What will be the effect of these proposed tax cuts? The Arkansas Department of Finance and Administration estimates that the income tax cuts will ($483.5 million in the first year, because the calendar and fiscal years don’t line up and this is retroactive for all of 2024). Property tax cuts will cost (this doesn’t come out of the state budget, but instead is funded out of a special 0.5% sales tax).

But what will the effect be for Arkansas taxpayers? The $75 property tax credit is straightforward: every primary residence in Arkansas will get the same benefit. For the personal income tax cuts, the savings received will depend on your level of income, but any Arkansas taxpayer with taxable income over $25,000 will receive some benefit. The table below shows several sample taxpayers and the benefit they will receive from the proposed reduction of the top marginal tax rate from 4.4% to 3.9% (note: income figures are forĚýtaxable income, which is after subtracting the standard deduction or other tax deductions, and they also include one personal credit):

It is also worth considering that the current proposed income tax cuts are the next step in a long series of tax reductions in Arkansas that began in 2015. The cumulative effects of these tax cuts, including the current proposal, result in very large tax reductions for middle-class households. Keep in mind also that dual-income families are taxed separately, so the benefit could be twice as large as the following table shows. This table compares the tax system in Arkansas before the first cuts in 2015 (when the top rate was 6.9% and many other features were different) were enacted with the proposal currently before the legislature to reduce the top rate to 3.9%:

For more information on the history of tax reform in Arkansas and ideas for future reforms, see our 2023 bookĚýThe Future of Arkansas Tax Reform jointly published with the Tax Foundation.

The newsletter from Monday also talked about the balance between different policy goals that all governments must strike. When it came to the balance between the public’s right to know what their government is doing and concerns about safety and efficiency, many legislators and members of the public thought the initial proposed changes to Arkansas’s FOIA law didn’t strike the right balance. As our policy analyst Joyce Ajayi explained in , as well as blog posts on Tuesday and Wednesday (co-authored with our policy analyst Joseph Johns), the initial bills didn’t just address the Governor’s personal safety, but also would have severely reduced state government transparency in other ways. A bill was ultimately passed (), but it was significantly slimmed down to only directly address issues related to safety and security.

The bill to reduce income taxes that I discussed last week in a blog post had a much smoother path to acceptance by the legislature (the bill is ). Starting in 2024, over 1 million Arkansans will now pay lower income tax rates (down from 4.7 to 4.4 percent for the top rate), and most Arkansans will also receive a $150 credit on their 2023 taxes. These changes continue the process of making Arkansas competitive with neighboring states, but, just as important, it will more closely restore the balance between taxes and state government spending.

And here’s a preview of something else coming up soon on taxes from ACRE: within the next month we will be releasing an updated book on tax reform in Arkansas, once again co-published with the Tax Foundation. This book will assess all of the tax changes in Arkansas since 2015, including this special session, and offer concrete plans of how to further reduce taxes in Arkansas. We’re excited for that book to be published, and we hope you are too.

The first “Extraordinary Session,” or special session, of the 2023 Arkansas General Assembly will once again take up the important issue of tax reform. The proposed billĚýĚý(and the companion billĚý) makes three changes to Arkansas tax law. First, the top personal income tax rate will be reduced from 4.7 to 4.4 percent. Second, the top corporate income tax rate will be reduced from 5.1 to 4.8 percent. Finally, a one-time tax credit of $150 will be given to Arkansas taxpayers with taxable income under $90,000 (the credit will phase-out after that). The rate changes take effect in 2024, and the $150 credit is for 2023.

By permanently reducing the personal and corporate income tax rates, the legislature would achieve another goal of “right sizing” the Arkansas tax system for current spending levels. After three years of , it is clear that Arkansas’s state tax system raises more revenue than the current legislature wants to spend. While the days of billion dollar surpluses are probably over, the Department of Finance & Administration’s for the current fiscal year suggests there could be a surplus of around $400 million this year. Reducing income taxes again will help to better align tax revenue with the spending priorities of the legislature.

The proposed tax reductions will have a fiscal cost of about $200 million per year going forward, and almost $100 million in the current fiscal year (which will be half over by the time the tax cuts take effect). But what do these million dollar numbers mean to a typical taxpaying family in Arkansas? About one year ago, ACRE analyzed the cumulative effect of the tax cuts enacted from 2015 to 2022 on sample taxpayers in Arkansas, finding that for middle-class families the tax cuts could mean somewhere between $400 and $1,000 in savings per year, every year going into the future. High-income taxpayers will benefit even more, potentially attracting highly productive individuals and businesses to Arkansas from other low-tax jurisdictions.

We can extend that analysis to incorporate the proposed special session tax cuts, and the tax cuts enacted in the regular 2023 session this past spring. The cumulative effect would be to take the top income tax rate down from 4.9 percent, which is where it was prior to 2023, down to 4.4 percent. Keep in mind that this rate doesn’t only apply to high-income Arkansans anymore, as thanks to past tax reforms the top tax rate now kicks in at $24,300 of taxable income in 2023 (this amount is adjusted up slightly each year for inflation). Individuals with taxable income under that threshold won’t see any direct benefit from these tax reductions, though they will benefit from the one-time $150 payment in this proposed legislation.

The following table shows sample taxpayers and their tax reductions from the 2023 tax cuts (including the proposed special session tax reduction).

