Candice Horbacz
On Election Day, Coloradans are poised to make a monumental decision regarding the future of the state’s income tax structure, with two distinct and competing measures appearing on the ballot. This electoral showdown presents a clear divergence in fiscal philosophy: one proposal, an initiated statute, seeks to enshrine the current 4.4 percent flat income tax rate as a permanent cap for both individual and corporate income taxes, while the other, a constitutional amendment paired with an initiated statute, aims to introduce a graduated-rate system with a top individual and corporate rate reaching 8.4 percent. The outcome of this vote will not only reshape Colorado’s revenue streams but also redefine its economic landscape for years to come, influencing everything from small business vitality to the state’s competitiveness in attracting and retaining residents and enterprises.
A Deep Dive into the Competing Proposals
At the heart of this electoral contest are two ballot initiatives, each with profound implications. The first is Amendment 87, a constitutional amendment that would fundamentally alter Colorado’s tax code by authorizing a graduated-rate individual and corporate income tax. Currently, the state’s constitution mandates a single, flat tax rate on all taxable net income. Amendment 87 proposes to remove this prohibition, thereby allowing for varied tax rates based on income levels. Accompanying this constitutional change is an initiated statute designed to set the initial graduated rates. Under this proposed structure, higher earners would face significantly increased rates: 7.4 percent for income above $500,000, 7.9 percent for income exceeding $750,000, and a top rate of 8.4 percent for income above $1 million. A crucial aspect of Amendment 87 is that while the authorization for a graduated tax would be constitutionally embedded, the specific rates and income brackets would be statutory, granting the legislature the power to adjust them at any time without further voter approval. Proponents of Amendment 87 often highlight the potential for increased revenue to fund critical public services such as education, healthcare, and childcare, arguing that those with higher incomes should contribute a larger share to the state’s collective well-being.
In stark contrast, Proposition 136 offers a different vision for Colorado’s tax future. This initiated statute aims to statutorily cap both individual and corporate income tax rates at their current level of 4.4 percent. Essentially, it seeks to lock in the flat tax rate that has been a defining characteristic of Colorado’s fiscal policy for decades. As a statutory change, Proposition 136 would require only a simple majority to pass, similar to Amendment 87’s accompanying statute. However, its binding nature is less robust than a constitutional amendment; future voters could repeal it, or the legislature could theoretically amend it, though doing so would represent a significant political challenge given a prior vote of the people. The primary function of Proposition 136 is to serve as a bulwark against efforts to raise income taxes, positioning itself as a measure that promotes tax stability and predictability for businesses and residents. Supporters of Proposition 136 emphasize the importance of maintaining a competitive tax environment to foster economic growth, attract investment, and prevent the out-migration of high-income earners and businesses.
Colorado’s Unique Tax History: A Timeline of Evolution
Colorado’s journey with income taxation offers a crucial historical context to the current debate. The state was not always a flat-tax bastion. In fact, Colorado operated with a graduated-rate income tax system for many years until a significant shift in 1987. At that time, Colorado became the first state in the nation to transition from a graduated income tax structure to a single-rate, flat income tax. Before this transition, the state’s top income tax rate stood at 8 percent for income exceeding $10,000, a rate that had been in place for 24 years. The move to a flat tax saw the top rate reduced to 5 percent, which, interestingly, had previously been the marginal rate for income between $4,000 and $5,000 (equivalent to approximately $12,200 to $15,250 in today’s purchasing power).
Since 1987, Colorado’s flat tax rate has seen further reductions. The initial 5 percent rate has been incrementally lowered over the decades, eventually reaching the current 4.4 percent. This gradual reduction underscores a key characteristic often attributed to flat tax systems: a single rate applied to all income levels is generally harder to raise due to its broad impact and, conversely, often proves more politically attractive to cut. This historical trend highlights a long-standing preference for a simpler, lower-rate tax system in Colorado.
