for the full phase-out of the standard deduction would receive a flat lump sum tax rebate. But as a proportion of income, middle income households in the $40,000-$100,000 range would receive the largest benefit from the combined reforms, with increases of 0.9%-1% in after-tax income.
