Thousands miss out on low-income tax forgiveness program due to outdated income limits

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Thousands of low-income Pennsylvanians are missing out on a signature state tax benefit because state lawmakers haven’t updated the income thresholds to qualify in nearly two decades.

For almost as long as Pennsylvania has had a state income tax, it has provided a special carve-out for the lowest-income residents. The state’s tax forgiveness provision reduces, or, in most cases, eliminates the personal income tax owed by roughly one in five Pennsylvania tax filers.

In 2003, the last time the income limits were adjusted, the cap for a married couple with two children to receive total tax forgiveness was set at $32,000. In today’s dollars, that would be almost $51,700.

As incomes rise because of inflation and wage increases, fewer people qualify.

Between 2004 and 2019, the number of people who received tax forgiveness fell by almost 20%, according to the state Department of Revenue. That number ticked up again when Pennsylvanians filed their tax returns for 2020, after the pandemic upended the economy and unemployment soared.

The nearly 20 years since lawmakers last revised the eligibility criteria marks the longest stretch of time without an update since tax forgiveness became law in 1974.

“These stagnant income amounts are leaving out a number of individuals and families who need all the help they can get,” wrote state Rep. Dan Miller (D., Allegheny) in a memo for a bill that would tie the income thresholds for the program to inflation.

Unlike most states and the federal government, Pennsylvania has a flat income tax: Someone making $50,000 per year who doesn’t qualify for tax forgiveness pays the same tax rate, currently 3.07%, as someone earning 10 times as much. The state Supreme Court has ruled that Pennsylvania’s Constitution forbids a graduated income tax, which would impose higher rates on higher earners.

As a result, Pennsylvania has one of the most regressive tax systems in the U.S, meaning that state and local taxes hit low-income residents the hardest. The bottom 20% of Pennsylvania taxpayers pay roughly twice as much of their income in state and local taxes as the top 1%, according to one analysis.

Advocates for low-income Pennsylvanians say tax forgiveness — also known as the “poverty exemption” — does not do enough to address this unfairness.

“It does its job, but it’s limited in what it does,” said Marc Stier, executive director of the Pennsylvania Policy Center, a progressive think tank. “It doesn’t apply to enough people and the benefit itself isn’t large enough.”

Recipients received an average of $188.38 in forgiveness on their 2020 tax returns.

A measure to increase the income limits for tax forgiveness each year to keep pace with inflation was included in a wide-ranging tax bill that narrowly passed the state House along party lines in early October. The provision would not, however, account for the inflation since the income limits were last updated.

​​“We’re going to raise the poverty exemption because too many people who make too little pay too much in taxes,” state House Majority Leader Matt Bradford (D., Montgomery) said during the debate on the bill.

The bill would also create a state version of a popular federal tax credit for low- and middle-income workers, which supporters say would help thousands of families who struggle to make ends meet but earn too much to qualify for state tax forgiveness.

The bill also contains business tax cuts, increased funding for public transit, and an expansion of a tax credit for child care costs, among many other provisions. Its chances of success in the Republican-controlled state Senate are unclear. In a statement in early October, state Senate Majority Leader Joe Pittman (R., Indiana) appeared open to considering the legislation, calling it “a historic shift in tax policy, which is very intriguing.”

Without a change in the law, the number of people receiving tax forgiveness is projected to keep declining. State budget documents estimate the value of tax forgiveness awarded will fall almost 13% over the next five fiscal years.

Flatness and fairness

When Gov. Milton Shapp signed Pennsylvania’s state income tax into law in 1971, he hoped it would be only a stopgap.

Shapp, a Democrat, wanted a system that would tax higher incomes at higher rates.

Instead, facing a looming fiscal crisis, and stymied by state Supreme Court rulings that a graduated tax would violate Pennsylvania’s Constitution, he had to settle for a flat tax.

The debate over the fairness of the state income tax has raged ever since.

“We must substitute it for a genuinely fair system which will take a greater share of the burden off the little man and place a greater share of it on the shoulders of those better able to pay,” Shapp said in a 1973 speech.

Largely because of its flat income tax, Pennsylvania has the seventh-most regressive tax system in the U.S., according to a 2018 study by the Institute on Taxation and Economic Policy, a left-leaning policy organization based in Washington, D.C. The bottom 20% of Pennsylvania taxpayers pay almost 14% of their income in state and local taxes, whereas the top 1% pay an effective tax rate of just 6%, the analysis found.

Sales and property taxes take a larger bite out of the incomes of lower earners. A graduated income tax can offset some of that imbalance, while a flat tax leaves those disparities unaddressed, the study said.

» Related: Explainer: The history behind Pennsylvania’s flat income tax

Not everyone agrees that a flat tax is unfair.

When everyone pays income tax at the same rate, lawmakers have a greater incentive to keep rates low, said Katherine Loughead, a senior policy analyst at the Tax Foundation, a Washington, D.C. think tank that generally advocates for lower taxes.

Flat taxes also make state revenues more stable and easier to predict, she said.

