Monthly Archives: February 2006

Income Tax Reform in Alabama

Income tax reform is sorely needed in a state that requires a person to pay income tax at only $4,600 in annual wages.

  1. Income Tax
    1. Definition
    2. Where does it come from
    3. What it is used for
      1. Nationally
      2. Locally
  2. Regressive Tax Structures
    1. Definition
    2. Manipulation by the state
    3. Proportional realities
  3. Alabama’s National Ranking
    1. Sales tax
    2. Property Tax
    3. Income tax
  4. Current plans for reform
    1. Revenue Neutral
    2. Bedford Plan
    3. Riley Plan
    4. Knight Plan
  5. Tomorrow in Alabama
    1. Progressive tax structure
    2. Proportional fairness
    3. Constitutional reform
    4. Improved quality of life

    Income Tax Reform in Alabama

    Income tax reform is sorely needed in a state that requires a person to pay income tax at only $4,600 in annual wages. Income tax is defined as a tax levied on the financial income of persons and corporations. “Almost half of all the money the State of Alabama takes in every year comes from taxes and fees that individuals and businesses pay.” (Budget Handbook) The remainder comes from the federal government. In fact, “Two of every four dollars Alabama takes in originates from Washington, while the average state contributes more of its own funding and receives only one of every five dollars in its budget from the federal government.” (Budget Handbook) “The Alabama legislature budgets just under $20 billion annually in federal and state money to keep state programs and services running.” (Budget Handbook) But unfortunately, Alabama “ . . . doesn’t take in enough money from year to year to support state services at an adequate level.” (Structural Deficit) Nationally, and in Alabama, income tax revenue is generally used for basic public services such as roads, education, and healthcare. Alabama is one of only a few in the nation that utilizing the function of earmarking its tax dollars. Earmarking is the practice of setting aside certain revenue for application to a specific service. Specifically, “Alabama earmarks seven of every eight dollars for specific purposes, a higher percentage than in any other state.” (Budget Handbook) Most of these funds are used for public school teacher’s salaries, and state law earmarks most of the sales tax revenue for general education.

    Tax systems that take a larger percentage of lower-income citizens’ total income than it takes higher-income citizens’ income are considered regressive tax systems. A flat tax is an example of a regressive tax although all income levels pay at the same rate. Alabama’s current income tax follows a flat tax structure. Some consider a tax structure in which all income levels pay equal shares is a fair tax; however, what must be remembered is that this amount represents a higher overall percentage of the working poor’s total income. Further exasperating this problem, rates tend to increase steadily and in response to overall lack of funds for specific areas. This ever-increasing sales tax removes yet another large portion from all Alabamians pockets, but again, this portion represents a higher percentage of the low-income Alabamian’s total income. Thus, low-income people are forced even deeper into poverty. “Of all the state income taxes, Alabama’s is the only one that hasn’t been revised in the last fifteen years to relieve low-income taxpayers.”(Budget Handbook) Alabama’s current sales tax, established in 1963, is four percent. This percentage is lower than that of most states; however, after combining local sales tax, the total is among the nation’s highest. The burden to the working poor is, on average, twenty-one percent higher than the burden from the average state sales tax. Alabama’s sales tax is defined in statutory law rather than in the state’s constitution. The result then is that, the state legislature can altar it without a popular vote. “Alabama is now only one of seven states that fully tax groceries without any rebates for low- and middle-income families.”(Budget Handbook) “Most Alabamians pay more tax on their groceries to support public schools than they pay in property tax on their homes.” (Alabama Taxes) In a particularly poignant example of the sales tax burden, “Alabama taxes infant formula for babies, but exempts formula for calves because it is an input to production.”(Alabama Taxes)

    The Alabama Constitution of 1901 established a property tax of 6.5 mills to fund state government. This tax is applied to real estate, motor vehicles, and boats. Property is taxed at only a fraction of its value. “Alabama’s property tax burden is sixty-four percent lower than the average state property tax in the nation” (Alabama Taxes); in fact, the tax could triple its average and barely reach the national average. Alabamians sixty-five years of age and older are exempt form state property tax on their homestead. Seniors with incomes of less than $12,000 a year get an increased homestead exemption on county property taxes, and those who earn below $7,500 are exempt from all taxes on homestead property up to 160 acres.

