When an interviewer recently asked Colorado’s Democratic governor Jared Polis what the state’s income-tax rate should be, he answered without hesitation: “It should be zero.”
For many Coloradans, this came as no surprise: The effort to chisel away at the income tax has already gained steam in the state. Last year, voters reduced the tax with Proposition 116 — a ballot initiative that brought the rate from 4.63 percent to 4.55 percent. The Denver-based Independence Institute, where I work, led last year’s rate-reduction campaign, through its issue committee, and plans to advocate another tax cut next year. Yet, for reasons discussed in further detail below, those eying complete elimination of the income tax may have to take another approach.
The Value of Zero Income Tax
If Colorado were to adopt the governor’s recommendation, it would join eight other states with no income tax and become the third blue state boasting the status, alongside Washington and Nevada.
Eliminating the tax would provide an enormous direct windfall to Colorado households. In 2017, the average Colorado family paid $2,850 to the state in income tax. But the indirect benefits of economic growth and opportunity for residents should not be understated.
In this recent interview, Governor Polis added that eliminating the income tax “would be a very pro-growth policy.” He went on to explain that taxing income discourages productivity and growth.
The governor was joined in the interview by Art Laffer, a conservative economist and economic adviser in the Reagan administration, who agreed that eliminating the income tax would boost the state’s economy. Notably, Polis grew up working for Dr. Laffer, and they remain good friends to this day.
While an outside observer would not know it from looking at his poor track record, Polis understands economic incentives and sound tax policy well. On the one hand, under his watch, Colorado has adopted a barrage of anti-jobs policies: a minimum wage increase to the 6th highest in the nation; a state payroll tax to fund America’s most generous state-mandated paid leave program; crushing new regulations on key Colorado industries; and billions of dollars in new government fees and taxes. Yet, on the other, he championed last year’s income tax rate reduction and now supports abolition of the tax. He contains multitudes.
For all his missteps, Polis appears to understand that businesses tend to gravitate away from high-tax, heavy-regulation jurisdictions to places where they are treated best. They bring jobs, wages, and opportunities with them.
To illustrate this principle, gaze over the Rockies at Colorado’s neighbor to the west: California. A study released this August from Stanford University’s Hoover Institution investigates the massive corporate exodus from the Golden State. It finds that of the 272 headquarters that have left since 2018, more than half have gone to just two states: Texas and Tennessee, neither of which levies any income tax. In fact, four of the top six destinations for California companies boast zero income tax.
In contrast, California has the highest individual income-tax rate and second-most-burdensome business-tax climate in the nation. The Hoover study ranks Texas and Tennessee as the first and third-most-attractive states for business; it puts California last.
It follows that every reduction in income tax will allow Coloradans to keep more of every dollar they earn, and it invites more jobs and opportunities for residents.
That’s why Polis went on to praise last year’s Proposition 116 as “progress in that direction.” “We celebrate every step of progress along the way,” he added.
Yet, due to an obscure nuance in how the state has chosen to apply certain provisions of law, Colorado taxpayers are not yet seeing the full benefits of tax cuts that they voted for in last year’s ballot initiative — an issue on which the governor has been silent.
Zero Income Tax Requires a New Approach
By approving Proposition 116, voters chose to reduce the income-tax rate . The logical consequence of doing so would be that they would thus be allowed to keep more of their own money. A close look at documents maintained by Legislative Council Staff (LCS), however, reveals that things did not work out how voters expected. Tax rates went down, but constitutionally mandated tax refunds — known as “TABOR refunds” — fell by the exact same amount, negating taxpayer savings from the voter-approved tax cut.
It’s a bit complicated, but here’s how it works.
Article X of the state constitution — commonly known as the Taxpayer’s Bill of Rights, or TABOR — sets limits on the amount of tax revenue the state can collect each year. If revenues, including income-tax collections, surpass the TABOR limit, the excess gets refunded back to voters.
Picture state coffers as a silo and revenues as grain filling it up. In a good year, there may be more bounty than what the silo can hold. In that case, the overflow goes back to the people.