For example, the table shows that an Arkansas taxpayer with $50,000 of taxable income would have their income taxes reduced by $129 per year. That’s in addition to the one-time $150 tax reduction. Also keep in mind that because Arkansas allows for separate filing of married couples, these should be thought of as sample individual taxpayers, not families. A family with two earners each with $50,000 of taxable income would receive double the $129 tax cut.

For some taxpayers, the reductions in taxes from this one tax will not be especially large, but when we take a long-term perspective – including both the past tax reductions since 2015 and the potential for future tax reductions – Arkansans across the income distribution will be seeing a lot more take-home income on their pay stubs next year and into the future.

The Arkansas General Assembly has informally adjourned, meaning that the time to pass new bills is over. They will reconvene in May to formally wrap up the session, but the major action is now concluded.

Prior to the session, ACRE put together a Top 10 List of policy ideas based on our research. And throughout the session, ACRE researchers were watching relevant bills and in Little Rock whenever our research could help inform the debate. So how did our Top 10 List turn out?

Occupational Licensing

ACRE Policy Analyst Zachary Burt

Major improvements were achieved in terms of interstate cooperation and lowering barriers for professionals who wish to move to Arkansas, through . This act provides for automatic license recognition for any out-of-state license holder who moves to Arkansas, allowing them to get to work after moving here much more quickly. License holders will be granted Arkansas licenses upon moving to the state as long as they have held the license in their previous state for one year and are in good standing. The bill was weakened to some extent from its original form, changing from saying licensing boards “may” administer an Arkansas-specific exam to an out-of-state , but the final bill says that they “shall” administer the exam. This change takes away flexibility from the licensing boards and slows down what would have been a more efficient recognition process, but the reform is still good and significant overall.

Three bills this session joined Arkansas to existing licensing compacts. These compacts are a related, but distinct, concept to universal licensing recognition. joined Arkansas to the Occupational Therapy Licensing Compact, joined the state to the Counseling Compact, and joined us to the Audiology and Speech Language Pathology Interstate Compact. These three acts are excellent steps towards getting more qualified healthcare and mental healthcare professionals to move to Arkansas.

In addition to these good steps forward, Arkansas also created or expanded at multiple occupational licenses, such as a new license for behavioral analysts (note: Governor Sanders recently ) and an expansion of the existing auctioneer license. These licenses will only add to the burden of licenses in Arkansas, and is especially worrying given that according to Arkansas already has the .

Taxes and Spending

ACRE Policy Analyst Joseph Johns

Changes to tax and spending policy can take both large and small forms. This session saw a number of small reforms pass with regard to state income taxes, but there were also some major reforms of local sales taxes.

ACRE’s big idea for tax and spending reform on our Top 10 list was a “tax and expenditure limit,” a policy that about half of US states, including all of Arkansas’s neighbors, already have. While a big change like this can take a long time to build public support – as it should for a major change – there was an important first step. Rep. Wayne Long proposed a constitutional amendment that would establish a TEL in Arkansas, which he called the Arkansas Taxpayer Bill of Rights. The legislature did not refer that amendment to the voters this year, but we are optimistic that it will start future conversations about this kind of tax and spending reform.

On state income taxes, the legislature passed another slight reduction in both personal and corporate income tax rates, lowering both by two-tenths of a percentage point (the top personal rate is now 4.7 percent). While this was a small reform, it is still important, and continues along the path that the legislature has taken in almost every session since 2015. Cumulatively, these small tax cuts have created large reductions in income taxes for middle class families of almost a thousand dollars per year.

One other major set of tax reforms was passed that will limit local sales tax increases. Through the passage of two bills this year, Arkansas both required local A&P taxes to be approved by the public (before this, no public vote was required) and set strict limits on when all local tax elections can be held. Cities, counties, and school districts will now have just two fixed dates each year (in May and November) to hold local tax elections. This reform was not on our Top 10 list, but it is one that ACRE has been working on for years. Additionally, another good corporate tax reform was enacted – repealing the throwback rule – which Arkansas has suggested for years beginning with our 2016 book on tax reform.

Government Transparency

While none of ACRE’s proposed Top 10 ideas for government transparency were passed, this doesn’t mean that we weren’t busy in this area. To the contrary, there were several bills proposed during the session which would have reduced local government transparency, and ACRE followed all of these bills, testified before the legislature multiple times, and explaining why these bills would reduce transparency.

ACRE Policy Analyst Dr. Joyce Ajayi

Even though no bills were passed from our Top 10 list, towards the end of the session, two bills were filed that would have greatly expanded theof public meetings and the for cities in Arkansas. Given how late the bills were filed, they didn’t end up becoming law, but we look forward to similar bills being filed in future sessions that will establish the same transparency in Arkansas cities that ACRE helped in 2019.

The challenges with government transparency in Arkansas were demonstrated in many ways, including several attempts to limit Arkansas’s FOIA law, which is generally regarded as among the best in the nation. ACRE’s advice to policymakers doesn’t always involve recommending new legislation, but often takes the form of preventing bad changes from happening.

Every session the Arkansas legislature considers many major and minor changes to both tax and budget policy. But it’s much rarer to see proposals to dramatically reform the entire fiscal process in Arkansas. As state legislators have begun to debate potential constitutional amendments to refer to the voters, one potential amendment would make fundamental changes to the way Arkansas tax and spending policy works in the future. The legislature can refer three constitutional amendments to the people each year, and have been proposed so far this session, though they will be narrowing down this list to just three amendments this week.

