Prepared for
AARP Alabama
August 2003
Samuel N. Addy, Ph.D.
Center for Business and Economic Research
Culverhouse College of Commerce and Business Administration
The University of Alabama
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
Other contributors to the report:
Ahmad Ijaz, Econometric Analyst
Young Kim, Graduate Research Assistant
Hwanseok Choi, Graduate Research Assistant
Contents
Executive Summary .............................................................................................................................................................i
Introduction .........................................................................................................................................................................1
Alabama Citizens 50+.........................................................................................................................................................3
If the Tax Package Passes ..................................................................................................................................................6
What if the Tax Package Fails?........................................................................................................................................10
Conclusions and Discussions ..........................................................................................................................................10
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
Executive Summary
This study estimates the effects of Governor Riley’s accountability and tax reform plan on Alabama
citizens who are 50 years old and over, Citizens-50+. These people are divided into two groups
because they are treated differently for tax purposes. Those 50-64 years of age are in one group and
those 65 years and older are in the second group. The study considers all parts of the tax portion of
the package except corporate taxes and mortgage and deed taxes. The analysis examines what the
effect of the package would have been if it had been in place in year 2000.
The tax portion of the plan will raise $1.2 billion to cover a $675 million shortfall and provide other
essential services. It will also make the rich pay more and the poor pay less, as a percentage of their
incomes, in taxes. The accountability portion is aimed at improving state government to make it
more efficient and also to raise the level and quality of education. If this happens, Alabama could
become more attractive to higher wage and high tech industries.
How does the tax package affect Alabama Citizens-50+? The package lowers the tax burden for the
average 65 and older taxpayer. Some in the 50-64 age group will pay more but those with three or
more dependents will pay less. Citizens-50+ folks who will pay more can reduce their tax bill if they
itemize and deduct the increased state income and property taxes. In addition, the recently passed
federal tax breaks may even offset the higher state taxes.
In general, the 65+ age group pays between $1,250 and $1,513 less on average. The range for those
in the 50-64 age group who pay more is $85 to $511. The effect by person or household depends
on filing status, income level, property ownership, and spending pattern. The average single 50-64
year-old will pay $511 more. Those who are married or heads of household with up to two
dependents will pay more. The rest pay less because they have more dependents. Those who pay
more will soon pay less as they transition into the 65+ age group.
The defined-contribution exclusion of the tax package provides the main benefit to Alabama
Citizens-50+. It excludes from state income taxes up to $40,000 a year of withdrawals from
defined-contribution retirement plans such as 401(k)s, Keogh plans, and traditional individual
retirement accounts. Such retirement plan withdrawals are fast becoming the major part of
retirement income. The exclusion grows from $7,000 in 2006 to $40,000 in 2011 and thereafter.
It is important to note that some Citizens-50+ are likely to pay more taxes. Those who have very
high incomes will pay more income tax, but not as much as they would without the definedcontribution exclusion. Also, those who own expensive homes or other property such as large tracts
of land will pay more property tax.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
i
The Governor’s Tax Package: What Passage or Failure Means for Alabama
Citizens 50+
Samuel Addy, Ph.D.
Introduction
This study estimates and discusses the effects of Governor Riley’s accountability and tax reform plan
on Alabama citizens who are 50 years old and over (hereafter referred to as Citizens-50+). These
citizens are divided into two groups because they are quite different for tax purposes. Those 50-64
years of age are in one group and those 65 years and older are in the other group. Two stark
differences between the groups relate to income level and source. First, average income for the 65+
age group is about half that of the 50-64 age group. Second, social security and other retirement are
the main sources of income for the 65+ group, while the other group draws mainly on wages and
salaries.
People must know how the tax package affects them, both as taxpayers and recipients of public
services. It is also important for voters to know how the plan affects the state as a whole to
complete the picture.1 In this way, voters will be well informed before going to the polls on
September 9, 2003. The package is being presented as Amendment 1 on the ballot. Television ads
and pamphlets are already out encouraging voters to vote for (YES) or against (NO) the package.
Well-informed voters can decide which way to vote on their own. So it is better to provide
information than to encourage, frighten, threaten, or persuade voters to vote some way.
