Giving Credit Where Credit Is Due: Reducing Inequality with a Progressive State Tax Credit

Abstract

Widening economic inequality is fast becoming the defining social problem of this era. Although there are a number of policy mechanisms available for addressing the problem, taxation is the first and best tool for the job. The federal income tax code is already moderately progressive and thus partially counteracts growing inequality in before-tax incomes. State taxation, however, is an entirely different matter: every single state has some combination of sales, property, and income taxes that, taken together are regressive: average (“effective”) state tax rates fall as income rises. It is perverse that taxation in each and every state exacerbates instead of ameliorates the nation’s burgeoning income inequality. This article outlines an innovative solution to this 50-state problem: a federal tax credit for total state tax payments (sum of income, sales, and property taxes) that would mitigate most of the regressivity due to state taxation. The key feature of the credit is that it is progressive: lower-income households would receive a federal income tax credit equal to 100% of their state tax payments; the percent of the credit would decrease with income, and eventually, at high enough incomes, would become a surcharge (a “negative credit”). In substance if not in form, this progressive state tax credit would produce income tax rates that vary from state to state. There are strong arguments, however, that this would not violate the Constitution’s Uniformity Clause.

Keywords: Taxation, Federal Taxation, State Taxation, Progressive Taxation, Tax Credit, Inequality, Income Tax, Sales Tax, Uniformity Clause, Regressive Taxation

JEL Classification: D30, D31, D63, H20, H23, H24, H73, H77, I30, K34