The proposed would establish for the first time in Arkansas a “tax and expenditure limit” (TEL), which the author of the proposed amendment (Rep. Wayne Long) refer to as the “Arkansas Taxpayer Bill of Rights.” While the title of the amendment is a reference to Colorado’s similar Taxpayer Bill of Rights, Colorado is not the only state with such a rule. About half of U.S. states have a rule that limits how much state tax revenue or spending can grow in a given year, usually based on a formula that takes into account some economic factors (such as growth in state income, or population and inflation). Arkansas has no such rule.

In this post I will briefly explain how a tax and expenditure limit works, what the research says about TELs, and highlight the primary features of the proposed amendment. Even if this amendment is not chosen as one of the three referred by the legislature this year, it gives Arkansans an opportunity to start thinking about the possibility of a policy such as this in the future.

ACRE has long suggested that a TEL of some sort would be beneficial for Arkansas’s state budgeting process. In a that I co-authored with Jacob Bundrick, we suggested a TEL as a possible reform to address increasing state spending, as well as putting the state’s balanced budget rule into the state constitution. ACRE Policy Analyst Joseph Johns has discussed the potential benefits of a TEL for Arkansas’s budget in the context of large budget surpluses last year. Enacting a TEL was also one of ACRE’s top 10 priorities for the current legislative session. Joseph Johns has also written a short background paper (available upon request) explaining the history of Arkansas’s fiscal institutions, as well as showing some examples of how different TEL rules would have affected state spending levels over the past few decades.

What is a Tax and Expenditure Limit?

A tax and expenditure limit is a fiscal rule that states adopt, either through their constitution or by statute, to limit the growth of state tax revenue or state spending based on a set of rules. They remove some of the discretion that legislators have over tax rates and spending levels, ensuring that taxpayers have some certainty about the growth of government.

About half of U.S. states have a fiscal rule that can be classified as a TEL, but the rules vary widely across states. Some are in state constitutions, some are instituted by statute. Some limit spending, while others limit revenue collection. Some TELs can be overridden with legislative supermajorities or public votes. A few require immediate refunds of any surplus over the TEL rule.

The TEL rules also vary across states. Some use population growth plus the rate of inflation. Some use either the growth in state income, or limit government spending to a specific share of state income. Some use specific, simple numerical limits on government growth, others have complex formulas that take into consideration many factors. They can be found in both liberal and conservative states, higher and lower income states, and more urban as well as more rural states. But they all have a common goal, which is providing taxpayers with some assurance that government growth won’t exceed a certain limit by a simple majority vote of the legislature.

What does the Academic Research on TELs Teach Us?

While early research into TELs suggested they may not be effective at limiting state spending growth, subsequent research has looked more into the details of which sorts of TELs work and which do not. A 1992 paper by found that specific kinds of TEL rules can be effective. Research by suggests that TELs are more likely to be effective when they use an “inflation plus population growth” rule, and when they immediately refund surpluses to taxpayers. Knowing which TELs have been effective can help Arkansas craft a TEL rule that fits our own needs, and will work as intended, while avoiding the pitfalls of curtailing revenue growth or state spending mandated within the Arkansas constitution.

Some recent research, such as a 2008 paper by , once again finds that TELs do not necessarily constrain state spending, but likely because “state officials can circumvent them by raising money through fees.” Again, this is a case where Arkansas can learn from fiscal rules that have been implemented in other states to strengthen the laws that we pass and avoid oversights made by others. As an example, in Colorado the legislature established “” which are private businesses delivering state services, partially funded by fees, which avoid the cap of Colorado’s TEL.

In a 2010 Mercatus Center paper, attempted to summarize the research and provide additional analysis of TEL rules based on the various strands of research already in the literature. He found the following key results from his survey of when TELs are effective:

• Constitutional (instead of statutory)
• Limit spending (rather than revenue)
• Automatically refund surpluses
• Requirement of supermajority or public vote to override

Furthermore, Mitchell found that TELs are more likely to work in states with lower-income levels (this is primarily driven by states using income growth as the TEL limit, since low-income states have tended to grow slower in recent decades).

What Would the Proposed “Arkansas Taxpayer Bill of Rights” Do?

HJR1005 makes the following changes to Arkansas’s budget process:

1. Requires a state balanced budget
2. Requires approval by three-fourths of each chamber (or a vote of the public) to increase any tax rate or establish a new tax
3. Limits the annual increase in state general revenue to 3 percent per year
4. Places excess revenue in the Catastrophic Reserve Fund and Budget Stabilization Trust Fund, until both reach 20 percent of previous fiscal year’s expenditures
5. Refund any excess revenue to taxpayers by temporarily reducing income or sales tax rates

Arkansas does have several balanced budget requirements, including Amendment 20 to the constitution which requires popular approval for issuing state debt. But most of the other requirements are in statute, such as a requirement that the Governor and that the Department of Finance and Administration . Putting this requirement into the constitution will solidify the practice of passing balanced budgets in Arkansas, and strengthening the state’s Revenue Stabilization Act.

Amendment 19 to the Arkansas constitution required that any increase in existing tax rates at the time of the amendment (1934) be approved by voters or three-fourths of both chambers of the legislature. But it did not place any limits on new taxes. Thus, when Arkansas enacted its general sales tax a few years later (1937), it was not bound by Amendment 19, and has been continuously increased in recent decades (sometimes by voters, though often by the legislature). The proposed amendment this year would extend Amendment 19 to cover all current and future taxes.