The tax plan has two parts, one on accountability and the other on tax reform. The accountability
portion of the tax package is aimed at making state government less cumbersome and less wasteful,
and therefore more efficient. This is to be achieved through making pass-through pork a crime,
having the legislature pay back monies taken from rainy day funds, health insurance reforms for
state employees, accountability for school teachers and administrators, establishing a fund for new
tax dollars that has no earmarking, a college scholarship plan, etc. The tax portion of the plan raises
more revenue and makes Alabama taxes fairer and more efficient. It affects taxes on individual and
1
A study by the Center for Business and Economic Research (CBER) at The University of Alabama has shown that
the tax package is good for Alabama because it will create jobs and increase income and state economic growth.
Visit CBER’s website at http://cber.cba.ua.edu to see the report on the macroeconomic impact of the tax package.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
1
business income, property, some sales, utility, insurance premium, and mortgages and deeds. People
with low income will pay less and those with high income will pay more. Also, people whose homes
and other property have low assessment will pay less and those who own expensive homes and large
property will pay much more. There will be flexibility of use of the new revenues, since they are not
earmarked for any specific purpose. Funds will be directed where needs are highest. The new
revenues will also be managed to avoid waste while promoting best use.
It is true that taxpayers do get something in return for paying taxes. The government uses taxes to
provide public infrastructure and services such as roads, schools, police, fire departments, worker
retraining, and prisons. These benefits can be direct, indirect, or both. For example, parents and
grandparents who drive on our roads can also enjoy the satisfaction of knowing that their children
or grandchildren are in well run schools that have good programs. While a lot of the benefits of
paying taxes such as roads and schools are material and visible, others are not. These other benefits
include the happiness and peace one gets from knowing that school systems are working well and
improving and also that streets and highways are safer. It is therefore not correct to only consider
material benefits, which are often measured in dollars, meals, miles of road, etc. Other things, such
as the level of education of the state’s people and the quality of education, must also be considered.
In the end, the real question is whether it is worthwhile to pay more taxes: do taxpayers get enough
back to justify the extra tax? Although the tax package will increase the amount of taxes collected,
not everyone will pay more. Indeed, many will end up paying less. The Public Affairs Research
Council of Alabama (PARCA) and the Governor’s office have analyzed and made available the
effects of the tax package on income and property taxes for taxpayers at various income levels.2
However, income varies among people in any age group. It is therefore important to also take a
look at how the tax and accountability plan affects people by age group. This is why AARP
Alabama asked for this study.
2
Tax calculators are available on their websites. Visit http://parca.samford.edu for PARCA and
http://www.governor.state.al.us for the Governor’s office.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
2
Alabama Citizens 50+
One must first know a few things about the two groups that make up Citizens-50+ to be able to
determine and understand the effects of the tax package on the groups. Table 1 shows some
selected characteristics. There were almost 1.3 million Alabama Citizens-50+ in 2000, about 29
percent of the total state population. There were more people age 50-64 years than people 65 and
over. The younger group makes more money and lives in more expensive houses than the older
group. A closer look at the table reveals that many in the 50-64 age group have very high incomes
while most of the 65+ age group have low incomes. For example, half of the older group makes
less than $22,000 compared to just 25 percent of the younger group. Table 1 shows income
distribution by householder because that is closest to the way that taxes are filed and is important for
the purpose of the study.
Table 2 shows average income and its sources for the two groups. Also shown are averages for
selected components of spending that will be affected by the tax package. Most of the discussion on
the tax package has centered on the income and property tax components because those form the
bulk of the expected tax increase. However, it is important to know the effects of the other parts of
the tax package as well.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
3
Table 1. Some Characteristics of Alabama Citizens-50+
Age Group
50-64
65+
Total
700,568
579,798
1,280,366
Percent of Alabama total
15.8%
13.0%
28.8%
Number of householders
409,457
386,445
Income
Less than $10,000
50,047
85,689
$10,000 to $19,999
49,807
94,634
$20,000 to $29,999
49,544
63,094
$30,000 to $39,999
49,155
43,346
$40,000 to $49,999
42,441
29,229
$50,000 to $74,999
78,492
37,524
$75,000 to $124,999
63,259
21,317
More than $125,000
26,712
11,612
Estimated median income
$41,398
$21,876
Average income
$54,668
$35,798
Estimated market value of owned home (South)
$97,536
$79,481
Population
Note: Income data is reported by householder. Market value of owned home is average for the entire South, not just
Alabama.
