HARRISBURG — A proposal by Democratic gubernatorial candidate Tom Wolf to overhaul the state income tax means grappling with a four-decade-old issue: making a progressive tax constitutional.
Wolf said the tax needs to be restructured so that the wealthier pay more and middle-income and lower-income taxpayers pay less. It’s part of an overall strategy to boost state financial support for public schools.
This strategy includes enacting a 5 percent severance tax on natural gas production as a first priority along with closing more of the Delaware loophole on state business taxes and changes to the charter school system.
Wolf proposes to increase the state income tax rate and use the additional portion of revenue to support schools and reduce school property taxes.
He would make the tax more progressive by creating one uniform exemption for income earners, thereby shifting the burden to higher income earners, campaign spokesman Jeffrey Sheridan said Friday.
This would work by having no tax levied on annual income below the exemption. Any portion of income above the exemption would be taxed at the higher tax rate.
Wolf has yet to propose a specific tax rate and exemption threshold to accompany this proposal, Sheridan said.
The ultimate goal is to generate enough revenue to ultimately increase the state share of public school costs to 50 percent from about 33 percent.
Pennsylvania’s personal income tax is now levied at a 3.07 percent flat rate regardless of how much an individual earns. The tax covers compensation, net profits from a business, dividends, interest, net income from sale of property, rents and royalties and net income from estates and trusts. Pennsylvania is one of seven states with a flat tax.
This tax resulted from a knock-down, drag-out political battle fought during the late 1960s and early 1970s, when Pennsylvania faced chronic fiscal problems. The role of state government was expanding as society grew more complex but the tax base was inadequate to support that effort.
Democratic Gov. Milton Shapp was elected in 1970 with the Republican party split over the income tax issue. Shapp quickly won enactment of a graduated income tax providing for a higher rate for higher incomes. The state Supreme Court threw out that tax on grounds that it violated the state constitutional provision that taxes be levied uniformly.
After all-night sessions during the summer of 1971, Shapp and the General Assembly finally passed the flat income tax familiar to us now.
The personal income tax was ranked No. 1 in a survey of the most important laws enacted during the period from 1968 to 2008, according to a 2011 study of the General Assembly by Temple University.
“Although this tax is sometimes criticized because the rate is flat rather than graduated, it does tax both earned and unearned (investment) income, and it does include progressive features authorized in the Constitution, namely exemptions for poverty, age and disability,” according to the study.
Pennsylvania’s flat income tax contributes to its overall regressive state and local tax system, according to a 2013 analysis of state and local tax systems by the Institute on Taxation and Economic Policy, a Washington-based nonprofit.
Without a graduated personal income tax rate that rises on more affluent earners, the income tax does little to offset more regressive state sales and local property taxes, the analysis found.
“Pennsylvania is No. 8 of the ‘Terrible 10’ most regressive tax systems, with the middle-income families paying double the share of their incomes as the top 1 percent and low-income families paying almost three times as much as a share of income,” said Sharon Ward, executive director of the Pennsylvania Budget and Policy Center, a Harrisburg think tank.
Wolf’s proposal tackles that problem through the exemptions, Ward said.
“This is really about tax reform that is long overdue,” she said.
Two other approaches would be a constitutional amendment to change the uniformity clause or levying a different tax rate on investment income and compensation, Ward said.
Wolf’s plan differs from the much publicized legislation to replace school property taxes with expanded state sales and income taxes.
The bill sponsored by Sen. David Argall, R-29, would increase the sales tax rate from 6 percent to 7 percent and the state income tax rate from 3.07 percent to 4.34 percent to offset the loss of property tax revenue. The flat income tax structure would remain.
“Taxpayers do not trust scenarios where one tax would be raised in order to only temporarily reduce another,” Argall said. “They would accept sales and income tax increases in order to completely eliminate all school property taxes — forever.”