Placing a hard limit of 3 percent growth in state spending will have a clear impact on state spending growth over time. In the past three decades, year-over-year state general revenue spending has grown by more than 3 percent in about half of the fiscal years (see the background paper by Joseph Johns for the data and calculations under other TEL rules). This cap is different from most state TELs, which typically use a limit based on some economic measure, such as income growth or inflation, but it is not completely unique. Ohio uses a limit of 3.5 percent per year (unless inflation plus population growth is greater). Before the adoption of the current TEL in Colorado, they used a 7 percent annual growth limit.

The final provisions of the proposed amendment which first ensure that the reserve funds are well funded, but then returns the excess to taxpayers, are some of the most important protections for taxpayers in the amendment. States as widely varied as California, Michigan, Missouri, and Oregon have provisions in their TELs that taxpayers will immediately be refunded the excess revenue if certain conditions are met. As Arkansas taxpayers saw record state surpluses of over $1 billion in the past two fiscal years, no doubt they would have preferred that some of that surplus be refunded to them. This amendment would make those refunds a reality in future Arkansas budgets.

HB1239 repeals the $150 to $400 “all corporations, LLC’s, banks, and insurance companies registered in Arkansas.” HB1045 repeals the state’s throwback rule, which results in some corporations paying more sales tax than necessary as a result of interstate apportionment overlaps. Finally, HB1044 allows certain corporations to continue to receive income tax deductions for certain property. Since corporate taxation is even more complex than the individual income taxation, I will also give some background on relevant aspects of the corporate tax code.

Repealing the throwback rule and franchise tax were two important reforms ofĚýcorporate taxation recommended by ACRE Director Jeremy Horpedahl in the 2016 publication he co-authored with the Tax Foundation,Ěý.ĚýModifying business deductions has become more important since federal tax changes in 2017, so that Arkansas aligns with federal tax law.

HB1239: Repeals Arkansas Franchise Tax

HB1239 repeals the Arkansas corporate franchise tax, a tax on the capital stock of businesses. As of January 1, 2022, only 16 states had capital stock taxes on their books. Arkansas had the highest franchise tax rate of any state in the nation, at 0.3 percent of a business’s net worth with an unlimited collection cap. Arkansas requires corporations and banks with stock as well as mortgage loan corporations to send the state 0.3 percent of the firm’s outstanding capital stock. This acts as a wealth tax, a poor revenue-raising tool, and a harmful tax on the accumulated wealth of corporations. Arkansas’s tax rate is the highest in the nation, and there is no cap on the amount a business can pay (about half the states with a capital stock tax have a limit).

Accumulated wealth is what allows corporations to invest in their communities, hire new workers, and make any improvements necessary to their businesses to guard against future economic downturns. These investments are ultimately beneficial to workers who would otherwise suffer from layoffs and lower pay during turbulent economic times. The corporate franchise tax reduces the total amount of funds available to corporations to reinvest in their communities, workers, and business models, potentially weakening Arkansas businesses. This is opposed to the prevailing sentiment that businesses are power hungry, greedy, and are indifferent toward the people they serve. Rather, businesses in Arkansas are compelled by the state of Arkansas to pay the highest fraction of their total net worth every year, relative to all other states in the nation.

According to , multiple states have been walking back their franchise taxes in an effort to attract and promote business formation and in-migration. “Kansas completely phased out its capital stock tax prior to tax year 2011, followed by Virginia and Rhode Island in 2015 and Pennsylvania in 2016. Mississippi is in the process of phasing out its capital stock tax, which should be completely eliminated by 2028. Connecticut is also phasing out this tax, completing the process by 2024.”

Despite the associated with HB1239, the Arkansas legislature should consider passing the bill to encourage more small businesses to locate in Arkansas and reduce the cost of doing businesses in the Natural State.

HB1045: Repeals Arkansas’s Throwback Rule

Currently, with what is known as a “throwback rule” which taxes income from sales that are not taxed in other states.

When a corporation meets certain benchmarks primarily related to the , the corporation establishes an economic nexus in that state, which makes under that state’s law. States started imposing throwback rules to recapture state sales tax revenue from corporations that did not have an economic nexus in other states where their sales occurred.

To understand the throwback rule, it is important to clearly define a concept known as “nowhere income” or the income that corporations make that is not taxed for the two reasons below. Corporate income can be classified as nowhere income in one of :

• The destination state doesn’t have a corporate income tax.
• The company’s activities in the state aren’t sufficient to establish legal “nexus” for purposes of the corporate income tax.

The Arkansas throwback rule states that sales by corporations originating in Arkansas to other states that satisfy conditions (1) and (2) above be “thrown back” to Arkansas to be eligible for taxation under the Arkansas corporate income tax.

Throwback rules are oftentimes inefficient and sometimes harmful when throwback-rule states attempt to court businesses to choose their state with such a convoluted tax law.

The pressure is even higher for states that utilize a single sales factor apportionment formula, such as Arkansas as of 2021. Apportionment essentially tells businesses that operate in more than one state how much of their sales are taxed in each state where they did business.

Therefore, only sales made inside the state contribute to taxable sales for multi-state corporations in Arkansas (as opposed to property and employee payroll, which is still used in some states).

Economists have found that states which emphasize sales in their apportionment formula tend to attract businesses that export most of their products or services to other states which emphasize sales in their apportionment formulas. This makes sense for exporting firms which have an economic incentive to locate to states that do not tax their goods and services as highly. Therefore, firms will be more likely to choose to locate inside a state that does not “throw back” their sales from other states and increase their corporate sales tax burden.

Research from found “no relationship between [the] imposition of a throwback rule and state tax revenue.” This means that states that adopt a throwback rule did not see any changes to their total tax revenue collection.

