23 10 2018

Study: Residents With Lower Incomes Pay a Higher Effective Tax Rate

In low- or no-income tax states, residents still have to pay fees and other taxes – leaving poor people burdened with a higher effective tax rate.

States and localities are filling their coffers by disproportionately burdening lower-income residents, who are taxed at a higher effective rate than top earners, according to a study released Wednesday by a tax policy group.

The 50-state analysis by the nonpartisan Institute on Taxation and Economic Policy found that the lower one's income, the higher the effective overall state and local tax rate. The study includes sales taxes, excise taxes, user fees and income taxes. In fact, states which boast low income taxes are often the most likely to have systems that end up shifting the fiscal burden to lower-income residents, Carl Davis, one of the authors of the study, told reporters in a conference call.

Then reason? States with low (or no) income tax meet their budgets by taxing consumer goods, property, and certain services and items, Davis said. Since those items and services are taxed at a flat rate – everyone pays the same rate, regardless of income – they add up to a bigger chunk of poorer earners' incomes than richer ones, he said. Further, people who choose to live in states with little or no income tax might find they end up paying more than if they lived in a state with higher income taxes.

"It's a common (belief) that states without income states are universally lower-tax states," Davis said. But "the reality is that low-income people living in Texas (which has no personal income tax) pay much higher taxes than they would if they lived in a so-called higher tax state like California or New York."

Nationally, the people in the bottom 20 percent of earners face a state and local tax rate that is 50 percent higher than the top 1 percent of households, the study said. That does not mean lower-income people pay more in absolute dollars, only that their effective tax rates are higher. The national average effective state and local tax rate is 11.4 percent for the bottom quintile of taxpayers, compared to 7.4 percent for the top 1 percent of income earners, the study said.

According to the study, Washington state is the least equitable in the nation, with the biggest disparity between effective rates for low-income people and rates for wealthier people. Rounding out the top 10 are Texas, Florida, South Dakota, Nevada, Tennessee, Pennsylvania, Illinois, Oklahoma and Wyoming.

States the authors deem most equitable – the ones with tax systems in which top earners pay more – are California, Vermont, Delaware, Minnesota, New Jersey, Maine, New York, Montana, Maryland and Oregon.

The differences come from the widely variant ways states raise their money. The federal income tax, for example, is progressive, meaning people earning more end up paying a higher portion of their income in taxes. While deductions can lower the ultimate tax bill, the basic format is intended to ease the burden for people with the least ability to pay.

States, however, do things differently. Some have progressive income taxes, some have flat rates for everyone, regardless of income, and some have no income tax at all.

All states, however, have to get their money from somewhere, and so impose other fees and taxes, including general sales tax, gas and other energy taxes, and levies on everything from homes to cars. Virginia, for example, levies an annual tax on automobiles – though federal law exempts members of Congress (except those representing Virginia) from the law. And that is where lower-income people get hit harder, Davis says.

For example, California has some of the highest state income taxes in the nation, with 10 tax brackets. But since that relieves the state from having to impose myriad other fees, it's the most "equitable," in ITEP's calculations. Nevada has no income tax, but levies taxes on consumer goods, tobacco, alcohol, gas and – notably – gaming.

The study does not take into account the impact of lower personal income and corporate taxes on the overall economy, says Demian Brady, research director for the National Taxpayers Union Foundation. "The whole study is basically biased against consumption taxes," Brady says. "The metric that it leaves out is economic growth" generated by the appeal of lower tax rates, he says.

Further, Brady says, income taxes are a volatile revenue source, since wages and employment rates can go up or down. User fees and consumption taxes are more predictable, helping states plan their budgets, he says. "States are trying to build a structure to grow the economy."

But Michael Leachman of the Center for Budget and Policy Priorities says the lure of lower income and corporate taxes is overrated. California, after all, is the location of super-successful Silicon Valley, he points out. Further, "California voters passed a new (tax) bracket, a higher bracket, on very high-income people around the same time Kansas implemented its big tax cuts, which disproportionately favored the wealthy," Leachman says. "California since that time, after 2012, has far outpaced the national economy, while Kansas has fallen behind."

Congress last year passed a law capping the amount of state and local taxes people can deduct from their earning for federal tax purposes.

"Given how high inequality is, there's good reason for states to require high income people and corporations to pay a reasonable share of their income to support services," Leachman says. "The cap doesn't change that. But it may make it a lot harder to do, politically."