Nothing wrong with a tax cut, but Idaho’s income tax structure needs to be revamped

With an estimated $1.9 billion budget surplus, it comes as no surprise that Idaho’s Republican legislators and the governor are proposing a tax cut — especially in an election year.

But the tax cut they’re proposing is a simple across-the-board cut and makes Idaho’s tax structure even flatter than it already is. Instead, legislators should be doing a comprehensive revamp of Idaho’s income tax brackets and target tax cuts to those who are just trying to make ends meet.

The proposal, introduced Wednesday, would reduce the number of Idaho’s income tax brackets from five to four, with new lower rates of 1%, 3%, 4.5%, and 6%. Idaho’s taxable income thresholds are $1,000, $3,000 and $5,000. After $5,000 of taxable income, you’re in the highest tax bracket.

The bill, if passed, would provide a one-time income tax rebate of $350 million, returning approximately 12% of Idaho tax paid in 2020 or $75 for each taxpayer and dependent, whichever is greater.

Everyone benefits from this tax cut, and who can complain about a tax cut, right?

The problem is that lower-income taxpayers get a benefit essentially so negligible that it won’t make much of a difference in their lives.

A person making $20,000 a year would get an income tax cut of about $22. Granted, they only pay about $300 in income taxes to begin with, so it stands to reason that they would get a smaller tax cut. With the rebate, that person would get the flat $75 rebate.

A person making $250,000, though, is going to see a tax cut of nearly $1,200 and a rebate of more than $1,800.

Low-income Idahoans are having trouble making rent as housing costs skyrocket. And that’s impacting businesses, who report they can’t find workers to fill their positions. A more targeted tax cut and rebate could help address this problem by giving significant aid to the working class, so they don’t have to move on to areas where housing is cheaper.

Compare the state’s relatively flat income tax structure with the federal income tax brackets, which is a much more progressive system, incrementally increasing tax rates for a single person at thresholds of about $10,000; $41,000; $86,000; $165,000; $210,000; and finally $524,000.

Idaho has long needed a thorough restructuring of its tax structure to restore the progressive income tax as it was originally intended.

The problem is with Idaho’s tax brackets — the threshold amounts that determine when someone’s earnings are taxed at a higher rate.

When Idaho’s tax brackets were created, they were not indexed to keep up with inflation. As nominal incomes rose over decades, that meant that the cutoffs were concentrated at the lower end of the income scale. At the federal level, you don’t hit the top marginal tax rate until you have over $524,000 in taxable income. In Idaho, you’ve already hit the top bracket at $5,000 of taxable income.

The effect of this bracket compression is that an individual making $100,000 per year pays almost the identical rate as a person making $1 million per year. Nearly all of the increase in rates on marginal income occurs between $0 and $50,000.

This isn’t fair or efficient.

It isn’t fair because if you make $30,000 per year, you might be having trouble making your rent. If you get a $3,000 raise, your effective tax rate rises much more (about 10 times more) than it would for someone who makes $250,000 and gets a $25,000 raise.

There’s nothing wrong with a tax cut, as long as it’s sustainable. But we’d also like to see the Legislature revamp the income tax brackets so that our income tax system is more progressive.

This story was originally published January 14, 2022 at 4:00 AM.