They also found that throwback rules “might raise effective business tax burdens and reduce economic activity.” This is due to the fact that firms always and everywhere seek to make a profit and will try to avoid anything that gets in the way of that goal. There is also that the throwback rule harms economic development. has found that firms have an economic incentive to locate in non-throwback states with single sales factor apportionment formulas to avoid further taxation from a state that “throws back” sales from states where the firm does not have nexus.

, provided a hypothetical example of the impact of a throwback rule on business sales and found that if a business with $100 million in sales to 10 different states were located in a state with a throwback rule, then if “that state imposes a corporate income tax of 6 percent, the effective rate on the actual income earned in the state is an astonishing 38 percent—more than enough to convince many companies to locate their operations elsewhere.”

Summarizing the content above, throwback rules have been found to produce little to no benefit for states which adopt them. They increase the cost of operating an exporting business by imposing taxation on products and services (tangibles and intangibles) that would have otherwise been untaxed. If Arkansas wants to reduce barriers to doing business in the Natural State, repealing the throwback rule is a good first step. The Arkansas HB1045 to cost $37 million in FY 2024 and $74 million in FY 2025. However, this is a static estimate and will be at least partially offset by new businesses locating to Arkansas as a result of the improved tax policy.

HB1044: Adopt Federal Depreciation Standards

Arkansas could also consider passing HB1044 which allows certain businesses to more fully deduct the cost of certain business inputs across the life of the assets in question. The bill also allows other corporations to claim a more specialized deduction, known as a which “allows businesses to deduct a large percentage of the purchase price of eligible assets upfront.”

Allowing firms to claim the deductions found in HB1044 essentially reduces those businesses’ corporate income tax rate by allowing the expenses associated with running the business to be deducted from the total corporate income that is considered “taxable” by the state of Arkansas. This same type of tax saving could be realized by lowering the corporate income tax rate by an amount equal to the savings associated with the deduction.

Businesses change their investment patterns differently when the state reduces the corporate income tax rate than when it increases the number of business deductions available to a particular business. For instance, when a state reduces its corporate tax rate by 1 percent, businesses will invest 39 percent more than if the state increases business input deductions by the same amount, according to economist

The is projected to be negative for the first five years as businesses adopt higher deductions and invest in more capital infrastructure, followed by a small revenue gain in 2028. However, the revenue loss is likely caused by deductions being taken earlier, and thus not being taken in 2028. Despite the lower results relative to corporate tax rate reductions, HB1044 will encourage Arkansas businesses to increase investment and reduce their corporate income tax burdens which will enable those businesses to free up resources which could be utilized to increase workers’ pay and training and advancement opportunities. The losses could be smaller than projected, since the DFA estimate doesn’t take into account any increased economic activity from the tax changes.

Figure I:

Another major benefit of this bill is easy to understand: it makes sure Arkansas’s corporate tax rules are in-line with federal corporate income tax rules. Not only does this make compliance with tax law easier for businesses, but it helps businesses make long-term decisions about investment that only has to apply to one set of rules.

Summing It All Up

Eliminating the throwback rule and the franchise tax were two of the key corporate tax reforms recommended in 2016 by Dr. Jeremy Horpedahl along with authors at the Tax Foundation in our joint publication ,Ěýand these reforms would be achieved by HB1044 and HB1045. The federal tax changes in 2017 have also made improving business deductions a priority in Arkansas to conform to federal taxes rules, which would be accomplished by HB1029. Arkansas has the opportunity to improve its corporate income tax code by passing these bills, implementing several reforms that don’t directly affect the income tax rate, but nevertheless make Arkansas a much more competitive state for business.

The Arkansas General Assembly has now completed 7 weeks of its 2023 Regular Session. While there is still a lot more work to be done this year, we’ve already seen some major developments, and at ACRE we are closely watching several pieces of legislation where our research can help inform the debate and legislative process. I wanted to provide a summary of what has happened so far, and what to look forward to in the remainder of the session.

The biggest news last week was the release of the full details the LEARNS Act (), which is Governor Sanders’ major initiative to reform K-12 education in Arkansas. Not only is this bill important in its own right, but it will also be important for allowing other parts of the legislative agenda to move forward. Given the potential fiscal costs of the education reform, other spending and taxation changes were partially on hold until the details became clear. I recently spoke with about how all of the proposed spending and tax changes in Arkansas might fit together this year.

The education reform bill has already made it through the Arkansas Senate and is expected to come up in the House next week. ACRE has published a variety of research on K-12 education and school choice in the past. In particular, several of our research papers address an important question in the current debate: does school choice hurt traditional public schools? Dr. Thomas Snyder summarizes his research and the research of other economists in a recent ACRE blogpost. In brief, most of the research suggests that school choice programs do not hurt student performance in traditional public schools.

Here are a few of the other pieces of legislation ACRE has been following.

Joseph Johns testifies on HB 1027

While there has not been a major tax reform bill filed yet for Arkansas income taxes, there have been several bills related to the issue of local taxes. ACRE Policy Analyst Joseph Johns summarized the relevant local tax issues in another ACRE blogpost. The first bill Mr. Johns discussed would ban local governments in Arkansas from enacting income taxes, and it has already been enacted into law as . Another bill would require A&P taxes to be put before voters before they can be enacted or increased. These are local sales taxes —Ěý primarily enacted by cities — on hotels, restaurants, and other similar businesses, but do not require a vote of the citizens. has already passed through the Arkansas House, and Mr. Johns testified before the House committee presenting ACRE’s research relevant to the bill.