Flush with budget surpluses after the pandemic, at least four states moved to adopt flat income taxes in 2022, arguing that the changes would spur economic growth.

Similar arguments in favor of keeping the flat tax ultimately ended Shapp’s push in the mid 1970s to change Pennsylvania’s Constitution to allow a graduated income tax. A series of public hearings revealed intense opposition to the idea; critics said it would drive away businesses and high earners.

Shapp eventually managed to reduce the burden of the new tax on the lowest-income residents, though. In 1974, as part of a deal to cut the income tax rate overall, lawmakers approved a system of exemptions.

The tax forgiveness program was made possible by a 1968 constitutional amendment that gave the General Assembly the authority to create special tax provisions for people determined to be in need because of “age, disability, infirmity or poverty.”

In 1981, a state commission said that “basic equity” called for increasing the income limits to qualify for tax forgiveness, which hadn’t been changed since it was created, to account for inflation.

Between 1987 and 2003, lawmakers tweaked the income thresholds nine times, gradually increasing them and targeting the benefit more toward those with children.

Then, the increases stopped.

Different approaches

Despite attempts by lawmakers in both parties, and by former Democratic Gov. Tom Wolf, it has been nearly 20 years since legislation to update tax forgiveness last gained traction in Harrisburg.

Divided government, other hot-button legislative priorities, and a series of difficult budget years during the Great Recession all played a role. So did the program’s own shortcomings.

The amount of tax forgiveness someone can receive is based on family size, marital status, and income. Some people whose incomes exceed the cap can still receive partial forgiveness, but only within a narrow range. Once someone makes more than $2,250 over the limit, they don’t qualify at all.

And because the eligibility formula doesn’t count retirement income — which generally isn’t taxed in Pennsylvania — some retirees with six-figure incomes can still receive tax forgiveness, said Jason Skrinak, an accountant and president of a tax consulting firm in Harrisburg.

“They qualify, so it totally makes sense for them to take it — I’m just not sure that was the true intent of this program,” he said.

In recent years, advocates for low-income Pennsylvanians have pushed to create a new state tax credit based on a longstanding federal one, which they argue would go further than the existing tax forgiveness provision.

The federal earned income tax credit gives money back to workers with low and moderate incomes. In 2022, one million Pennsylvania households received the federal credit, IRS figures show. A state version would allow recipients to claim a portion of the federal credit on their state tax returns.

Thirty-one states already have their own versions of the federal credit, which supporters say is one of the most effective federal anti-poverty programs.

A proposal to create a state credit worth 25% of the federal one passed the state House in June with bipartisan support. The measure was also included in the omnibus tax bill that passed the state House along party lines in early October.

A state earned income tax credit would help working families who are living paycheck to paycheck but who mostly don’t qualify for tax forgiveness or for other government assistance programs, said Philip Falvo, public policy director of the United Way of Pennsylvania, which is advocating for the state credit.

For a married couple with two children, the income limit to receive full tax forgiveness is $32,000. The threshold for the same family to qualify for the federal earned income tax credit, by contrast, would be almost $59,500.

Unlike tax forgiveness, a state earned income tax credit would be refundable, allowing recipients to get back more than they would otherwise owe in taxes.

A state-level credit could also encourage more people to apply for the federal one, advocates say. An estimated 18% of Pennsylvanians who qualified for the federal credit did not claim it in tax year 2019, IRS figures show.

“For those who believe the tax forgiveness program is enough, enactment of a state earned income tax credit will ensure working middle- to low-income families that are currently struggling will have additional resources to avoid the slide into poverty,” said state Rep. Christina Sappey (D., Chester), the bill’s sponsor, during a debate in June.

The proposed tax credit would cost $405 million annually by the 2027-8 fiscal year, the state Department of Revenue estimates.

In addition to raising concerns about the cost, some Republican lawmakers argue that Pennsylvania doesn’t need another program in addition to tax forgiveness. Tax forgiveness “has a greater impact on those that actually would benefit from it,” state House Minority Leader Bryan Cutler (R., Lancaster) said during the debate on the state earned income tax credit proposal in June.

The bill would require taxpayers eligible for both programs to choose between them.

As the state House prepared to vote on the tax package in early October, Cutler said he supported expanding tax forgiveness, but criticized the bill overall as a “legislative hostage situation” that he said was put together at the last minute with no input from Republicans.

Outdated income thresholds also led to a decline in the number of people benefitting from a state program that gives older and disabled Pennsylvanians a partial refund on their rent and property taxes. Fulfilling a key campaign promise, Democratic Gov. Josh Shapiro successfully pushed for a major expansion of that program. Going forward, the income limits for the program will be adjusted for inflation each year, preventing the problem from repeating itself.

In a budget hearing earlier this year, revenue secretary Pat Browne said both the rebate program and tax forgiveness were “keynote programs.”

Manuel Bonder, a spokesperson for Shapiro, said in a statement that the governor “supports further efforts to lower costs for Pennsylvania families and his Administration is open to exploring additional, fiscally responsible steps to ensure critical programs keep pace with the cost of living.”

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