At the intersection of Mormons and tax policy? This article is pure #BrunsonBait. Paging professor @smbrnsnhttps://t.co/rJ29KNG4p8
— Sheldon Gilbert (@sheldongilbert) February 20, 2019
This morning, I woke up to this Twitter notification. (Turns out that Sheldon does really know me: this was #BrunsonBait in basically its purest form.) I immediately knew I was going to write a BCC explainer, and I figured it would be a quick and easy explainer: Utah’s tax conformity to the federal income tax meant that, when the TCJA reduced personal exemptions to $0, Utah’s personal exemptions fell to the same rate.
It turns out the story is more complicated than a story of the inadvertent loss of a tax benefit: Utah legislators did this deliberately.
But I’m getting a little ahead of myself. What’s the this that is happening to Utah taxpayers? In short, according to the article, the elimination of personal exemptions meant that Utahns, with their larger-than-average family size, would face a higher tax bill in 2018 than they would have without the federal TCJA.
Tell Me About Rolling Conformity
Utah’s income tax (like many states’) has “rolling conformity” with the federal income tax. What is tax conformity? It means that the state income tax adopts much (or all) of the federal income tax. And rolling conformity means that when the relevant federal tax law changes, so does the state’s.
How does this rolling conformity function in Utah? Well, under the Utah income tax, taxpayers calculate their taxable income by figuring out their adjusted gross income under the Internal Revenue Code, then making some adjustments laid out in the state tax law.
So the Elimination of the Federal Personal Exemption Changed the Federal Adjusted Gross Income?
This is the part that started confusing me. See, under the federal income tax, personal exemptions were deducted after figuring out adjusted gross income. Don’t worry too much about that; for these purposes, I just mean that eliminating the personal exemption for federal tax purposes wouldn’t impact a taxpayer’s adjusted gross income at all.
Okay, Now I’m Confused
I was, too. I had to dig through the Utah state income tax, and eventually I found the personal exemption language. And imagine my surprise at learning that it was utterly unrelated to the federal personal exemption. And, unlike the federal personal exemption, which was a deduction, the Utah personal exemption is a tax credit. And credits come long after adjusted gross income.
Okay, Gre … Wait a Second—What’s the Difference Between a Deduction and a Tax Credit?
Both reduce your tax liability. A deduction reduces your tax liability by the amount of the deduction times your marginal tax rate. A credit, by contrast, reduces your tax liability on a dollar-for-dollar basis. As an example: the current Utah personal income tax rate is 4.95%. So if you have a $100 deduction, that reduces your state income tax by $4.95. If you have a $100 credit, it reduces your state income taxes by $100. (This becomes relevant in just a minute.)
Great. Where Did the Article Get the Idea That the Personal Exemption Was Gone, Then?
That took me a lot of time to figure out. It turns out that in July 2018, Utah’s governor signed H.B. 2003, which adjusted the state income tax in several ways, including by addressing the personal exemption problem.
Prior to the amendment, the personal exemption did conform to the federal personal exemption. For each dependent, a taxpayer got a credit, calculated by multiplying 75% of the amount allowed as a federal personal exemption and 6%.
The federal personal exemption amount was indexed to inflation but, because the TCJA was enacted so late in the year, the IRS had already given the inflation-adjusted amount for personal exemptions. They would have been $4,150 per dependent. $4,150 x 0.75 x 0.06 = $186.75; in other words, a family’s state tax liability would go down by $186.75 for each dependent. A family with three qualifying children, then, would reduce their its tax bill by $560.25.
Of course, with conformity, that number would have dropped to $0. Seventy-five percent of a $0 federal personal exemption is $0. The Utah legislature thus replaced that personal exemption with its new version. And how much does the new version reduce taxes?
Not nearly as much. The new Utah personal exemption is $565 per dependent. To calculate the tax credit, a taxpayer multiplies that amount by 6%, and reduces her state tax bill by $33.90 per dependent (or a whopping $101.70 for three).
That is, Utah’s personal exemption has fallen by 82%.
Of course, this isn’t entirely apples-to-apples. The same bill reduced the income tax rate from 5% to 4.95%. And what does that mean? Let’s illustrate it with a hypothetical Utah family with three children under the age of 16 and $50,000 of Utah taxable income.
In a world without the TCJA, where Utah kept its tax rate at 5%, the family would originally owe $2,500 in taxes. They would reduce the tax bill by their $560.25 credit, for an ultimate state tax bill of $1,939.75.
In the world that exists, though, the family faces a tax rate of 4.95% for an initial tax bill of $2,475. They reduce that bill by their $101.70 for an ultimate tax liability of $2,373.30.
So Why Would Utah Do This?
To be fair, with state taxes, I’d never 100% write off the idea of incompetence.
But I kind of doubt it’s that. The math isn’t that complicated. Honestly, I suspect it was a stealth tax increase.
I mean, it’s very clearly a tax increase; the amount of tax the family owes went up by more than $400, which is right around 1/5 of the total tax bill. Some rough back-of-the-keyboard math: about 30% of Utah’s 3.2 million person population is under 18. Assuming they all qualify as dependents of Utah taxpayers, that means there are about 960,000 minors in Utah. If each child represents a $152.85 increase in the family’s state tax bill, that’s an additional $146.7 million for the state. (My numbers are almost certainly high: the credit is non-refundable, so if a family isn’t paying taxes, they don’t have a tax reduction. And not every child under 18 is going to be a dependent. But it gives a rough sense of how much money is at stake.)
But it’s not an obvious tax increase. In fact, the legislature lowered the tax rate. So legislators can say—honestly and with a straight face—that they didn’t increase taxes while, at precisely the same time, increasing taxes.
[Thanks to Nicole Kaeding, John Buhl, and Jared Walczak, who helped me think through this stuff on Twitter.]