The state’s tax landscape is further defined by the Taxpayer’s Bill of Rights (TABOR), a constitutional amendment passed by voters in 1992. TABOR fundamentally restricts the growth of state and local government revenues and spending to the rate of inflation plus population growth. Any revenue collected above this limit must be refunded to taxpayers unless voters approve its retention. Crucially, TABOR also requires voter approval for any tax rate increase or new tax. This constitutional constraint means that even if the legislature were inclined to raise income tax rates under a future graduated system, such an increase would still be subject to a statewide vote. Proposition 136, while statutory, aligns with the spirit of TABOR by seeking to cap rates, further reinforcing the principle of voter control over taxation. Amendment 87, by requiring a constitutional amendment to permit graduated rates, also acknowledges TABOR’s foundational role in Colorado’s fiscal governance. The unique construction of Amendment 87, which primarily eliminates existing constitutional language rather than adding new, is a strategic move to potentially circumvent the usual 55 percent voter approval threshold for constitutional amendments, aiming instead for a simple majority. This legal nuance adds another layer of complexity to the election.
Economic Implications of a Graduated Tax: A Closer Look at Amendment 87
The economic analysis of Amendment 87, particularly its impact on businesses and high-income earners, forms a central pillar of the debate. Critics of the proposed graduated tax system, including many business groups and fiscal conservative organizations, warn of significant negative consequences.
One of the most frequently cited concerns revolves around Colorado’s small businesses. The state boasts approximately 731,000 small businesses, which collectively employ nearly 49 percent of all Colorado workers. A vast majority of these businesses, such as S corporations, partnerships, and LLCs, are structured as "pass-through" entities. This means their business income is not taxed at the corporate level but rather "passes through" to the owners and is reported on their individual income tax returns. According to IRS data, among Colorado’s 53,640 filers with adjusted gross incomes above $500,000 – the threshold for higher marginal rates under Amendment 87 – a substantial 30,850 receive partnership or S corporation income, and an additional 14,310 report other business or professional income. In fact, households earning $500,000 or more derive 27 percent more from business income than from wage income. This data suggests that the proposed higher marginal rates would, to a considerable extent, function as a direct tax increase on small business ownership.
The implications for these businesses could be far-reaching. Higher tax rates could reduce small business profitability, potentially placing Colorado’s enterprises at a competitive disadvantage against rivals in states with lower or no income taxes. This disadvantage could manifest in several ways:
- Reduced Investment and Growth: When the effective tax rate on the next dollar of income rises, business owners may be less inclined to invest in expansion, purchase new equipment, or undertake new ventures.
- Business Attrition and Relocation: Over time, some businesses might choose to scale back operations in Colorado or even relocate to more tax-friendly states, leading to job losses and a diminished tax base.
- Lower Wages and Higher Prices: To offset increased tax burdens, businesses might face pressure to reduce employee wages or benefits, or they may pass on the higher costs to consumers through increased prices, thereby impacting the broader economy.
Furthermore, critics argue that the definition of "wealthy" under Amendment 87’s thresholds might be misleading. Many individuals might report income exceeding $500,000 only once or twice in their lifetime, particularly when selling a long-held business or a significant investment property. For these individuals, the higher rates would function more like a "surtax" on retirement savings or the culmination of years of entrepreneurial risk-taking, where gains are realized in a lump sum rather than spread out over time. This could discourage long-term investment and business creation.
The "Marriage Penalty" and Equity Concerns
A significant structural flaw identified in Amendment 87’s proposed rate schedule is the embedding of an "extreme marriage penalty." This occurs because the income bracket widths are designed identically for single filers and married couples filing jointly. In a progressive tax system, a marriage penalty arises when a couple’s combined tax liability increases simply by marrying and filing jointly, compared to what they would pay as two single individuals.
Under Amendment 87’s proposed structure, this penalty could be substantial. For instance, a couple where each spouse earns $25,000 would face a marriage penalty of $125. For higher-income couples, the penalty escalates dramatically: a couple earning $500,000 each would face a marriage penalty of $16,575. This disincentive to marriage from a tax perspective is often seen as inequitable and can disproportionately affect middle and upper-middle-income families.
Lessons from Other States: The Impact of High Top Rates
The debate over graduated income taxes in Colorado is not unique; other states have grappled with similar policy choices, offering valuable case studies. The experiences of California, New Jersey, and New York are frequently cited by those cautioning against higher top rates:
- California: In 2012, California voters approved increases to its top income tax rates. Subsequent analysis has suggested that a combination of out-migration, reduced in-state investment, slower economic growth, and tax avoidance strategies eroded an estimated 61 percent of the anticipated revenue gains. Beyond the fiscal impact, the state’s economy experienced broader harm.
- New Jersey: Following the adoption of a new top rate of 8.97 percent for income above $500,000 in 2004, New Jersey’s Department of the Treasury assessed that the change contributed to an increase in out-migration by 20,000 residents over the subsequent five years.
- New York: The Citizens Budget Commission in New York found that the state’s share of the nation’s millionaires declined significantly, from 12.7 percent in 2010 to 8.7 percent in 2022. They estimated that had New York maintained its share of millionaires, the state would have collected an additional $10.7 billion in individual income tax revenue in 2022.
These examples are used by opponents of Amendment 87 to argue that significantly raising top income tax rates can be counterproductive, leading to economic stagnation and a flight of capital and talent, ultimately undermining the very revenue goals they aim to achieve.
Corporate Income Tax Changes: A Less Intuitive Graduated Structure
Beyond individual income taxes, Amendment 87 also proposes to establish a graduated corporate income tax. This aspect of the proposal draws particular scrutiny because, unlike individual income taxes, a progressive rate schedule often makes little economic sense for corporate income taxes. The size of a business, which might correlate with its profits, is largely irrelevant to the income level of its shareholders. A low-income household, for example, might hold shares of some of the world’s largest corporations through a 401(k), while wealthy households might own a stake in a small, privately held corporation.
Colorado, like many states, employs a single sales factor apportionment method for corporate income tax. This means that a corporation’s profits are taxed by Colorado based on its share of sales within Colorado. As economists have noted, this functionally transforms the corporate income tax into a tax on sales into the state, which often manifests as higher prices for consumers. Therefore, the tax is not costless for the state nor is it solely borne by distant investors; its burden can ultimately fall on Colorado residents through increased costs of goods and services.
The Conundrum of Competing Measures: What Happens If Both Pass?
Perhaps the most intriguing and potentially litigious aspect of this election is the scenario where both Amendment 87 and Proposition 136 pass. Colorado law dictates that if two conflicting measures both pass, the one receiving the higher number of votes prevails on any conflicting provisions.
This creates a complex legal and practical quandary. A straightforward reading suggests that if Proposition 136 receives more votes, it would cap all individual and corporate income tax rates at 4.4 percent. However, Amendment 87’s accompanying statute is written to impose higher rates on income above $500,000. If the 4.4 percent cap were applied literally to this structure, it could theoretically leave income above $500,000 entirely untaxed, as the higher rates would be struck down and no alternative rate specified for those brackets. Such an outcome is clearly unintended and would create significant textual tensions within the tax code.
The state’s official ballot information book, commonly known as the "Blue Book," explicitly acknowledges this ambiguity, stating that the outcome of any conflict between the two measures is unclear and would ultimately have to be resolved by the courts. Legal experts anticipate that, in such a scenario, courts would likely interpret the measures to allow all higher income to be taxed at the 4.4 percent cap, rather than leaving it untaxed. Nonetheless, the prospect of post-election litigation adds an element of uncertainty to an already critical vote.
National Trends and Colorado’s Defining Choice
Colorado’s decision on these ballot measures comes at a time when states across the nation are increasingly diverging in their approaches to income taxation. Many states have pursued aggressive income tax rate cuts in recent years, aiming to boost economic competitiveness and attract residents and businesses. States like Arizona, Idaho, Iowa, Mississippi, and North Carolina have all enacted significant tax reforms, often moving towards flatter, lower-rate systems or even eliminating income taxes entirely.
Conversely, a smaller number of states have opted to double down on much higher, more progressive rates, often driven by a desire to increase funding for public services and address income inequality. California, New York, and Hawaii are prominent examples in this category.
At its current 4.4 percent flat rate, Colorado remains competitive with many of its regional peers. The vote on Amendment 87 and Proposition 136 will determine which side of this national divide Colorado chooses to join. The outcome will signal whether the state prioritizes a stable, lower-rate tax environment aimed at fostering broad-based economic growth, or whether it embraces a more progressive system designed to redistribute wealth and generate additional revenue from its highest earners. The implications extend beyond state coffers, touching on the fundamental economic philosophy that will guide Colorado’s future. The choice before Coloradans is not merely about numbers on a tax form; it is about the very identity and economic direction of the Centennial State.