    A 1933 Alabama Constitutional amendment authorized the state to create a tax on personal income and set a limit of five percent for the tax rate. Alabama uses exemptions and deductions which are meant to exclude the most basic costs of living from taxation; however, these exemptions and deductions are much lower than those in most states and falls far short of covering the exclusions intended. The standard deduction of $2,000 for individuals and $4,000 for married couples is just over half of what is allowed for federal income tax. A 1965 Amendment to the Alabama Constitution also allows a deduction on state taxes for federal income tax payments. This Amendment rewards high-income earners with a special break because they are allowed to deduct more from their state taxes than the working poor who pay less in federal tax. Furthermore, a deduction for Social Security contributions which is meant to assist low-income people who tend to pay a large portion of their income to Social Security, fails to provide this aid when it was amended to only be available to those who itemize their deductions. This excludes most middle- and low-income people. The lowest-earning twenty percent of Alabama’s taxpayers pay 10.6 percent of their annual salary in total taxes (income, sales, property), while the highest-earning 1 percent pay only 3.8 percent of their annual salary. Most states define their income tax in statutory law, but major parts of Alabama’s income tax law are written into the state constitution, which is much harder to change or reform (Budget Handbook).

    Despite this being an election year in which few representatives wish to discuss change, there are currently three plans for tax reform. One of those plans, the Riley Plan, is spearheaded by Alabama’s Governor Bob Riley. This plan’s aim is to increase income tax deductions for a family of four over five years. Unfortunately, this plan would ultimately cut education revenue by $214 million. If enacted in 2006, it should be fully implemented by 2011. The current personal exemption of $1,500 per adult would increase to $1,600 in 2007, then $2,000 in 2011. The current dependent deduction of $300 per child would increase to $600 per child in 2007 and $2,000 in 2011. The current standard deduction would be increased to $4,000 per couple in 2007 and $7,000 per couple in 2011. Currently, Riley’s plan does not adjust for inflation, and the deduction for federal income tax remains intact. The maximum family tax cut in 2007 would be $55 for every family of four, rich or poor. The current income tax threshold for a family of four is $4,600. This would be increased to $8,800 in 2007 and $15,100 in 2011 still below the national poverty line. No popular vote on this plan is required for implementation. In terms of winners and losers, minor winners would be families of four receiving a small tax cut each year. The big loser would be public education in the state. The Riley Plan will ultimately cost the state’s education budget $28 million in 2007 and $214 million in 2011 (“Comparison of Plans”).

    Senator Bedford has introduced another plan for consideration. His plan would increase income deductions, end deduction for federal income tax, and remove four percent of the tax on groceries. This plan, if begun in 2006, would be fully implemented in 2007. The current personal exemption of $1,500 per adult would be increased to $2,000 per adult in 2007. The current dependent deduction of $300 would be increased to $2,000 per child in 2007. The current standard deduction would be increased to $4,000 per couple in 2007. Like the Riley Plan, Bedford’s plan does not adjust for inflation. The income tax threshold for a family of four would be raised from the current $4,600 to $12,100 in 2007 remaining the same in 2011. The maximum family tax cut in 2007 could be as much as $536 for a family of four. A popular vote is required to implement this plan. Unlike the Riley Plan, the Bedford Plan takes no revenue from the education budget. This plan being only just introduced has not yet been reviewed for clear winners or losers, and does not indicate how the plan will be paid for. It would seem that both the general fund and education budgets would be forced to shoulder the cost of the plan (“Comparison of Plans”).