Source: U.S. Bureau of the Census, U.S. Bureau of Labor Statistics, and Center for Business and Economic Research,
The University of Alabama.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
4
Table 2. Source of Income and Selected Expenditure for Alabama Citizens-50+
Age Group
65+
50-64
Average household income
$54,668
$35,798
41,401
7,334
Self-employment income
4,795
1,652
Social Security, private and government retirement
6,081
23,597
Interest, dividends, rental income, other property income
1,264
2,661
Unemployment and workers' compensation, veterans' benefits
277
166
Public assistance, supplemental security income, food stamps
353
252
Regular contributions for support
301
87
Other income
195
48
Tobacco products and smoking supplies
$411
$225
Utilities, fuels, and public services
3,087
3,187
Auto sales
4,007
2,727
Vehicle rental, leases, licenses, other charges
426
287
Vehicle maintenance and repairs
733
670
1,052
1,390
Wages and salaries
Selected expenditure
Home maintenance, repairs, insurance, other expenses
Note: The breakdown of average income into its sources and the selected expenditures are extrapolated from data on
the entire South. The U.S. Bureau of Labor Statistics defines the South to cover Alabama, Arkansas, Delaware,
District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina,
Oklahoma, South Carolina, Tennessee, Texas, Virginia and West Virginia.
Source: U.S. Bureau of Labor Statistics and Center for Business and Economic Research, The University of Alabama.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
5
If the Tax Package Passes
The governor has indicated that passing the package will move Alabama forward by protecting our
seniors, creating higher paying jobs, and making the state a leader in education. The accountability
portion of the tax package will eliminate pass-through pork and make the legislature pay back
monies taken from rainy day funds. It will also reform health insurance for state employees, make
school teachers and administrators more accountable, establish a college scholarship plan, and create
a fund for new tax dollars that has no earmarking, etc. Most of the benefits of the accountability
portion of the package will affect Alabama Citizens-50+ indirectly but are very valuable to the state
as a whole.
The plan is expected to raise $1.2 billion new tax revenues.3 More than $1.0 billion will go to state
government and the remainder to local government at full phase-in of the tax package (Table 3).
Income and property tax collections of about $912 million make up the bulk of the package. These
income and property taxes can be deducted on federal tax returns. Personal exemption and
standard and dependent deductions will be increased and tied to federal levels. This raises the
threshold at which a family of four begins to pay income taxes from $4,600 to $16,630 next year and
to $20,000 by 2007. A new six percent rate for income over $75,000 for single taxpayers and
$150,000 for married filers will be introduced. The state portion of property taxes will increase
while allowing for higher homestead and farmstead exemptions. The net effect is that the poor will
pay less state and local taxes but the rich will pay more.
Taxes on business income, some sales, utility, insurance premium, and mortgages and deeds will also
increase slightly. Estimates of what these other taxes and property taxes will cost the two groups are
shown in Table 4. On average, the 50-64 age group will pay $210 more and the 65+ group will pay
$68 more as a result of these other taxes.
3
The Governor’s office (http://www.governor.state.al.us) and the Legislative Fiscal Office
(http://www.lfo.state.al.us) have estimated somewhat similar potential revenues to be raised with the tax package.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
6
Table 3. Potential Revenues of the Tax Package
$ Millions
Tax component
Personal income tax
Property tax
State
Local
Total
$375
$375
410
70
480
Corporate income tax
45
45
Banks excise tax
12
12
Sales tax
118
Cigarette tax
Insurance premium tax
Mortgage and deed recording fees
TOTAL
65
183
50
50
5
5
45
45
$1,060
$135
$1,195
Note: Sales and excise taxes will affect cigarettes, auto sales, service labor, auto leasing and renting, etc.
Source: Laying the Foundation for Greatness: Governor Bob Riley’s Plan to Invest in Alabama’s Future. June 2003.
http://www.governorpress.state.al.us/downloads/03-06-12-Tax-Reform-Presentation.ppt
Table 4. Estimated Changes of Property and Other Taxes on Alabama Citizens-50+
Age Group
50-64
65+
Property Tax
$129
-
Cigarette Tax
18
10
Utility Tax
-14
-14
Auto sales
20
13
6
4
Vehicle maintenance and repairs
29
27
Home maintenance, repairs, insurance, other expenses
21
28
$210
$68
Vehicle rental, leases, licenses, other charges
TOTAL
Note: Estimates are based on spending in Table 2. It is assumed that half of vehicle maintenance and repairs and a
quarter of home maintenance, repairs, and insurance spending will be affected by the proposed taxes.
