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Here’s the nuance behind Colorado Democrats’ effort to eliminate 9 tax breaks, pump $1.6 billion into state coffers

Colorado lawmakers have used the elimination of tax breaks in prior recessions to bolster the state’s budget. But there are legal questions and unknowns around whether Gov. Jared Polis will sign off on House Bill 1420, which also gives immigrants access to a tax credit.

The Colorado Capitol. (Jesse Paul, The Colorado Sun)
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To generate money for the coronavirus-depleted state budget, Democratic state lawmakers in Colorado want to slash or change nine tax breaks to generate $1.6 billion in revenue over the next four years.

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House Bill 1420, introduced Monday with just days left in the 2020 lawmaking term, would revoke tax breaks included in the federal stimulus bill known as the CARES Act and the 2017 tax cuts signed by President Donald Trump, as well as slash current state tax credits for certain industries. 

Because Colorado is “coupled” with the federal tax code, changes made by Congress automatically apply to the state’s tax system. But lawmakers can pass legislation to “decouple” Colorado and make changes. 

The Democratic bill sponsors say the goal is to generate more money for K-12 education after the current coronavirus recession put a $3 billion deficit in the state’s $30 billion budget. In addition, the lawmakers argue that the wealthiest Coloradans who receive the bulk of the current tax breaks should pay a larger share. 

But a nonpartisan legislative analysis shows there are some important nuances to the bill.

Less than half of the new revenue expected to be generated in the next four years, or $750 million, would go toward schools.  All other dollars would go to the general fund, the discretionary spending account lawmakers allocate each year.

After the four years are up, starting in the 2025-2026 fiscal year, the state is expected to collect $230 million a year through the eliminated tax breaks . None of that money is earmarked for education.

The annual tax revenue forecast for Colorado’s budget if House Bill 1420 is signed into law. (Colorado Legsilative Council Staff)

Democrats say they didn’t earmark more for education to prevent themselves from committing more money than is generated by the breaks given the volatility of the economy. That could handcuff future legislatures by forcing them to make up the difference. They also ended the allocation to education after four years for the same reason, giving future legislatures the ability to use the money how they wish.

One other provision tucked inside the bill would expand a state tax break for low-income workers, known as the earned-income tax credit. Starting this year, the measure would allow immigrants who work in the state — whether they live in the U.S. legally or illegally — to claim the state credit by removing the requirement for a Social Security number and instead allowing filers to use a taxpayer identification number.

About 36,000 people in Colorado file taxes with an identification number and are ineligible for the earned-income tax credit.

Further, the bill would double the state tax break to 20% from 10%  of the federal credit for everyone eligible in 2023. Over four years, the expanded tax break would cost the state $193 million.

State Rep. Emily Sirota, a Denver Democrat and prime sponsor of the measure, says the goal is to ensure Colorado’s wealthiest people and businesses are helping ease the state’s budgetary woes.

“What we’re doing is not impacting those mom-and-pop, main-street businesses,” she said. “We are ensuring that really wealthy individuals and business owners — these companies should be paying their fair share, especially in this time of crisis where we need to come together to meet the needs of our state.”

Rep. Emily Sirota, D-Denver, joins other lawmakers in the House chambers as the second regular session of the 72nd Colorado General Assembly convenes at the Colorado State Capitol on Jan. 8, 2020 in Denver. (Kathryn Scott, Special to The Colorado Sun)

The alterations to decouple the state and remove existing tax breaks are so expansive that the Colorado Department of Revenue would have to spend about $4 million per year for each of the next four fiscal years on hiring the equivalent of 45 full-time staff to implement the changes. 

And it mirrors the strategy Democrats used after the Great Recession to generate more money. In 2010, the party’s leaders pushed legislation to repeal or reduce more than a dozen tax breaks — what critics called “the dirty dozen” — and generate $700 million in new revenue over four years, a legislative analysis showed. Back then most of the changes were temporary, but the new legislation ends many of the tax breaks for good.

Even if the bill passes the legislature, there are questions about its legality and whether Gov. Jared Polis, a Democrat, will sign off. Polis made an income tax cut a top priority in his first term and wanted to repeal existing tax breaks to cover the cost. His Democratic counterparts in the legislature rejected the idea in the 2019 session and again this year amid the state’s budget woes.

An even bigger question looms about whether the legislation meets the requirements of the Taxpayer’s Bill of Rights, which requires voter approval for increases in taxes. Jon Caldara at the Independence Institute, an advocacy group that supports TABOR, questioned the move to add revenue without a vote. “I’ve never understood how the issue of voter consent is such a tricky one for lawmakers,” he said.

In prior cases, state courts ruled that tax policy changes that generate a net increase in revenue don’t need voter approval if they remain below the current spending limits under TABOR. A separate ruling suggested any small revenue increases wouldn’t need a referendum, but never defined the threshold.

Under the new legislation, the additional revenue won’t put Colorado over the cap, but in future years it could, according to legislative analysts. The increase represents about 4% of general fund revenue. 

“There’s no tax increase in this,” said Rep. Matt Gray, a Broomfield Democrat. “There have been adjustments like this that have been made to bolster K-12 in the last several recessions. None of them have gone to the ballot and all of them have been upheld by the courts. It’s a tool that we have during tough times to shore up our schools.”

Speaker of the House KC Becker, right, meets with House Majority Leader Alec Garnett, left, and Rep. Matt Gray, D-Broomfield, as the second regular session of the 72nd Colorado General Assembly convenes at the Colorado Capitol on January 8, 2020. (Kathryn Scott, Special to The Colorado Sun)

Meanwhile, business groups have aligned against the measure, warning that it will hamper an already hurting economy. 

