Five states made changes to their income tax codes in 2004, all of which were overseen by first-term Democratic governors. The modifications represented a mixed bag of policies.
Three states, New Mexico, Oklahoma, and Michigan, reduced tax rates for 2004, whereas New Jersey and Pennsylvania raised them. The adjustments were applied to either maximum tax brackets or flat taxes.
Although in recent years some states have raised rates on the maximum tax brackets because it affects the least people and it is an easy way to fix budget shortfalls during a recession, states have become more reluctant to raise taxes, according to Nicholas Jenny, senior policy analyst at the Rockefeller Institute of Government in Albany, N.Y.
New Jersey was the only state to raise its maximum bracket for 2004. Under the leadership of former Gov. James E. McGreevey, the tax rate for residents earning $500,000 or more was raised to 8.97% in 2004 from 6.37% in 2003. McGreevey won his first term in the fall of 2001, but resigned in November 2004 after details of an extramarital affair surfaced.
In Pennsylvania under Gov. Edward G. Rendell, the flat tax was hiked to 3.07% for 2004 from 2.80% for 2003.
While no other state hiked income taxes for 2004, Nebraska raised the amount of income necessary to qualify for one of the add-on rates to its top tax bracket to $142,701, up from $137,300.
"Income tax is a pretty visible tax, and states and local governments are reluctant to change that tax," said Martin Mauro, a senior economist at Merrill Lynch & Co. in New York. "State governments try to do less visible things, like raising property taxes."
Those states that do have to raise income taxes often find it politically easier to do so for the highest income earners because there are fewer of them, Mauro said.
Several states were able to augment their tax revenues by raising sales and tobacco taxes, according to Jenny. Indeed, Virginia raised its sales tax to 4.00% in 2004 from 3.50% in 2003 and Arkansas raised its sales tax to 6.00% from 5.125%, according to Yetter Consulting Services Inc. in Chicago.
The magnitude of the tax code changes in New Jersey and New Mexico -- which lowered its top tax bracket for 2004 -- affected demand for bonds in those states, according to Mauro.
New Mexico reduced the maximum tax rate to 6.8% in 2004 from 7.7% in 2003 under Gov. Bill Richardson. Last year, the highest tax bracket in New Mexico applied to all workers earning more than $26,000 a year. In 2005, the earnings requirement will be reduced to $16,001 or more, and the tax rate will be lowered to 6.0%.
"If you lived in New Jersey and you were considering an out-of-state bond and you were in the top income category, you would have been taxed at 8.97% of that interest income from the out-of-state bond, whereas before you were taxed at only 6.37%," Mauro said. "So the tax increase made New Jersey bonds look quite attractive. In New Mexico it went the other way because they lowered their top rate, so out-of-state bonds were a little bit more attractive."
Oklahoma also reduced the maximum tax bracket to 6.65% for 2004 from 7.0% in 2003, under the leadership of Gov. Brad Henry. The state's highest bracket applied to all workers that earned more than $10,000 during the year.
Under changes instituted by Gov. Jennifer M. Granholm, the flat tax Michigan residents will pay in 2004 will amount to 3.95% of their earnings. Lawmakers sought to change the rate to 3.90% from 4.00%, but because that legislation did not take effect until mid-year, the state is requiring residents to pay a mid-point rate of 3.95% for 2004. Beginning in 2005, Michigan residents will pay income taxes amounting to 3.90% of their annual earnings.
