Montana’s income tax system could see a nearly wholesale rewrite if a bill passed by the state Senate last week and now under consideration by the House becomes law, bundling lower top-bracket tax rates sought by Republicans with a slew of other tweaks to the state tax code.
Sponsor Greg Hertz, a Republican senator from Polson, has pitched Senate Bill 399 as a tax code simplification measure. If passed, he says, it would make filing personal state income taxes easier and fairer by pruning the number of state tax credits and aligning the calculations required on state tax forms more closely with the ones taxpayers already have to do for their federal taxes.
“Once you finish your federal tax return, you should be able to jump right over to your state tax form, make a few adjustments, and know exactly what you owe,” Hertz said as he pitched the bill on the Senate floor last week.
As is often the case with legislation aimed at streamlining tangled tax code, however, the proposal’s details are anything but simple — and potentially consequential, given how even arcane tax code tweaks can ripple through the wallets of Montana taxpayers up and down the income spectrum.
Further complicating the picture, the 98-page Hertz bill also bakes in a major Republican priority for the legislative session: lowering the income tax rate on high earners, on the logic that lighter taxes on the wealthy will boost the Montana economy by making the state a more attractive destination for out-of-state entrepreneurs.
“That’s my fear, as we move forward and continue to ratchet down the amount of money that we bring in revenue to the state of Montana, that that is going to cause us to have to have a sales tax in order to make things right for education and the folks we care about out on the ground.”
SENATE MINORITY LEADER JILL COHENOUR, D-EAST HELENA
Democrats argue the Hertz bill has been rushed through the legislative process, and that Republicans’ push to reduce Montana’s income taxes will put the state on a path toward needing a sales tax to fund government services.
“That’s my fear, as we move forward and continue to ratchet down the amount of money that we bring in revenue to the state of Montana, that that is going to cause us to have to have a sales tax in order to make things right for education and the folks we care about out on the ground,” Senate Minority Leader Jill Cohenour, D-East Helena, said on the Senate floor last week.
Hertz, who served as Speaker of the House in 2019, has sponsored several significant tax bills this session, including some implementing different pieces of the tax policy suite proposed by Gov. Greg Gianforte in his January budget proposal.
Among those governor-backed budget bills is Senate Bill 159, which as initially introduced would have pulled the state’s top bracket income tax rate down from 6.9% to 6.75%. After passing the Senate, it was amended by House Taxation Committee Republicans to drop the rate further to 6.5% — a change that increased the cut’s cost to state coffers substantially, from about $30 million to about $80 million a year.
The new Hertz bill matches that 6.5% rate for high earners, but also reconfigures several other pieces of the tax code to collect more revenue in other places, bringing its annual price tag to roughly $40 million.
For example, Montana has historically taxed capital gains, or investment income, at a lower rate than wage income. The Hertz bill keeps a similar reduction for long-term capital gains, or income from investments held longer than a year, but eliminates it for short-term capital gains.
The Hertz bill also strikes 16 other tax credits from the state tax code, including credits for mineral exploration, adoptions, and an energy conservation credit that, according to the state Department of Revenue, saves 9,000 taxpayers a combined $4 million a year. Hertz argues those credits are rarely used, outdated, or ultimately provide taxpayers with insignificant savings relative to analogous federal tax credits.
The bill does leave many of the state’s tax credits in place, including a credit for elderly homeowners and an Earned Income Tax Credit that supports working families. Credits for historic preservation and recycling businesses were eliminated in an earlier version of the bill, but have been removed from the chopping block.
The Hertz bill also broadly redefines how the state requires taxpayers to calculate their taxable income, aligning the Montana definition more closely with the federal system. Under current law, for example, tips earned by waitresses and other service industry workers aren’t counted as taxable income for Montana taxes, but are counted for federal taxes submitted to the IRS. That and similar state exemptions for unemployment insurance benefits and some pension payments would end if the Hertz bill passes into law.
The bill also collapses the Montana income tax system from seven tax brackets to two, in addition to specifying different bracket thresholds for single people and married couples. The intent behind the latter change, Hertz has said, is to no longer have the state tax code push spouses to file separately so they can divide their income to classify more of it in lower tax brackets.
