Evaluating Proposed Pennsylvania Income Tax Reforms

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PA Tax Cuts: Pennsylvania Income Tax Reform Proposal

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A pair of bills, SB 269 and HB 2388, cutting taxes in Pennsylvania are moving through the state legislature, but they stand in stark contrast to the governor’s proposed spending increases.

The PA Senate recently passed SB 269, which reduces the Pennsylvania individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.
and eliminates the locally assessed gross receipts taxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding.
for electricity producers. The Pennsylvania House of Representatives has a companion bill, HB 2388, which is currently awaiting a hearing in the Pennsylvania House Finance Committee. These reforms could result in significant savings for Pennsylvania residents.

The plan, sponsored by Senator Gebhard (R) and Representative O’Neal (R), is a response to Governor Josh Shapiro’s (D) 2024 state budget, which spends $3 billion more than revenues this year and creates a structural deficit of more than $6 billion by 2028, according to a Commonwealth Foundation analysis.

This reform proposal could parallel Pennsylvania HB 1342 passed in 2022 to incrementally reduce the Commonwealth’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
from 9.99 percent to 4.99 percent as of January 1, 2031. Pennsylvania is one of 14 states with a flat state-level individual income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
, which can increase the efficiency of rate reductions, as the reduced rate definitionally applies to marginal investment. In some ways, the flat rate also makes rate reductions politically easier, since all taxpayers pay the same lower percentage of their income under the new lower rate.

Pennsylvania would not be the only state to lower its individual income tax rate this year. On January 1 of this year, 14 other states reduced their individual income tax rates. Seven of the 14 states also had flat income tax structures: Georgia, Indiana, Kentucky, Michigan, Mississippi, New Hampshire, and North Carolina. Utah, another state with a single rate individual income tax, adopted an income tax rate cut later, retroactive to January 1.

SB 269 is projected to save Pennsylvania taxpayers approximately $1.27 billion between the individual rate reduction and the elimination of the gross receipts tax on electricity generation in FY 2025 alone. The total savings associated with SB 269 over the next three years actually exceed the $6 billion structural deficit under the governor’s spending proposal by over $1 billion—that is, the proposed tax cut is larger than the governor’s proposed spending increases. Most of these changes are associated with the reduction in the individual income tax rate in the second and third years. The Commonwealth Foundation estimated that the tax cuts would save $400 per family of four in FY 2024-25 and $900 per family of four in FY 2025-26.

These rate reductions would reduce the individual income tax rate to its pre-2003 levels. Pennsylvanians paid $538 (in nominal terms) in state income taxes per capita in 2003. After adjusting for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
between 2003 and 2024, Pennsylvanians paid $913 per capita in state-level individual income taxes in 2003. Residents now pay $1,340 in FY 2024. That’s a difference of $427 per capita in real terms, since the passage of Governor Ed Rendell’s (D) initial tax increase.

These reforms would also make Pennsylvania more competitive with the other 16 states that reduced their individual income tax rates this year, or the 27 that cut such taxes since 2021. Our State Business Tax Climate Index measures the competitiveness of state tax systems. Pennsylvania ranked 31st overall on the 2024 Index and 23rd in the individual income tax subindex. If HB 2388 took effect, Pennsylvania would rank 29th overall and 22nd in the individual income tax subindex.

The Pennsylvania legislature could also improve the structure of the local gross receipts tax elimination plan. Currently, Pennsylvania assesses its gross receipts tax at the local level on five separate industry classifications: (1) electric companies, (2) telecommunications, (3) transportation firms, (4) private bankers, and (5) managed care organizations.

Instead of eliminating the electricity producer gross receipt tax wholesale at the end of this year, legislators should pursue a broad-based rate reduction strategy that reduces the gross receipts tax across all five industries until it’s completely eliminated. This would prevent special interests from any one of the remaining industry groups from hijacking the elimination proposal by advocating for increased gross receipts tax levies against any of the other three industry groups.

The budgetary context in which the Pennsylvania legislature is considering these changes also matters for economic growth. The economic literature cautions that reductions in state-level individual income tax rates must be funded by concomitant reductions in state-level expenditures or come out of projected growth. While a more competitive tax code can help generate economic growth and reduce the cost of tax cuts, they do not come close to eliminating the cost, which must be paid for in some way. There is also an additional risk in pursuing this course of action since the tax cuts are not phased in across multiple years. HB 2388 seeks to apply the rate reduction as of FY 2025, the second year in which Governor Shapiro’s budget is implemented. This matters since Governor Shapiro’s budget creates a $6 billion deficit by FY 2028. Republican lawmakers presumably want rate cuts in lieu of spending increases, but rate cuts combined with spending increases would dramatically exacerbate the imbalance. The cut, moreover, is larger than currently projected revenue growth.

As such, the details of HB 2388 may work better as a preliminary negotiating position than a final plan, just as, presumably, Gov. Shapiro’s budget proposal is an initial offering. The governor has offered large spending increases. Legislative Republicans have offered a large tax cut. This lays the groundwork for a valuable debate about priorities, with the likelihood that anything enacted would have to be negotiated.

Overall, the tax reform proposal is a good example of what can be done to reduce tax burdens on residents if spending is constrained. There are real, tangible benefits associated with enacting this pro-growth reform that should not be discounted. Pennsylvania legislators should seek to simplify gross receipts tax filing procedures and reduce the individual tax burden for the broadest swath of households and businesses as possible.

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