What gets taxed and where does it go? A look at Nebraska’s budget policy during a deficit

Nebraska has faced back to back years of significant budget deficits, forcing lawmakers to fill a $471.5 million gap this year. But back in 2022, things looked pretty good. The state had a balance of more than $1.6 billion after a series of tax changes and pandemic-era federal stimulus funds.

“So, truly record-breaking revenue growth at that period of time,” Rebecca Firestone with Open Sky Policy said. “And, because it was record breaking, we wouldn’t expect for that to continue.”

According to Firestone, in the 2023 fiscal year, the state not only spent a good chunk of that $1.6 billion, but lawmakers passed new legislation in LB754, which Firestone said reduced revenue streams.

“We have been on a glide path to collect less in income taxes, both personal and corporate, since 2023,” Firestone said.

LB754 lowered individual income tax rates, taking the highest income bracket down incrementally from 6.84% in 2023 to 3.99% by 2027. That’s led individual income tax revenue to shrink from its peak at more than $3.2 billion down to $2.1 billion a year.

LB754 also created a pass-through entity income tax (PTET), which changed how business owners can file their taxes retroactively over the five years prior. This resulted in a one-time boost in corporate income taxes as business owners filed taxes for the previous five years.

Firestone believes the income tax cuts, along with the state’s ever-growing investment in property tax credits, carry a big part of the blame for this year’s nearly half a billion dollar budget deficit.

“The increases in spending on property tax breaks are just growing at a rate that dwarfs any increase in spending on general fund appropriations,” Firestone said.

Looking at the state budget book, it is clear Nebraska is spending a lot more money from its general fund on reimbursing property tax credits to Nebraskans. It started in 2007 with the Property Tax Credit Act. That first year, that state spent $105 million on property tax credits. In the current fiscal year, Nebraska spent $427 million on reimbursing property tax credits. And for Gov. Jim Pillen’s administration, things are going exactly as intended.

Lee Will, the state’s director of Administrative Services, attributes the budget deficit to global economic factors, which Nebraska is not alone in grappling with.

“It's really the cyclical nature of revenue and expenditures within the state government,” Will said. “I've been here for about 11 years. You see the ups and downs in revenue, but the thing that Gov. Pillen has been consistent on is we're going to shrink the size of government.”

Pillen’s staff said 31 other states had to cut their budgets this year and that the property tax credits rightfully give money back to the taxpayers. And Will pushed back on the idea that income tax cuts are bad policy.

“The Democrat senators say that (income tax cuts) are going to the wealthiest Nebraskans,” Will said, referencing objections to the cuts made by left-leaning lawmakers in the state’s officially non-partisan Legislature. “The highest income bracket begins at $35,000 for a family. And to me, that just isn't wealth in Nebraska. And that's an everyday Nebraskan that brings in $35,000 a year. So I think that optic is just, you know, false on its face.”

Will added that the state gave out $1.8 billion in property tax credits, community college funding and other benefits for Nebraskans this year.

Jared Walczak, senior tax policy advisor with the Platte Institute, said Nebraska should have broadened its sales tax base to offset income tax cuts.

“There's a modernization effort that can take place within the sales tax that can actually be a fairly progressive policy,” Walczak said.

This works best when the state taxes goods typically used by folks with high incomes. For example, Nebraska taxes horse boarding and training but not veterinary services, even for large animals. Walczak said income taxes are just a tax on economic development, while also being less reliable than sales taxes.

“Any tax is going to have some drag on the economy, but you have to fund the government,” Walczak said. “And the income tax cuts are important to Nebraska’s economy.”

Will also said that the state is careful not to raise sales taxes on essential goods. For example, most food items are exempt from sales tax.

“Those folks that have limited income, most likely, they're not going to be buying goods or have the choice to buy goods that are going to be taxed,” Will said.

Efforts to broaden the sales tax base failed largely because senators could not agree on what should be taxed and what should remain exempt. Also, some Republican senators opposed any new sales taxes.

Another of Pillen’s aims to balance the budget that caused a fair amount of controversy was pulling extra money from cash funds, which are raised by fees for specific services. Democratic senators opposed those efforts and some former state officials filed a lawsuit over millions taken from the Nebraska Environmental Trust fund and used for purposes they say are unrelated to the environment.

“(Cash funds) are not ideally suited to raising general revenue,” Walczak said. “But lawmakers often see them as a way to raise additional revenue without being perceived as raising taxes. That's not really the way to go.”

Often, lawmakers will use cash funds for purposes related to the appropriation. For instance, lawmakers funded the Supreme Court with transfers from the Nebraska Opioid Recovery Trust Fund. Courts often handle drug cases and received $6.5 million from the fund. Lawmakers can also just create cash funds and then create rules for how they will be used.

One bill, LB838, raised a new 25% excise tax on remittance transfers, or electronic transfers sent to people in other countries. The budget estimates this bill will bring in more than $17 million for the general fund over the next three fiscal years.

And one of the many provisions under LB935 included the creation of new fees, such as a new $36 fee for traffic misdemeanor cases. The fees are slated to go into the general fund, while most fees typically go into a specific cash fund. Bill proponent Sen. Carolyn Bosn said the fees will go into the general fund because the courts should be funded with revenue from the general fund, which is a more reliable source than cash funds.

In an April 1 debate over LB935, Sen. Wendy DeBoer raised objections to the bill.

“We are just raising these fees for a basic function of government in order to support the general fund, that's basically like what we do with the tax, we put it into the general fund,” DeBoer said. “There's no way to track which dollar came from court fees and which dollar came from income taxes once they get put into the general fund.”

Sen. Danielle Conrad also objected to the fees, arguing they will only impact some Nebraskans.

“As clearly analyzed by the American Bar Association, the ABA considers court-imposed fines and fees to be regressive because they disproportionately burden low-income individuals functioning like a tax on the poor rather than a fair system of justice,” Conrad said.

While many surplus cash funds were used to help plug the budget deficit, senators argued that there should not be so much extra money in those accounts, and that if the money is not being spent, the fees should be reassessed. Will said fees could be lowered, but the state also must be competitive with fees charged by surrounding states.

Pillen’s staff said excess cash funds combined with sales taxes will help close the budget deficit in future. This relies on no increases in government spending, Will said.

In the Department of Revenue’s April report on general fund receipts, sales and use taxes came in 11% higher than expected. Individual income taxes came in more than 45% below forecast and corporate taxes were more than 4.5% below forecast. Altogether, the state expected $696 million in tax receipts and instead received $639 million.

Based on preliminary estimates, the state is already set to be in a $135 million deficit next year and a $630 million deficit in the next biennium.