14 June 2007

When Did Colorado's Tax System Become Regressive?

Colorado's tax system was slightly more regressive in 1990 than it was in 2000, but actually had a slightly progressive state and local tax system in 1980.

Notably, the increased regressivity of Colorado's tax system predates the 1992 adoption by Colorado voters of theTaxpayer's Bill of Rights (TABOR), which has had almost no direct impact on the regressivity or progressivity of Colorado's tax system, even though it is the feature of Colorado's tax system for which it is best known. Arguably, however, TABOR has played a role in preventing major reforms of Colorado's system, thus maintaining a regressive status quo, because voter approval requirements discourage complicated changes in the tax system, even if they are revenue neutral.

Indeed, at first glance, the causes of this shift defy conventional wisdom, because at the state level, the shift between 1980 and 1990 was towards taxes that are usually more progressive. In 1980, Colorado adopted many sales tax and income tax breaks when it was flush with oil money. But, while many of the sales tax breaks stayed, most of the income tax breaks were repealed in the early 1980s in the face of the oil bust, and the state's income tax base was broadened greatly in 1987, in response to the federal income tax overhaul that took place in 1986.

Personal income taxes are now (2002) a much larger share of the state general fund budget than there were then (1976) (55% v. 39%), state sales taxes are a slightly smaller share (34% v. 37%), and sin taxes on alcohol and tobacco are also less important (1.7% v. 5.7% of state general fund revenues). Corporate income taxes have declined significantly (8.0% v. 2.9%) as the tax reforms of 1986 made the C corporation less attractive as an organizational form for small businesses.

Colorado has the lowest state income tax rate (2.9%) of any state in the nation which has a sales tax. Alaska, Delaware, Montana, New Hampshire and Oregon, however, have no state sales taxes.

The mystery is solved by looking at changes in local government taxes in Colorado, which collect an unusually large share of all state and local taxes in the state. Colorado's combined state and local tax collections are just about at the median for the nation, even though its state level tax collections are among the lowest. One major factor that lead to a more regressive tax system in Colorado was the Gallagher Amendment (Ref. #1) passed by voters in 1982 (basically, Article X, Section 3 of the Colorado Constitution), which has limited increases in non-business property taxes to a rate significant below that of business property taxes. It has also significantly reduced overall property tax collections. Property taxes as a percentage of personal income fell 20% from 1991 to 2001.

This has pressured local governments, particularly those with primarily residential tax bases, to look to sales taxes rather than less regressive property taxes for additional revenues. Colorado now ranks 41st among the states in the percentage of local government revenue obtained from property taxes. Four of the nine states (Table 441) that have local governments less reliant on property taxes: have significant local income taxes, something no present in Colorado. They are New York, Maryland, Kentucky, and Missouri.

Meanwhile, since 1980, Colorado, like the rest of the country, has seen the income of its top earners surge, while middle and lower class income have remained relatively stagnant.

This then, is the history of how Colorado's tax system got to the regressive state it has reached now, and given the double whammy of TABOR and the single subject requirement for ballot measures, it will be hard to get out of this mess (although TABOR actually does have a large scale tax reform exception).

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