Each year, the limit — or the size of the silo — increases based on population growth and inflation, allowing government spending to grow automatically. If the state wants to collect or keep tax monies at a level higher than automatic growth permits, it must win voter consent at the ballot.
When voters reduced revenues last year, they voted to decrease the amount of grain put into the silo by a specified amount. In executing the will of the people, the state reduced the amount of grain but put it in the same, larger silo. At the lower income-tax rates, the harvest (i.e. revenues) would have to be exceptionally good to fill up the same silo and trigger a refund.
Incidentally, state revenue forecasts show very bountiful times ahead and refunds for at least four consecutive years. So, despite the people putting a smaller percentage of their grain into the same large silo, tax contributions will still overfill the public storehouse. Now imagine how much more the silo would be overflowing if, when voters reduced the tax rate, they also began using a smaller silo to account for the reduction! To be entirely accurate, the people will see the savings from Proposition 116, but for at least this year and the next three, the tax reduction will result in smaller refunds—offsetting the cuts—unless additional reforms are adopted.
Read plainly, TABOR appears to guard against this outcome by requiring the limit to be “adjusted for revenue changes approved by voters.” LCS evidently has a different interpretation—one which has effectively stripped voters of their tax cut.
If Polis truly supports the cut, which he enthusiastically lauded in his recent interview, he should be the first to question LCS’s application of the law, and if necessary, advocate for additional reforms to ensure voters receive the tax reduction they voted for. Meanwhile, incremental rate reductions like Proposition 116 alone may not be the best path to eliminate the state’s income tax.
The Path to Zero
Fortunately, there’s another way to get there.
Through the ballot, voters can (1) require the state to issue all future TABOR refunds through income-tax reductions and (2) make any new income-tax rate created by these reductions permanent.
First, these reforms would put the journey to no income tax on autopilot. Rather than requiring new legislation or ballot measures for each new rate reduction, this would create an automatic trigger for reducing the income tax.
This approach would also prevent any surprises for appropriators that can come when voters reduce taxes from one year to the next. The rate reductions would kick in when the state issues refunds. This will never cause the state to collect less revenue than expected. Revenue forecasts would give appropriators several years of forewarning that tax collections will exceed the TABOR limit and lead to a permanent rate reduction in future years.
The changes would not reduce the amount of revenue the state can collect. And based on current forecasts, they would not reduce the revenues the legislature is currently expecting to receive. Thus, these changes would reduce taxes without affecting the state budget within the current forecast window, and they would ensure taxpayers realize the income tax savings they voted for.
To eliminate the income tax entirely, the state would likely need to begin lowering the revenue limit along with the rate reductions in the future. Meanwhile, these two reforms would put the state on a path to zero, just as Governor Polis championed.
Putting Colorado on Top
Colorado currently ranks in the middle of the pack on such issues as taxes, economic freedom, and business friendliness. Yet, despite its average performance by these measures, Colorado is the fifth most likely landing state for California businesses.
Fourteen companies chose to relocate to the beautiful Rocky Mountain state rather than the 20 states with less-burdensome business taxes and more economic freedom — or the eight states with no income tax.
Still, 113 companies leaving California from 2018 to 2021 chose Texas, a state with no income tax, first for business friendliness, and ninth for economic freedom. Twenty-five chose Tennessee — a state with no income tax and the third best state for business, according to Hoover.
Imagine, then, if Colorado were to eliminate its income tax.
Considering its proven lure, the Centennial State could easily dethrone Texas and Tennessee as the most attractive state for new businesses, jobs, and opportunity.
Dr. Laffer agreed. “If Colorado were to eliminate its income tax, believe me, [it] would rank above all nine states that don’t have an income tax,” he proclaimed in the August interview with Polis.
Not only would all Coloradans benefit from the increased economic activity in the state, but every worker would also benefit directly by retaining more wages in every paycheck.
If Polis can pull this off, he just might shake his reputation as “Governor Unemployment.”
This article first appeared in National Review Online on October 18, 2021. A few non-substantive adaptions were made for republication here.