Dr. Joyce Ajayi testifies on HB 1318

Several bills have also been proposed which would improve local government transparency in Arkansas, and our Policy Analyst Dr. Joyce Ajayi has testified on several of them. would improve the bidding process for city governments in Arkansas, making the process more transparent, and it has passed the Arkansas Senate. Another transparency bill is even more closely aligned with ACRE’s research. HB 1399 would give city governments the option to publish budgets online, rather than in newspapers, which has the potential to save cities money, and would also improve their scores in ACRE’s web transparency index. ACRE’s index already planned to include cities in our new 2023 report, and this bill would give them an immediate improvement in their scores for fiscal transparency. Dr. Ajayi testified before the House committee on this bill as well, but it is currently on hold awaiting a fiscal impact statement.

We’ve also seen a major bill proposed related to ACRE’s research on occupational licensing. Policy Analyst Zach Burt explained in a blog post how SB 90 would improve opportunities for work in Arkansas by establishing “universal licensing recognition.” A law like this would mean that workers could move to Arkansas and not need to go through a lot of red tape to start working if they were already licensed in another state. The bill has not been presented in committee yet, but ACRE is prepared to share our research with the legislature when it is presented, potentially in the very near future.

Thank you for continuing to follow ACRE’s research and our educational outreach to the legislature. Be sure to continue checking our blog and subscribe to our newsletter (go to the bottom of this page:Ěý/acre/) as we will continue to provide weekly updates throughout the session.

Arkansas has reduced its state income tax in recent years. However, Arkansans still face considerable tax burdens at the local level. Taxpayers face multiple local tax burdens that chip into their earnings and reduce the overall well-being of Arkansas’s citizens. Currently, there are two bills before the Arkansas legislature that could limit these harmful local taxes which will be discussed in more depth below.

Local Income Taxes

While most US states, including Arkansas, have statewide income taxes, in a few states there are income taxes imposed at the local level. , as of 2022, “Seventeen states have county- or city-level income taxes.” Arkansas is fortunately not on that list. However, the unintended consequences of local income taxes are still important to consider and guard against to protect taxpayers’ financial stability during these potentially turbulent times. [R-Maumelle] filed which bans cities, counties, and other local governments in Arkansas from imposing an individual income tax.

Policymakers realize that the Arkansas income tax code needs to remain competitive with other states and have taken steps in the past several legislative sessions to address the problems associated with the Arkansas income tax. The Arkansas General Assembly reduced the top personal income tax rate from the highest in state history in 2015, seven percent, to the lowest it’s ever been in state history in 2022, 4.9 percent.

Restricting counties and municipalities from assessing an income tax would be beneficial for multiple reasons. The first and most important is that it keeps more money in the hands of hard-working taxpayers. which assessed county income taxes in FY 2021, collected $3.49 billion in real 2022 dollars from county individual income tax receipts. This is equivalent to $513 per capita in real 2022 dollars. County income taxes are imposed in every county in Indiana, and the median local option income tax rate was 1.75 percent in FY 2021. If Arkansas had adopted the same median rate, the per capita local income tax amount in Arkansas could be around $340 (a rough estimate using IRS taxable income in Arkansas). The Indiana rate is also roughly the median of the current county local option sales tax which reaches as high as (before including city sales taxes).

Local Option Sales Taxes

While the Natural State does not currently have any counties that impose a local option income tax, Arkansas does have a large number of local sales taxes, which have been rising the past few decades primarily due to local option sales tax elections held at special elections. , which was filed in the 93rd General Assembly in 2021, would have limited when special elections could be held to overlap with general or primary election dates, but did not pass (some restrictions on election dates were imposed by a separate 2021 bill, ).

Seventy-four out of 75 Arkansas counties assess a , as well as over 300 cities (Monroe County has no sales tax, but 4 cities in the county do, with 3 cities taxing at 3 percent). As a result, Arkansans currently pay the third highest combined in the nation at 9.47 percent as of July 2022. According to the Tax Foundation, Arkansas has a 6.5 percent statewide sales tax, while local sales tax rates can be as high as 6.125 percent, with an average of about 3 percent.

Dr. Jeremy Horpedahl, Director of ACRE and Associate Professor of Economics at the 51ÇŕÂĄ, studied the effects of local option sales tax elections to determine how much this seemingly benign policy had on Arkansas taxpayers. He found that 82.2 percent of the 1,004 local option sales tax elections were held during special elections. This is important due to the low turnout rate for special elections. The figure below shows the inverse relationship between turnout rates and the success of a local option sales tax election.

Figure I: LOST Election Voter Turnout Passage Rates

The most significant lesson from the chart above is that as voter turnout for local elections increases, the passage rate of local taxes decreases. Therefore, if Arkansas wants to limit the further increase of local sales taxes, they could require such elections be held during special or general election dates.

There are also additional costs to holding special local option income tax elections. Horpedahl estimated that local option sales tax elections cost taxpayers a cumulative $10 million (in inflation-adjusted dollars), or over $250,000 per year from 1981 to 2020. $10 million is the cost of holding the elections themselves, and not the added tax burden that would result from the successful passage of a local income or sales tax election. This is not just the “cost of democracy” but rather an unnecessary burden that Arkansas counties have placed on their residents since they could be held alongside general or primary elections at no additional monetary cost.