Source: Center for Business and Economic Research, The University of Alabama.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
7
One very important part of the tax package is that it excludes from state income taxes up to $40,000
a year of withdrawals from defined-contribution retirement plans such as 401(k)s, Keogh plans, and
traditional individual retirement accounts. This is a significant break for seniors because such
retirement plan withdrawals are increasingly becoming the major part of their total incomes. The
exclusion grows from $7,000 in 2006 to $40,000 in 2011 and thereafter. Effects of changes in
income taxes depend on filing status. Table 5 shows estimated effects of the entire tax package on
the two groups if the package had been in place in year 2000.
Clearly, the tax package is really good for the average Alabama citizen who is 65 years and older.
This is because the package either eliminates or lowers the tax burden for this group. The effect is
definitely not the same for every citizen in the 50-64 age group. Some will pay more state and local
taxes and others will pay less. The average 50-64 year-old who has up to two dependents will pay
more. This ranges from $85 for those who are married with two dependents to $511 for the average
single filer in this group. This is the cost to these people for an improved Alabama. For them, the
cost and any other benefits of the package must be compared with what happens if voters reject the
plan. The good news is that they can look forward to a very nice retirement as they transition into
the 65+ group.
If the tax had been in place in 2000, the 65+ group would pay between $1,250 and $1,513 less on
average. This is because of the larger effect of the defined-contribution exclusion on their income
taxes. This older group will also have to compare their lowered tax burden and any other benefits of
the package with what happens if voters reject the plan.
It is important to note that some Citizens-50+ are likely to also pay more taxes. For example, those
who have very high incomes will pay more income tax, but not as much as they would without the
defined-contribution exclusion. Also, those who own expensive homes or other property such as
large tracts of land are likely to pay more property tax. This is all due to the more progressive tax
structure proposed; the poor pay less and the rich pay more. Table 5 does not include estimates of
changes due to increased corporate taxes and mortgage and deed tax effects.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
8
Table 5. Estimated Effects of Tax Package on Alabama Citizens 50+
Age 50-64: Based on $54,668 average income
Single
Head of Household
Married filing Joint
1 dependent 2 dependents
No dependent
MarriedJ1
MarriedJ2
Current income tax
$1,461
$1,519
$1,563
$1,264
$1,309
$1,353
Package income tax
$1,985
$1,780
$1,666
$1,680
$1,565
$1,451
Income tax change
$524
$261
$103
$416
$256
$98
Other tax change
$210
$210
$210
$210
$210
$210
-$222
-$222
-$222
-$222
-$222
-$222
Combined effect
$511
$248
$90
$403
$243
$85
Percent of income
1.0%
0.5%
0.2%
0.8%
0.5%
0.2%
Defined-contribution
exclusion
Age 65 and over: Based on $35,798 average income
Single
Head of Household
Married filing Joint
1 dependent 2 dependents
No dependent
MarriedJ1
MarriedJ2
Current income tax
$312
$333
$318
$82
$76
$70
Package income tax
$217
$70
$70
$70
$70
$70
Income tax change
-$95
-$263
-$248
-$12
-$6
$0
$68
$68
$68
$68
$68
$68
-$1,318
-$1,318
-$1,318
-$1,318
-$1,318
-$1,318
Combined effect
-$1,345
-$1,513
-$1,498
-$1,262
-$1,256
-$1,250
Percent of income
-5.3%
-6.0%
-5.9%
-5.0%
-4.9%
-4.9%
Other tax change
Defined-contribution
exclusion
Note:
Adjusted gross income (AGI) needed to determine the current and package income taxes are taken as the sum
of wages and salaries, self-employment income, interests etc., and other income in Table 2. Tax payments are
taken from the PARCA analysis and adjustments are made to incorporate any variation from the PARCA AGI
levels. Other tax change is the sum of property and other tax changes in Table 4. Defined-contribution plan
withdrawal credits are made according to the ratio of social security and other retirement income to average
income. This is why the credits are bigger for the 65+ group.
Source: Center for Business and Economic Research, The University of Alabama.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
9
What if the Tax Package Fails?
