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Research & Commentary: Pennsylvania Considers Cut to Income Tax Rate

February 5, 2018

In this Research & Commentary, Matthew Glans examines a new effort in Pennsylvania to lower the personal income tax.

Taxes on income are considered by many economists to be the most destructive form of taxation, because they stunt economic growth by taking dollars out of the hands of consumers and businesses, stifling production, innovation, and risk-taking – the main factors that drive economic growth.

In an effort to boost Pennsylvania’s economy and reduce the burden on taxpayers, state Rep. Jason Ortitay (R-Washington) has introduced a new bill that would lower the commonwealth’s personal income tax rate from 3.07 percent to 2.82 percent. The estimated savings per household under the new rate would be around $500 per year. 

High income taxes deter economic development by discouraging workers and investors from moving into or remaining in a high-tax state. 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.”

Another proposal called “The Fair Share Tax Plan” would divide the state’s personal income tax into two separate taxes. The tax on wages and interest – the tax paid by most taxpayers – would be reduced to 2.8 percent, similar to Ortitay’s plan. However, this plan would also create a levy on so-called “income from wealth,” which includes business profits, capital gains, dividends, royalties, and estates. The tax on “income from wealth” would be increased to 6.5 percent.

The second tax targets higher-income taxpayers, a strategy that has failed in other states that have attempted such measures. Higher taxes drive wealthy taxpayers out of state, taking their income, capital, and businesses with them. In 2009, Maryland created a “millionaire tax” that was projected to raise an additional $106 million. However, instead of providing the expected new revenue, the number of people in the state reporting incomes of $1 million or more fell by one-third after just one year. The State of Maryland ended up receiving $100 million less from millionaire earners than the year prior to the millionaire tax going into effect. Because of the policy’s disastrous effects, lawmakers allowed the tax to expire in 2010.

Bob Dick, senior policy analyst at the Commonwealth Foundation, argues Ortitay’s proposal will help get Pennsylvania’s economy moving in the right direction. “Tax relief is desperately needed given Pennsylvania’s stagnant economy. Since 1970, the state ranks 49th in job growth, 48th in population growth, and 44th in personal income growth; no one should find this acceptable,” Dick told City and State Pennsylvania. “Over that same period, what you’ll see is an increase in government spending in just about every single year. If more public investment was the solution, then obviously Pennsylvania’s economy should be humming right now, but we continue growing at a much slower pace than the rest of the nation.”

A state’s tax policy should focus on bringing in enough revenue to cover the costs of necessary functions of government in the least economically distorting way possible. Maintaining a complex income tax code imposes high administrative costs on the government and high compliance costs on businesses and individuals. They also discourage capital from flowing into a state and hinder the creation of new jobs. Cutting the income tax would improve Pennsylvania’s economic competitiveness by leaving more money in the pockets of the state’s citizens and businesses to spend, save, and invest.

The following documents examine income tax reform in greater detail.
 

Ten Principles of State Fiscal Policy
http://heartland.org/policy-documents/ten-principles-state-fiscal-policy
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.”

Recommendations for Tax Reform in Pennsylvania
https://www.mercatus.org/publications/recommendations-tax-reform-pennsylvania
In this testimony before the Pennsylvania House Appropriations Subcommittee on Fiscal Policy, Pavel A. Yakovlev, an affiliated scholar at the Mercatus Center at George Mason University, outlines several tax reform proposals Pennsylvania could follow to improve the state’s economy and budget outlook.

Rich States, Poor States
http://www.richstatespoorstates.org/publication/rich-states-poor-states-10th-edition/
The 10th edition of this publication from the American Legislative Exchange Council and authors Arthur Laffer, Stephen Moore, and Jonathan Williams offers both individual-state and comparative accounts of the negative effects of high 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.”

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.

State Budget Reform Toolkit
https://www.heartland.org/publications-resources/publications/state-budget-reform-toolkit
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.

Policy Tip Sheet: Spending Reforms
https://www.heartland.org/publications-resources/publications/policy-tip-sheet--spending-reforms
The Heartland Institute outlines several reforms state legislators can take to address spending problems, including privatization, tax and expenditure limits, and retirement reforms.

Balancing State Budgets the Smart Way
http://taxfoundation.org/article/balancing-state-budgets-smart-way
Joseph Henchman of the Tax Foundation examines an array of options states can use to remedy both short-term and long-term fiscal woes and put their budgets back on sounder legal footing.

What Pennsylvania Can Do on Tax Reform this Session
http://taxfoundation.org/blog/what-pennsylvania-can-do-tax-reform-session
Scott Drenkard of the Tax Foundation outlines the organization’s findings regarding Pennsylvania Gov. Tom Wolf’s tax proposal, placing it in a national context, making note of recent legislative efforts, and recommending policy reforms for consideration.

Five Steps Toward a Balanced Budget
http://www.commonwealthfoundation.org/issues/detail/five-steps-toward-a-balanced-budget
The Commonwealth Foundation argues lawmakers can pass a balanced budget that respects three important principles: “Protect families and business from tax increases. Avoid overspending. The state should not spend more than it collects in revenue. Limit spending growth to the Taxpayer Protection Act index of inflation plus population growth.”

 

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 John Nothdurft, Heartland’s director of government relations, at jnothdurft@heartland.org or 312/377-4000.

Article Tags
Taxes
Sub-topic
Taxes: Income Tax
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