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Research & Commentary: North Dakota Considers Flat Tax

January 28, 2019

In this Research & Commentary, Matthew Glans examines several proposals in North Dakota that would shift the state's tax system to a flat tax.

In 2019, income tax reform will be near the top of the legislative agenda for North Dakota lawmakers. One proposal that is gaining attention is a flat tax model. Not only would this move the state away from its progressive income tax system, it could also lead to a repeal of the states’ personal and corporate income taxes. North Dakota currently imposes an income tax on personal and corporate income. The personal tax rate ranges from 1.1 percent to 2.9 percent, based on income brackets, and the corporate tax rate ranges from 1.41 to 4.31 percent.

There are several flat tax proposals being considered by the legislature. One proposal, House Bill 1319, would replace the corporate, individual, estate, and trust income tax rate schedule with a flat rate of 0 percent, effectively eliminating these taxes. Doing away with the income tax is the ideal reform for North Dakota because it keeps more money in the pockets of taxpayers and will likely attract new businesses to the state.

Although abolishing the income tax can be difficult to accomplish, politically, other options have been introduced that would create a flat tax that would either be set at a low rate or gradually phase the tax out over time. Another proposal, House Bill 1222, would eliminate the current corporate, individual, estate, and trust income tax rate schedule and replace them with a flat income tax rate of 1 percent. Although this falls short of a complete repeal, it would be a strong improvement of the state’s tax code and might be more palatable for lawmakers.

Another major proposal was introduced by State Rep. Craig Headland (R-Jamestown), the chair of the North Dakota House Finance and Taxation Committee. Headland’s proposal would gradually eliminate individual and corporate income taxes as additional Legacy Fund revenue comes in. This process, known as tax cut triggers, allows states to ensure budgets are stable before any tax cuts are implemented. This plan would also improve North Dakota’s tax code and make the state more competitive.

Flat taxes are beneficial for several reasons. They avoid penalizing the citizens who produce the majority of jobs and economic activity with higher tax rates. Flat taxes simplify the tax code by eliminating credits, exemptions, and deductions. In essence, taxpayers will no longer need to hire expensive tax accountants or use expensive computer programs to file their state taxes. Although critics of flat taxes argue they represent a tax cut for the rich, even under a flat tax, those who earn higher incomes pay more in taxes, achieving the “social justice” progressive tax proponents claim to seek.

Personal and corporate income taxes are generally considered to be the most destructive taxes because they disincentivize production, innovation, and risk-taking. Recent studies show states with no income tax or with lower income taxes perform better economically and achieve greater job and population growth than those with higher income taxes. High income taxes deter economic development by discouraging higher-income-earners and new capital from moving into a state, remaining there, or investing their money. A study by the Americans for Tax Reform Foundation found, “Each positive 1 percentage point tax burden differential between states decreases the ratio of income migration into the high-tax state by 6.78 percent in a given year.”

Tax revenues are much less predictable under progressive tax systems compared to flat tax models, making budgeting more difficult. Relying on a small percentage of higher-income taxpayers for a larger percentage of revenues generates revenue windfalls and spending free-for-alls during economic booms, followed by massive budget gaps during economic recessions.

For North Dakota to remain competitive with its neighboring states, it must implement a tax environment that encourages investment and economic growth. Currently, North Dakota ranks 17th in the Tax Foundation’s 2019 State Business Tax Climate Index, a study that compares states across multiple areas of taxation. North Dakota’s ranking is lower than many of its neighboring states, including Wyoming, which was ranked as the best tax climate in the nation. Both South Dakota (3rd) and Montana (5th) also ranked amongst the nation’s best tax climates.

The proposed flat tax is a good step that would simplify the state’s tax code and keep the Peace Garden State competitive with its neighbors.
 

A Brief Guide to the Flat Tax
https://www.heartland.org/publications-resources/publications/a-brief-guide-to-the-flat-tax-1?source=policybot
Everything you wanted to know about the flat tax is provided in this PolicyFax by Dan Mitchell of The Heritage Foundation. Mitchell says the flat tax eliminates special-interest favoritism and prevents taxpayers from finding tax loopholes by hiring an army of lawyers, accountants, and lobbyists.

Ten Principles of State Fiscal Policy
https://www.heartland.org/publications-resources/publications/ten-principles-of-state-fiscal-policy?source=policybot
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”

What Are Flat Taxes?
http://taxfoundation.org/blog/what-are-flat-taxes
Kyle Pomerleau of the Tax Foundation examines flat taxes and explains how different flat tax proposals work.

State Individual Income Tax Rates and Brackets for 2016
http://taxfoundation.org/article/state-individual-income-tax-rates-and-brackets-2016
Nicole Kaeding of the Tax Foundation analyzes the most up-to-date data available on state individual income tax rates, brackets, standard deductions, and personal exemptions for both single and joint filers.

Rich States, Poor States
http://www.alec.org/publications/rich-states-poor-states/ 
The ninth edition of this publication from the American Legislative Exchange Council and authors Laffer, Moore, and Williams offers both individual-state and comparative accounts of the negative effects of income taxes.

Institute Brief—No Income Tax: The Key to Economic Growth
http://heartland.org/policy-documents/institute-brief-no-income-tax-key-economic-growth
The Public Interest Institute examines how states with no income tax are doing compared to those with income taxes: “Studies show that states without an income tax have greater economic growth rates than states with an income tax, including greater rates of income growth, population growth, and job growth, and are more attractive to businesses looking for locations to build or expand.”

The Effect of Progressive Tax Codes
https://www.heartland.org/publications-resources/publications/the-effect-of-progressive-tax-codes?source=policybot
Bill Ahern of the Tax Foundation discusses the effects of different kinds of progressive taxes on taxpayers and the economy.

State Budget Reform Toolkit
https://www.heartland.org/publications-resources/publications/state-budget-reform-toolkit?source=policybot
The American Legislative Exchange Council outlines a set of budget and procurement best practices to guide state policymakers as they work to solve the budget shortfalls. The toolkit will assist legislators in prioritizing and more efficiently delivering core government services by advancing free markets, limiting government, and promoting federalism and individual liberty.

The Historical Lessons of Lower Tax Rates
http://www.heritage.org/research/reports/2003/08/the-historical-lessons-of-lower-tax-rates  
Examining the historical results of income tax cuts, Daniel Mitchell of the Heritage Foundation finds a distinct pattern throughout American history: When tax rates are reduced, the economy's growth rate improves and living standards increase.
 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.

The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact Research Fellow Bette Grande at Bette@BetteGrande.com.

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR