Overview

Nebraska's individual income tax, like that of most states, is largely based on the federal individual income tax. The starting point for Nebraska's tax is federal adjusted gross income. Allowed deductions are for federal itemized deductions or the federal standard deductions. There are some differences between federal taxable income and state taxable income. Primarily, these are the addition of income from municipal bonds issued from another state, which are not deductible in Nebraska and our treatment of personal exemptions. Personal exemptions are deductions in the federal system and credits against tax in the state system.

Once taxable income is determined, the Nebraska individual income tax imposes a progressive, four rate schedule. The top rate is 6.84% and it is imposed at a modest income level ($54,000 for a married joint filer and $27,000 for a single filer).

The final step in calculating the Nebraska individual income tax is determining the tax amount for the given taxable income and subtracting credits from the tax due. Credits against the Nebraska Tax include the personal exemption credit, low-income elderly credit, child care credit, earned income tax credit, beginning farmer credit, and numerous other economic or community development credits.

Tax Policy and the Individual Income Tax

Adequacy - The personal income tax is Nebraska's fastest growing tax base. Over the last 25 years, the individual income tax has grown 1.18 times faster than the rate of personal income growth after base and rate adjustments. This means that for each one percent of growth in personal income, individual income tax receipts increase by 1.18 percent. The tax does tend to be more unstable, however, since net receipts fall faster than other taxes when the economy turns sour. This is especially true with our income tax base that treats most long term capital gains like ordinary, wage income. As a review of the "Components of Individual Income Tax" analysis shows, capital gains drove much of the rapid growth of the 1990s in income tax receipts, but the sharp reductions in capital gains in the first part of this decade disproportionately contributed to the downturn in tax receipts growth in the first part of this decade.

Equity - Income tax tends to treat similar taxpayers similarly, at least from the standpoint of ability to pay. While there are exclusions from income, like most social security, income from Nebraska municipal bonds, and certain capital gains income, these exclusions are similar to federal exclusions and are less prevalent in Nebraska than in other states.

Also, the income tax is one of the few taxes that is truly progressive. Some argue that taxes should not be progressive, however, most experts believe that a progressive income tax helps compensate for other regressive state and local taxes. Nebraska's income tax is more progressive than that of most other states. Many states have flat income taxes or fewer rates. Also, our treatment of personal exemptions as credits adds to this progressivity. More detail on this may be found in "Program History and Description" and "Income Tax Receipts and Liability".

There is little connection between income tax liability and the benefits received by the taxpayer from the government levying the tax, the state in this case.

Simplicity - Because calculating the tax uses much of the same information as is presently collected by the Internal Revenue Service, the income tax, both individual and corporate, is relatively easy to administer. Although high income taxpayers face phase-outs and other complications, there are relatively few taxpayers affected. From the standpoint of the state, auditing can be done in large part using federal tapes, simplifying the task. Recently, Nebraska has decoupled from federal income tax changes enacted by Congress to provide economic stimulus. These federal changes included greater immediate write-offs of capital expenditures and a change in the federal standard deduction to eliminate the so-called marriage penalty. Nebraska's actions to counter the negative revenue impacts of these federal changes temporarily increased complexity of our income tax. In 2006 and 2007, legislation was enacted to remove these two differences between the state and federal law, again simplifying the tax.

Accountability - Income tax is a state tax whose proceeds are spent away from the local level. This lessens the accountability of the tax to taxpayer. Also, the fact that most taxpayers pay income tax through periodic withholding and in conjunction with federal income tax tends to insulate the state from taxpayer pressure regarding the amount and use of the tax. Although Nebraska has never authorized local income taxes, a few states do. Resident individual income can easily be located at the residence of the taxpayer and taxed by local entities. Local income taxes may be more accountable with regard to local taxpayers. 

Economic competitiveness - There is much uncertainty as to the impact state and local taxes have on business relocation. However, research which asks top executives what influences relocation decisions tends to indicate that individual income tax rates in the high income brackets is a factor, especially for businesses which propose employing high income people. Examples would be research driven or headquarters operations. Nebraska's progressivity may further contribute to this negative aspect of the tax.

Key Points from the Analysis

1. Individual income tax receipts have grown far faster than the state's economy. As the analysis page entitled "Individual Income Tax Receipts and Liability" shows, tax receipts were about $600 million higher in FY2006-07 than they would have been had they grown at the same rate as personal income since 1980. This is in spite of the fact that fiscal years 2001-02 and 2002-03 saw a $100 million decline in receipts from the FY2000-01 level. Unlike the sales tax growth, most of this is explained by the natural growth of the tax base. While there were tax rate increases in the early 1980s and school finance legislation enacted increases in 1990 and 1991, changes since that time have usually been decreases. Taxable incomes grow faster than the economy of the state.

While capital gains growth explains much of the rapid growth in receipts in the 1990s, wage income itself also grew as fast as the state's economy since 1991. (See "Components of Individual Income Tax".) While capital gains growth and decline explain much of the recent volatility in tax receipts, wages and salaries are still account for nearly 90% of taxable income.

2. Nebraska's individual income tax is progressive. The highest income 10% of all returns filed carried more than half of the Nebraska tax liability for the entire state. This is more progressive than the income taxes of most states. One measure of progressivity uses information from the Tax Rates and Tax Burdens report of the Department of Finance of the District of Columbia for 2005 and shows Omaha, Nebraska to have the 29th highest effective rate of income tax for a family of three with an adjusted gross income of $50,000, but the 23rd highest for a family with $150,000 of adjusted gross income.

This ranking information may be found by going to "Rankings".