“The short-sighted view of the legislature is particularly concerning during this time of serious economic challenge for Coloradans,” said Kelly Brough, president and CEO of the Denver Metro Chamber of Commerce. “It makes no sense to close a budget gap by slowing the very engine that puts Coloradans to work and in return generates tax revenue.”

GOP lawmakers, who are in the minority in the legislature, are also expressing concern. Rep. Shane Sandrige, a Colorado Springs Republican, said he is fearful that corporations will move their headquarters elsewhere if the measure passes as they are courted by states with lower tax rates.

“If you don’t think that this bill may put a business over the edge, it very well could,” Sandridge.

As for Polis, he signaled Tuesday that he is not on board.

“We have not reached an agreement with the legislature on fiscal reform,” he said at a news conference, discussing his push for an income tax reduction. “We are happy to negotiate with all parties.”

The bill’s sponsors are hopeful, however, that Polis won’t block their efforts.

“Throughout our time working with the governor he has talked several times about closing special interest tax breaks,” Sirota said. “So I do think we share that perspective. I also know that the governor supports adequately funding K-12 education and preventing devastating cuts to our budget.”

House Bill 1420, which cleared its first committee hearing Tuesday on a 7-4, party-line vote, would send $150 million toward K-12 education in the coming fiscal year, which begins in July, and then $200 million for every fiscal year after that through the 2024-25 fiscal year. 

Democrats will try to push the bill through before Friday, when the legislature is set to convene for the year to limit lawmakers’ exposure to coronavirus.

Here is a breakdown of the nine tax breaks that would be eliminated under the bill and how much money would be generated by getting rid of them:

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1. The net operating loss deduction cap

Colorado businesses have traditionally been able to deduct up to 80% of their net operating losses. But under the CARES Act that proportion has been increased to 100%. 

House Bill 1420 would cap the amount of net operating losses a business can deduct from its state taxes at $400,000, which bill proponents say encapsulates the vast majority of businesses that report a net operating loss. In other words, the change would affect only the most cash-flush and largest of businesses.

2. Capital gains deductions for out-of-state property sales

Colorado tax law allows people to deduct capital gains — also known as profit — on out-of-state property sales, including real estate, vehicles and jewelry. Under the measure, that benefit would be eliminated. 

3. Sales tax exemption on energy use

Sales and purchases of energy — think electricity, coal or fuel — for the purposes of manufacturing, irrigation, construction, mining and refining are exempt from taxation because they are considered wholesale. House Bill 1420 would eliminate that break.

The legislation, however, also enacts a tax credit of up to $12,000 a year for energy purchases, which is meant to ensure that small businesses and manufacturers that benefit from the break would not be affected by the change.

There are also exemptions in House Bill 1420 for “public good” entities, like agricultural operations and government transportation entities, that would ensure they continue to benefit from the exemption. Newspaper publishers also would continue to receive a tax break on the ink they purchase.

The change is expected to generate $52 million in tax revenue during the next fiscal year and increase in the years after that.

4. A tax break for insurance companies

Insurance companies receive a break on the taxes they pay on each premium they write if they have an office in Colorado. The reduction, which was aimed at creating more insurance industry jobs in the state, would be eliminated under the legislation. 

Proponents of the bill say the credit did not work as intended. The legislature’s fiscal analysts say the change would pump $30 million into the state’s budget in the next fiscal year and about $100 million in each fiscal year after that.

5. The premium tax exemption for deposit funds

Under current Colorado law, annuities are exempt from the state’s premium tax. House Bill 1420 would clarify that certain insurance products or contracts are not truly annuities and therefore shouldn’t qualify for the exemption.

6. Net operating loss deductions

Under the CARES Act, businesses can use net operating losses to revise their tax returns from prior years and in some cases even receive a refund check from the state. The measure would eliminate that ability. 

7. The excess businesses loss deduction

The CARES Act allows owners of pass-through businesses to deduct their operating losses from their income from other investments. In other words, if the pass-through business loses $1 million and the owner makes $1 million, they could report no income. 

House Bill 1420 restores the tax code to what it was before the CARES Act, capping the amount of losses the owner of a pass-through business can deduct from their other income at $250,000 for single filers and $500,000 for joint filers.

Proponents of the measure believe it would pump some $73 million back into the state’s budget in the next fiscal year.

8. The interest expense deduction

Under the CARES Act, businesses with at least $25 million in annual receipts and with one or more loans can deduct the interest they pay of up to 50% of their adjusted taxable income for the 2019 and 2020 tax years. In all other tax years, they may deduct the loan interest from up to 30% of their adjusted taxable income. 

That extra break would be eliminated under House Bill 1420, returning the amount businesses can deduct from their adjusted taxable income to 30% and, proponents say, sending $2 million into the state’s coffers in the next fiscal year.

9. The qualified business income deduction

Under Republicans’ 2017 Tax Cuts and Jobs Act passed by Congress, owners of pass-through businesses — like a limited liability company, partnership or sole proprietorship — can take a deduction of 20% off their qualified business income if they have an income below $157,000 for single tax filer and $315,000 for a joint filer. 

House Bill 1420 would change the tax break to limit who can receive the 20% break to people with an income below $75,000 for a single filer and $150,000 for a joint filer. 

People could still receive deductions on the federal level if the bill passes. Proponents believe the change would pump about $43 million back into the state’s budget in the coming fiscal year and even more moving forward.

Rising Sun