Tennessee on its way to becoming a bona fide no-income-tax state in 2021

Hall income tax to be totally phased out in two years

A group of seniors attend a roundtable over taxes in this file photo. The Hall income tax is being phased out with the rate at just 2 percent this year.

Tennessee is on its way to becoming what some experts say is truly a no-income-tax state, one of just eight in the country.

The state Legislature agreed in 2016 to start phasing out the Hall income tax, with its total elimination beginning Jan. 1, 2021.

"The Hall tax repeal is among the most important tax reforms in Tennessee history," says Justin Owen, chief executive officer of the Beacon Center of Tennessee, a Nashville-based conservative-leaning think tank that has long pushed to end the Hall tax.

photo Everlena Holmes and others attend a meeting on taxes in Chattanooga in this file photo. The Hall income tax will be phased out in 2021.

The Hall income tax was enacted in 1929 and was originally called the Hall income tax for the senator who sponsored the legislation. It is imposed on individuals and other entities receiving interest from bonds and notes and dividends from stock. From a 6 percent tax rate on investment income, the levy was to be reduced by 1 percent each year though 2020. Estimates from the Tax Foundation is that about 200,000 Tennessee households pay the Hall tax. For the year that started Jan. 1, the rate is 2 percent.

Once fully phased out in 2021, Tennessee will join seven other states - Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming - that do not tax individual income.

Owen said that with the repeal, Tennessee can finally hold true to its claims of being an income tax-free state. He said the state will no longer punish retirees for saving for their future, drive investors out of our state, and make it harder for entrepreneurs to raise capital.

"The repeal is not only important for those who pay the Hall tax, but it will benefit every Tennessean through a stronger state economy," Owen says.

Over the years, Tennessee officials boasted at times that the state didn't have an income tax, though they were careful to note the Volunteer State had no income tax "on wages and salaries" only.

For the purposes of Tennessee's Hall income tax, dividends from stock are taxable. A person's interest in the mutual fund is the equivalent of stock.

Repeal of the Hall income tax is seen by some as benefiting the state because it will make Tennessee even more attractive in wooing retirees and owners of some corporations.

For example, over half the tax paid to the state from the Hall tax is derived from middle class retirees who have invested in 401K's or mutual funds. The average tax liability in 2014 was about $1,400 per person, according to the CPA group PHB.

Before the rate began being reduced, the Hall tax raised about $300 million annually for state and local governments - with cities and counties taking three-fifths of the income.

Groups such as the Tax Foundation criticized the Hall income tax because of what it said was a failure to bring in enough revenue to be worth the economic and administrative costs of collecting it. In fiscal year 2012, for example, Hall tax collections accounted for just 0.9 percent of state and local tax collections, according to the group.

That said, some small cities in Tennessee have depended on income generated by the Hall levy and have used the tax in the past to keep other taxes lower. With the elimination of the Hall income tax, some cities are raising property taxes to recoup revenue for municipal services.

Lookout Mountain, for example, raised its property taxes in 2017 when the Hall income tax was reduced. The Hall tax raised $572,455, or 20 percent of the town's budget, in 2017.

Owen said that most cities relied on the Hall tax for a small percentage of their budgets.

"They should have reined in their spending rather than increased other taxes to offset the minimal lost revenue," he says. "Failure to do so is just poor fiscal management and a weak excuse for being frugal with taxpayers' hard-earned money."