The Alaska Landmine Friday column: Alaska’s existing personal income tax (“reduction in income”) rates

This week, we calculate the personal income tax (or, if you prefer, “reduction in income”) rates embedded in the Senate’s proposed versions of the FY24 supplemental & FY25 budgets

On Thursday of this week, Legislative Finance presented a “Fiscal Update” to the Senate Finance Committee covering Committee Substitute 2 (CS2) of both the FY25 Operating Budget and the FY24 Supplemental Budget. At the end of the meeting, the Committee passed both out of the Committee for action by the Senate as a whole.

While there may be marginal changes from here to the end of the current legislative session, in the current political environment, the versions of both passed out of the Committee — just like the Senate version of the FY25 Capital Budget — likely will largely define the legislative outcome. The Senate as a whole will largely pass whatever the Committee version reflects. Then, after a conference committee likely adopts most of the Senate version, a combination of the House minority and some members from the House majority will do similarly.

While Governor Mike Dunleavy (R — Alaska) may reduce some of the spending levels at the margin, most of the spending and other fiscal steps taken in the Senate Finance Committee version will likely survive.

The purpose of this week’s column is to calculate and put in recent historical context the personal income tax rate(s) embedded in the Senate Finance Committee versions of both the FY24 budget, as supplemented, and the FY25 budget. The taxes result from the reductions made in the Permanent Fund Dividend (PFD) for both years from the levels provided in the current law. Just like income taxes collected at the federal and other state levels, the amounts are being collected by the government by withholding a portion of the cash required to be distributed to Alaska residents under current law (the relevant statute uses the word “shall”) and diverting it instead to government accounts.

While some who benefit from the approach by minimizing or avoiding their contributions attempt to obfuscate the effect by wrapping it in other language, the economic impact on Alaska families — particularly middle and lower-income Alaska families — is excruciatingly clear: “Let’s be honest,” Professor Matthew Berman of the University of Alaska — Anchorage Institute of Social and Economic Research (ISER) wrote in an April 7, 2023, column in the Anchorage Daily News, “A cut in the PFD is a tax — the most regressive tax ever proposed.”

But for those that prefer to avoid calling it what it is, just think of the PFD cuts as a “reduction in personal income.” It is inarguable that the reductions in the statutory PFD enacted by the Legislature are that.

The overall tax (or, for the linguistically squeamish, “reduction in personal income”) rates resulting from the Senate Finance Committee versions of the budget are relatively simple to calculate. The federal Internal Revenue Service (IRS) annually provides statistics on the amount of adjusted gross income (AGI) reflected in the income tax returns filed from each state. While the data released by the IRS lags in time, estimates of current levels can be made by adjusting prior year levels based on historical trends.

The chart below reflects the AGI levels for Alaska from 2017 through the current year. Those over the 5-year period from 2017 through 2021 are taken straight from the IRS statistics. Those from 2022 through 2025 are derived by adjusting the 2021 level forward at the same compound growth rate calculated from the actual data over the previous five years.

The overall tax amount is similarly simple to calculate by deducting the amount of the PFD actually distributed in each year from the amount of the PFD otherwise required to be distributed under current law. The amount of the PFD otherwise required to be distributed under current law is easily calculable from the historical data available from the Permanent Fund Corporation. The amount of the PFD actually distributed each year — or to be distributed under the FY24 and FY25 budgets — can be derived from the budget bills.

The overall tax (“reduction in personal income”) rate is calculated by dividing the amount of the overall reduction by the sum of the AGI reported to the IRS plus the amount of the reduction, which otherwise is not included in the IRS data. Here are the rates for the period through FY23, as well as FY24 and FY25 based on the data contained in the Senate Finance Committee versions of the FY24 Supplemental and FY25 budgets.

The average overall tax rate for the full period is 3.4%. Those voting for the Senate Finance Committee versions of the FY Supplemental and FY25 budgets will vote for overall personal income tax rates (“reductions in personal income”) of approximately 3.9% and 3.7% for each year.

However, the analysis is misleading if we stop simply at calculating the overall tax rate. To fully understand the full impact of what legislators have in the past and are continuing to vote to adopt, it is important also to look at the effective tax rates by income bracket.

The effective tax rate (“reduction in personal income”) by income bracket resulting from using PFD cuts to raise revenue is relatively easy to calculate using the same methodology incorporated in the 2017 study by the Institute on Taxation and Economic Policy (ITEP) for the Legislature. There, ITEP determined the average income of Alaska families by income bracket and then calculated from that, the impact of the PFD cuts on that income. The percentage impact is the effective tax (“reduction in income”) rate on that income bracket.

We did the same in a column on these pages earlier this year, following ITEP’s latest update of average Alaska incomes by income bracket. That analysis looked at the impact of PFD cuts in calendar year 2023 (FY24), the same calendar year used by ITEP in its latest update. The chart we developed there is this:

The third from the last line reflects the effective tax rate (“reduction in personal income”) by income bracket resulting from the FY24 PFD cut. The effective tax rate (“reduction in personal income”) by income bracket for FY25 won’t materially differ.

Just as in every other year since the Legislature started using PFD cuts — taxes on (“reductions in”) personal income — to close its budget deficits, 80% of Alaska families — those in the middle and lower-income brackets — will contribute much more of their income than the overall tax rate, while those in the top 20% will contribute much less than the overall tax rate. Non-residents receiving income from Alaska sources will contribute zero. The impact of their zero contribution is that, in Alaska, residents will be required to contribute comparatively more toward government costs than residents in any other state, where non-residents contribute at least something.

Some claim that the excess above the overall tax rate taken from middle and lower-income (80% of) Alaska families is used to help fund government spending. But that’s not accurate. Instead, the excess is used effectively to subsidize the lower than overall tax (“reduction in personal income”) rates experienced by those in the top 20% and non-residents.

Even though middle and lower-income (80% of) Alaska families are contributing more than the overall rate, the state still is only receiving roughly 3.9% (FY24) and 3.7% (FY25) of overall adjusted Alaska AGI. The excess above that rate being taken from middle and lower-income Alaska families is being used to offset — effectively, to subsidize — the lower than overall rates being collected from those in the top 20% and non-residents.

By being allowed to contribute less than the overall tax (“reduction in personal income”) rate, those in the top 20% and non-residents are receiving the benefit of what we have described in previous columns as an additional “tax avoidance dividend” funded by the remaining 80% of Alaska families. As explained in those columns, that additional dividend is sometimes worth as much as $100,000 per year to those families.

By failing to include information on the effect of using PFD cuts as a funding source by income bracket, Legislative Finance and others in the Legislature obscure its impact on Alaska families.

But the numbers are there and don’t lie. Those in the Senate and House voting for budgets that rely on PFD cuts to fund government are voting for a personal income tax (“reduction in personal income”) on Alaskan families. Middle and lower-income families are compelled to contribute much more than the overall rate to subsidize those in the top 20% and non-residents. We remain astonished that legislators — particularly some in the minority Alaska House Coalition who claim otherwise to prioritize the impact of legislation on “working Alaska families” — continue to support and advocate for such an approach.