The governor has noted that the consequences of rejecting the package will be very painful because
the state is facing a $675 million shortfall. If voters do not vote for the plan and nothing else is
done, the shortfall will mean that there will be deep cuts in essential services. Some examples are:
-
Closure of 60 Senior Service Centers, eliminating 800,000 meals for the elderly
Laying off thousands of teachers
Adverse impact on 50,000 child support cases, causing a loss of $50 million in annual
child support payments
Reduction by one-third of State Trooper routine patrol and response manpower
Loss of almost all drug coverage for 11,000 mentally ill Alabama citizens
Bankruptcy of as many as 25 of the poorest school systems, affecting 100,000
students
Slashing of Medicaid budget in 2005, jeopardizing 450,000 Alabamians or 10 percent
of the state’s population
Layoff of hundreds of Corrections Department employees and release of thousands
of prisoners.4
This author has not verified the above list. However, some cuts are necessary to balance the budget
when there is a shortfall. Even if just half of the above actions are taken, the results will still be
devastating for the state. Some Alabama Citizens-50+ will have fewer meals with the closure of
Senior Service Centers. Some who are teachers may be laid off. There will be less public safety, less
healthcare, and many troubled school systems. To do nothing seems disastrous. Is paying more
taxes worth avoiding these impacts and improving the state? That is the question voters have to
deal with.
Discussions and Conclusions
Several reports have noted how regressive the Alabama tax system is, making the poor pay more of
their income in taxes than the rich. The Governor’s tax package seems like a good way to start
addressing problems with the current state tax structure. The tax portion will raise $1.2 billion to
cover a $675 million shortfall and provide other essential services. It also tries to make the rich pay
4
Laying the Foundation for Greatness: Governor Bob Riley’s Plan to Invest in Alabama’s Future. June 2003.
http://www.governorpress.state.al.us/downloads/03-06-12-Tax-Reform-Presentation.ppt
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
10
more and the poor pay less. The accountability portion is aimed at improving state government to
make it more efficient. The package has dynamic features built in to prevent a regression over time.
There are several other benefits that can be realized if the tax package helps to raise the level and
quality of education. For example, a higher skilled labor force is more attractive to higher wage and
high tech industries.
It is common knowledge that the package will affect people in different ways. How does the tax
package affect Alabama Citizens-50+? The average person 65 years of age and over will benefit
greatly. These people may even see their tax burdens eliminated and they will enjoy the statewide
effects directly and indirectly while paying less tax. Some will pay more. Of those who will pay
more, the federal tax breaks will certainly help. However, the effects of the tax package must be
looked at separately because no one knows how long those tax breaks will last. In any case, it is a
separate issue. For this reason, effects of the federal tax breaks have not been included in this
analysis. It is important to note that those who pay higher income and property taxes as a result of
the package passing will be able to deduct those taxes on their federal returns if they itemize.
The tax package has mixed effects on the average Alabama citizen who is 50-64 years old. This is
because the package lowers the tax burden only for members of this group who have three or more
dependents. The effect by person or household will depend on filing status, income level, property
ownership, and spending pattern. The average 50-64 year-old who is single will pay $511 more in
taxes. Those who are married will pay $408 more if they have no dependents, $243 with one
dependent, and $85 with two dependents. A head of household with one dependent will pay $248
more and $90 more with two dependents. The good news is that these paying Citizen-50+ can look
forward to a very nice retirement as they transition into the 65+ group.
In general, the effect of the tax package on the 65+ group is a decrease of between $1,250 and
$1,513 less on their tax bill because of the larger effect of the defined-contribution exclusion on
their income taxes. This group will also have to compare their lowered tax burden and any other
benefits of the package with what happens if voters reject the plan.
It is important to note that some Citizens-50+ are likely to also pay more taxes. For example, those
who have very high incomes will pay more income tax, but not as much as they would without the
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
11
defined-contribution exclusion. Also, those who own expensive homes or other property such as
large tracts of land are likely to pay more property tax. This is all due to the more progressive tax
structure proposed; the poor pay less and the rich pay more. The study does not include estimates
of changes due to increased corporate income taxes and mortgage and deed tax effects.
Whether or not the package is passed, the state must not stop improving the tax structure and
making government more accountable. Maybe, the next thing to do if the package is passed is to
remove sales taxes on food items and medicines. This will definitely and directly benefit Alabama
Citizens-50+.
Tax Package Effect on Alabama Citizens 50+
CBER, UA
August 8, 2003
12