    The Knight Plan, introduced in this and for the last four legislative sessions by Rep. Knight, intends to increase income tax deductions to federal levels and end the deduction for federal income tax. This plan, if enacted in 2006, would be fully implemented in 2007. The current personal exemption of $1,500 per adult would be raised to $3,200 per adult in 2007. The current dependent deduction of $300 per child would be increased to $3,200 per child in 2007. The current standard deduction would be raised to $10,000 per couple in 2007. An inflation adjustment would be included which annually increases as federal deductions grow. A deduction for federal income tax would not be allowed. The maximum family tax cut in 2007 would be as much as $760 for a family of four. A popular vote would be necessary to implement this plan. In terms of winners and losers, three out of five Alabamians would pay less state tax and one of those same five would pay the same in state tax as they have paid. It’s hard to identify a true “loser” in this plan. While one of every five Alabamians will pay more in state tax, that one person would be top income earner who should be able to pay more. This plan will cost the education budget nothing. The current income tax threshold of $4,600 would be increased to $22,900 in 2007, growing with inflation to roughly $27,000 in 2011 above the national poverty threshold (2006) of $18,850 (“Comparison of Plans”).

    A progressive tax requires people who make more money to pay a bigger share of their income than those who make less. Low-income families can be exempted entirely, and tax rates can be graduated so that middle- and high-income families pay taxes fairly related to what they can afford. At both the state and federal levels, personal income taxes can be, and typically are, designed to be progressive taxes. Creating a new top income tax rate of six percent would capture revenue from higher-income individuals. Raising the income threshold of $4,600, at which a family of four starts paying income tax, to $18,850, the federal poverty line, could also create a progressive tax. (Budget Handbook)

    Since Alabama’s income tax structure is mostly written into the state constitution, changing it would first require changing the constitution. The Alabama constitution is the longest and most cumbersome with more than nine-hundred amendments of all fifty states; it is even larger than the national constitution. Alabama’s constitution has not been rewritten since 1902 resulting in outdated economic values, racist language, and absence of “home rule”, which would allow counties to make their own decisions. A rewritten and reformed state constitution could eliminate these antiquated factors, as well as, set the stage for income tax reform in the state.

    Alabama’s tomorrow should have a proportionally fair tax. The tax system needs stability and proportions placed lightly upon the working poor and heavier on the wealthiest top one percent of state income earners. Furthermore, constitutional reform is equivalently necessary to facilitate the adjustment for tax reform. Quality of life should not be this harsh and difficult for the working poor just because of an inadequate tax structure. Implementation of an effective income tax reform plan would result in a more fairly balanced income tax structure assuring a better quality of life for Alabama’s working poor while not detrimentally affecting anyone else. In addition to being treated more fairly and being respected by their state government, the very people who must need additional income, “the least of these”, will find themselves with more disposable income tax for life’s necessities like childcare, healthcare, transportation, and habitable housing. Alabama should see the benefit of investing in their citizens. This investment would translate into a stronger state economy. Tomorrow in Alabama should be bright, and the state, a place where people “want” to live. Without fair income tax reform, however, tomorrow in Alabama looks bleak.

    Works Cited

    Alabama Taxes Are Not Fair.” 14 Aug. 2003.

    How Does Alabama’s Income Tax Measure Up?” The Alabama Tax and Budget Handbook Aug. 2005: 23+.

    How Does Alabama’s Income Tax Work?” The Alabama Tax and Budget Handbook Aug. 2005: 21+.

    How Does Alabama’s Sales Tax Measure Up?” The Alabama Tax and Budget Handbook Aug. 2005: 29+.

    How Does Alabama’s Sales Tax Work?” The Alabama Tax and Budget Handbook Aug. 2005: 27+.

    How Does Alabama’s Property Tax Measure Up?” The Alabama Tax and Budget Handbook Aug. 2005: 37+.

    How Does Alabama’s Property Tax Work?” The Alabama Tax and Budget Handbook Aug. 2005: 33+.

    How Do State Taxes Work?” The Alabama Tax and Budget Handbook Aug. 2005: 15+.

    Two Steps Back: Alabama’s Structural Deficit.” 3 May 2004.

    Where Does the State Get Its Money?” The Alabama Tax and Budget Handbook Aug. 2005: 11+.