A&P Taxes

ĚýAdvertisement and Promotion, or A&P taxes, are assessed on the sales of prepared food and/or short-term lodging accommodations in Arkansas. The tax is often colloquially referred to as the “hamburger tax” or “hotel tax.” It affects local business owners and increases the cost to consumers of many everyday needs. If you have ever stayed in a hotel in Bentonville or Little Rock, or eaten out in one of the 57 cities or towns with A&P taxes in Arkansas, then you have felt the cost of this often-overlooked tax. The tax is imposed on top of the general sales tax discussed in the previous section, meaning the combined tax rate can be well over 10 percent in many cities.

Enforcement of these taxes is oftentimes ambiguous and difficult to manage. The state of Arkansas has a precise can make it difficult for grocery stores to differentiate between “prepared food” and everything else. For instance, when the seller heats or mixes any food and sells it to the customer, that food is considered prepared. It gets worse. Deli meats and cheeses also get a carve out (pun intended) since “food that is only cut, repackaged, or pasteurized by the seller” is not considered prepared food. This implies that such foods are not included in the gross receipts tax assessed under the A&P tax definition.

The proceeds of A&P taxes are used for the purpose of advertising and promoting the city raising the tax. The logic for imposing the tax on businesses such as restaurants and motels is that they are the industries that would primarily benefit from increased visitors to an area. However, the added burden of A&P taxes could also make it more difficult for lodging and dining establishments to compete with localities without these burdens. Each A&P tax is approved by an unelected advertisement and promotion commission. are composed of seven members, including at least three owners of hotels or restaurants. Each A&P Commission has the power to unilaterally impose local option sales tax rates of up to 3 percent (and an additional 1 percent in some cities) without consulting the voters. [R-Maumelle] filed to require voter approval of A&P taxes before a city or county can assess such a tax.

The A&P tax is also imposed despite record high levels of food inflation. Prices at restaurants soared 9.1 percent in 2022 in the West South Central U.S. Census Region (which includes Arkansas), according to the U.S. Bureau of Labor Statistics (data from CUUR0370SEFV). Requiring voter approval for A&P taxes would help reduce the share of cities with A&P taxes since past research by Dr. Horpedahl has found an inverse relationship between turnout rates and other local sales tax elections.

There has also been some examples of waste and abuse of A&P tax funds in Arkansas. The Searcy A&P Commission was to pay for wasteful sports infrastructure projects in 2021. Conway paid $130,000 for a with A&P tax revenue in 2013. Moreover, many cities seem to have moved beyond in using the funds, which limits the funds for use in advertising and promoting the city, constructing and operating a convention center, and operating a tourist promotion facility (in , an additional 1 percent tax can be used for city parks and recreation).

Enhancing taxpayer protections from local taxes can improve the quality of life for Arkansans and their communities. Requiring all local tax elections to be included during general and primary elections can help reduce the burden of local tax rates and prevent counties from working against the wishes of the to reduce tax burdens for all Arkansas residents.

Consumer price inflation hit 40-year highs in 2022. The rapid increase in prices has already hit households hard in their wallets as they buy everyday goods and services. But for taxpayers in Arkansas, there could be another hidden cost of inflation: your taxes could be going up in real terms, even if your income barely kept up with inflation. How does the complicated relationship between taxes and inflation work?

Arkansas is one of seventeen states that adjusts their individual income tax brackets to inflation as of 2022, according to the . That’s good for taxpayers. The federal tax code is also adjusted for inflation. For both states and the federal tax code, this means that each year the income levels in tax brackets (as well as other parts of the tax code) are adjusted upward to avoid what is known as bracket creep. The summarizes the issue:

Bracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions [that would otherwise help reduce income tax burdens.] Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation.

Think of it this way: if your income increased 6.5 percent in 2022, just barely enough to keep up with inflation, you wouldn’t want your taxes to go up by more than 6.5 percent either. Inflation-adjusting tax brackets prevent you from being bumped up into a higher tax bracket, when your real income hasn’t increased.

Given all this, it’s a good idea that Arkansas already , and that the Arkansas legislature also recently to inflation during the Second Extraordinary Session of the Arkansas General Assembly in 2021. So what’s the problem for Arkansans?

Under current tax law, Arkansas places a hard cap of 3 percent on inflation adjustments each year. Very few states have a cap on inflation adjustments, with almost all using the full inflation rate. This cap limits the effectiveness of adjusting brackets to inflation since inflation . Because of this cap, many Arkansas taxpayers could see higher taxes as they are pushed into tax brackets with higher rates.

A bill before the Arkansas legislature, known as the “” (not to be confused with the ), would remove this 3 percent limit on annual inflation adjustments. Instead, individual income tax brackets and the standard deduction would be indexed to the full rate of inflation under this bill. Additionally, the bill utilizes a newer measure of inflation from the Bureau of Labor Statistics (BLS), a version of the well-known Consumer Price Index that applies to the “” division, a four-state area that includes Arkansas. This index should more accurately reflect the inflation situation in Arkansas, rather than the index that uses all 50 states.

The Department of Finance and Administration (DF&A) estimates that of $32.6 million in 2023 and $65 million in 2024. In other words, by lifting the cap on inflation adjustments (currently 3 percent), Arkansans will avoid close to $100 million in inflation-induced taxes over the next 2 years. After that, DFA assumes that inflation levels will fall back below 3 percent, thus there would be no additional fiscal impact. But if high inflation returns in the future, this safeguard will protect future taxpayers as well.

Beyond just the impact on tax brackets, the costs of inflation to Arkansans are already large. The Congressional (JEC) began tracking inflation beginning in January 2021 since inflation “was within recent historical norms at 1.4 percent.” It had not yet started to increase at the interval it did from February 2021 through December 2022.