While collapsing lower-end tax brackets means lower-income taxpayers could face higher rates, the bill also expands Montana’s standard deduction to match the federal one: $12,550 this year for single taxpayers. For taxpayers who don’t itemize their deductions, that change essentially exempts a bigger share of their income from taxes outright.
Hertz told the House Taxation Committee Tuesday that particular change would lift state taxes entirely on many lower-income Montanans.
Given the scope of the bill, its impacts on individual taxpayers will be highly situational. An analysis by the revenue department estimates that slightly less than half of Montana taxpayers would pay less under the proposal, and about a fifth would pay more.
Those winners and losers would likely be scattered up and down the income spectrum. In a middle-income bracket representing taxpayers who make between roughly $33,000 and $43,000 a year, the revenue department estimates taxpayers would pay $92 a year less on average, with two-thirds of taxpayers paying less and a fifth paying more.
For taxpayers in the top 10% reporting $143,000 a year or more in income, the average savings are estimated at $126 a year. In that income range, the department predicts about two taxpayers in 10 will pay less under the revised tax code, with roughly the same number paying more.
While the Hertz bill has already been endorsed by the state Senate, it needs quick action in the House to make it to the governor’s desk before the 2021 legislative session wraps up in the coming weeks.
The bill has won support from the Montana Taxpayers Association, the Montana Chamber of Commerce and the Montana Society of Certified Public Accountants, all of which have argued it will make filing state taxes less of a hassle for individuals and businesses.
Like most other Republican tax bills this session, though, the proposal has faced opposition from progressive groups and minority party Democrats, who’ve criticized its cuts for high earners. Additionally, while the Gianforte administration has signaled the governor wants to work toward the 6.5% level for the state’s top-bracket tax rate, his office hasn’t publicly thrown its weight behind the measure.
“Governor Gianforte supports simplifying our tax code and cutting income taxes for hardworking Montanans to make our state more competitive and create more good-paying Montana jobs,” Press Secretary Brooke Stroyke said in a statement. “He will carefully consider the bill in final form when it reaches his desk.”
“Once you finish your federal tax return, you should be able to jump right over to your state tax form, make a few adjustments, and know exactly what you owe.”
SEN. GREG HERTZ, R-POLSON
Rose Bender, an analyst with the progressive Montana Budget and Policy Center, has argued in public hearings that it’s a mistake for the state to tie its income taxes directly to the federal tax code. She said that’s particularly true because the state’s every-other-year legislative calendar means state lawmakers may not be able to respond quickly if the U.S. Congress shifts the tax code, as it did in passing the 2017 Tax Cut and Jobs Act.
“This bill opens Montana up to additional revenue volatility,” Bender said in testimony before the Senate Taxation Committee.
Individual income taxes are the state’s single most important revenue source, accounting for more than half of its General Fund collections.
Democratic lawmakers have also criticized the bill for eliminating energy conservation tax breaks and said that it was brought too late in the session to give lawmakers enough time to fully grapple with its implications. The Hertz bill was introduced on March 26, one business day before the deadline for presenting the 2021 Legislature with new revenue bills.
“This kind of tax simplification should have started at the very beginning of the session,” House Minority Leader Kim Abbott, D-Helena, said at a Tuesday press briefing.
Republicans have defended the timing by noting that portions of the Hertz bill are similar to a 2015 bill brought by former Rep. Bruce Tutvedt, which passed the Legislature before being vetoed by then-Gov. Steve Bullock. They’ve argued that means many of the provisions in the new bill are in effect pre-vetted.
Hertz also argued this week that the bill is a fairer way to scale down Montana’s top income tax rate than other proposals in circulation at the Legislature, and goes beyond being a simple giveaway for the wealthy.
“I think this does a little bit better job of flattening out who pays, and the winners and losers,” Hertz said Tuesday.
“There’s significant reduction in taxes for low-income folks,” he added, “and there are some increases for individuals in the higher brackets too.”
MBPC is a nonprofit organization focused on providing credible and timely research and analysis on budget, tax, and economic issues that impact low- and moderate-income Montana families.