Montana and Tax Reform - Guest Editorial
By Kurt Alme, Director, Montana Department of Revenue
January 23, 2002
We're number one!! If you're talking about Montana's 2001 national champion football team, that's good. But if you're thinking about the fact that Montana's top marginal income tax rates of 9% to 11% are the highest compared to other states in the region, being top-ranked is not so attractive.
Tax experts agree that being number one in tax rates can have undesirable consequences when it comes to developing a sound economy and high paying jobs. One expert, John Shannon, has noted that states competing against each other's tax profiles are like ships in wartime convoy. In short, a state cannot risk letting its tax rates get too far ahead of its comrades … or it's likely to get sunk.
Tax structure is not the only thing that affects economic development. Business people consider other factors, such as a quality workforce, nearness to markets, reasonable energy and labor costs, reasonable regulatory structure, and general quality of life, to be important also. But as states compete for business and jobs, significant tax differences may well be the critical factor that sways a decision to locate to or stay in Montana, or to go elsewhere.
Policy makers must have a firm understanding of how our state ranks when compared to those states we compete with for jobs. Under the direction of the Governor, the Department of Revenue has compared Montana's tax rates with those of competing states. What we have found is just what tax professionals and business groups are telling us. Montana's major taxes, including property tax and corporate license tax, are not out of line with states in the Rocky Mountain region.
The notable exception is our individual income tax, where we have the highest stated tax rates and the highest marginal capital gains rates. Here is how Montana compares to other states in our region:
Highest Statutory Income Tax Rate
Montana, 11%; New Mexico, 8.2%; Idaho, 8.1%; Utah, 7%; North Dakota, 5.54%; Arizona, 5.04%; Colorado, 4.63%; Wyoming, 0%; Nevada, 0%; South Dakota, 0%
Highest Marginal Rate of Tax on Capital Gains Income*
Montana, 5.7%; Idaho, 4.9%; New Mexico, 4.6%; Utah, 3.9%; Arizona, 2.9%; Colorado, 2.8%; North Dakota, 2.2%; Wyoming, 0%; Nevada, 0%; South Dakota, 0%
Much confusion surrounds the issues of stated tax rates and marginal capital gains rates. Oftentimes the discussion focuses on the notion that the trouble with our 11% statutory income tax rate is really just perception, and that our "effective" tax rate is much lower and probably competitive. To some extent this is true. Montana is one of a few states that allows income taxpayers to fully deduct their federal income taxes. Combined with the fact that the federal government also allows taxpayers to itemize deductions for state income taxes, this acts to reduce our effective tax rate.
Is it enough to make us competitive? What we discovered is that when you look at income other than capital gains income, the "double deductibility" provisions of federal and state tax law act to rank Montana closer to the middle of the pack with respect to our effective income tax rate. However, when the focus is on capital gains income, Montana's taxpayers face the highest tax rates in the Rocky Mountain region.
Why are these findings important? First, just the perception that a state has a high tax rate may be all it takes to keep business owners and entrepreneurs from locating here or to encourage them to leave. Second, the fact that we have the highest capital gains tax rate among our competing states provides an incentive for taxpayers to either never locate in Montana, or to relocate elsewhere when it's time to sell the family business or farm.
In the end, this deprives Montana of good-paying jobs, investment and consumer spending, and taxes on businesses and individuals (leading to higher taxes on the rest of us). All of which makes the "number one" seat not conducive to economic development. Resolving our high income tax perception and high capital gain rates will move our state toward a more competitive tax environment and a stronger economy.
The Governor's Office of Economic Opportunity will be holding public forums throughout the state over the next six weeks. Please plan to attend a forum in a town near you, and discuss your tax reform ideas with me.
* Considering the combined impact of federal and state tax interactions relative to a state with no state income tax. Montana's top marginal effective capital gains rate is 9.0%. (Note: The last sentence of this notation was added for clarification after the editorial was submitted for publication.)