Utilizing data from the BLS Consumer Price Index (CPI), the JEC staff calculated each state’s monthly household inflation costs. They found that inflation peaked in Arkansas in October 2022. During that month, households needed $579 more per month to maintain the same standard of living as they enjoyed in January 2021. Figure I below shows the inflation costs for Arkansas households between January 2021 and December 2022 (for this calculation we used the West South Central division CPI).

ĚýFigure I:

The Arkansas Joint Budget Committee could also consider further consolidating the two tax brackets to a unitary table. This type of reform would reduce, but not wholly eliminate concerns about bracket creep by eliminating the differences between tax rates when income levels change. Only a flat tax with a single rate avoids bracket creep since there is no possibility of moving to a different rate in the same table.

Regardless of how the Arkansas legislature chooses to respond to the uptick in inflation, such trends persist as a toll first on the earnings of Arkansas citizens and should be controlled for by fully indexing all elements of the Arkansas tax code to inflation. This will allow current households to avoid paying more in taxes than is absolutely necessary and guard against any future spikes in inflation as a result of federal monetary policy.

Beginning in 2015, Arkansas has been making gradual reductions in both personal and corporate income tax rates. The cumulative personal income tax reductions could be saving middle-income families in Arkansas $2,000-$5,000 every year, as an analysis by ACRE Policy Analyst Joseph Johns shows. Not only has the top income tax rate been reduced for individuals and families, but many lower rates have been cut as well. The corporate tax rate has been reduced from 6.5% to 5.3%, along with other important changes to the structure of the corporate tax code.

These changes have clearly benefited Arkansan citizens and businesses, but have these tax cuts greatly reduced available state revenue? This concern is potentially real, since income taxes make up over half of state general revenue in Arkansas. It could also be a concern moving forward, as the legislature considers further tax cuts in the current legislative session.

Despite these concerns, the data so far shows that there has been no reduction in income tax revenue in Arkansas. The best way to measure how much tax revenue is being collected is to express it as a percent of personal income in the state. If tax revenue was being significantly affected by the tax changes since 2015, we would expect this number to decline.

The tax revenue data in the chart comes from the Arkansas Bureau of Legislative Research in their “. Personal income data is from the US Bureau of Economic Analysis. Both are expressed for the fiscal years, which run from start in the third quarter of the year (e.g., Fiscal Year 2022 ran from July 2021 to June 2022).

While there is some fluctuation from year-to-year, this figure has stayed right around 2.7% since 2015, which is the average both before and after the tax changes began. We all know why 2020 was an unusual year and revenue was down slightly, but 2022 also proved to be an above-average year as the economy began to return to normal.

The chart above is not adjusted for price inflation, because it doesn’t need to be. Both tax revenue and personal income are expressed in nominal dollars from the same time period, so it is adjusted for the size of the economy. But we could also adjust the tax revenue data for inflation to make sure it is growing each year, which is what the table below shows (all dollars expressed in January 2022 dollars).

We can see that even after adjusting for inflation, total income tax revenue in Arkansas was over $700 million greater in 2022 than it was in 2015, before the tax reductions began.

That’s all good news for Arkansas, both for taxpayers and the state budget. But it might seem surprising. How can tax revenue continue to increase when taxes are being cut?

The overriding reason these tax reductions haven’t lowered total revenue very much is that these tax cuts were small compared with the overall budget. While the cumulative amount is somewhere around , this total was phased-in over multiple fiscal years. During most years, the total new reductions were somewhere around $100 or $200 million, or less than 5% of income tax revenue and an even smaller share of the total general revenue budget. Gradually reducing income tax rates has meant there is never a large hit to the state budget, since tax revenue tends to grow every year anyway along with the economy growing. Adjusted for inflation, was almost 12% larger in FY 2022 than it was in FY 2015.

Another reason is that there will be some positive impact on economic growth from these tax cuts. Economists sometimes refer to the dynamic cost of a tax cut, which is different from the static cost. The static cost () assumes that people’s behavior doesn’t change in response to the tax changes. But changing behavior, such as encouraging work and business formations, is one of the policy goals of lowering taxes. If people do change their behavior, the dynamic cost will be less than the static cost, since more economic activity partially offsets the lower tax revenue.

Dynamic scoring is often challenging to do, and the Arkansas Department of Finance and Administration typically only scores legislative bills based on their static costs, which means it is hard to say exactly how much of the effect we see in the charts above is due to dynamic behavior changing by individuals and businesses. And tax cuts rarely “pay for themselves,” in the sense of all of the revenue being made up by more economic activity, which would only happen at very high tax rates (a relationship sometimes called the Laffer Curve). But there is likely some positive, offsetting effect on tax revenues: they won’t decrease as much as the static analysis suggests.

In 2018, the Arkansas Tax Reform and Relief Legislative Task Force had some economists model the dynamic effects for reducing the personal and corporate tax rates to 6% (when they were both higher), and most estimates suggested $300 million of new economic activity from the personal income tax cuts and another almost $50 million from the corporate rate cut. This new activity should not be confused with new tax revenue, which will only be a fraction of the economic growth, but it does show there is some dynamic offset likely to have occurred as rates decreased (the analysis starts on ).

As the legislature looks to further reduce the burden of taxation in Arkansas, they should be able to comfortably lower rates by roughly the same magnitude as recent years without worrying about dramatically impacting the state budget.