Holes in the Safety Net: Federalism and Poverty Chapter 5: State Tax Takeaways

Abstract

While the aggregate tax system is mildly progressive, state and local tax systems are notably regressive. The lowest 95 percent of all income earners pay on average a higher percent of their income in state and local taxes than their share of aggregate income. By comparison, the top 5 percent of all income earners pay a lower percent of their income in state and local taxes than their aggregate share of household income. As a result, the lowest quartile of income earners pays a higher effective tax rate than the highest 1 percent of all income earners. The ratio of effective state and local tax rates for lowest income to highest income taxpayers is as high as 7 times in Wyoming, Washington and Florida. None of these states has an income tax so they rely heavily on regressive consumption tax revenues. For state and local governments this is a no-win race to the bottom because as income becomes increasingly concentrated among the wealthy, consumption and state and local tax revenues decrease.

This chapter reviews the basic components of state and local tax systems focusing on their many regressive attributes and make suggestions on how states might improve them. American has fifty state tax laboratories plus the District of Columbia that offer a myriad of dynamic time-tested tax structures. Nearly every state currently taxes lower-income families at a higher effective tax rate than higher income families. On average, the lowest income families are paying state and local taxes at an effective rate that is twice as high as the rate that the top 1 percent of income households enjoy. “Identifying state tax trends serves a dual purpose: first, as a leading indicator providing a sense of what we can expect in the coming months and years, and second, as a set of case studies, placing ideas into greater circulation and allowing empirical consideration of what has and has not worked.” As state and local governments continue to confront tax reform in these resource challenging times this chapter serves as a guide for front line progressive tax innovations, justice, and equity for all.

Keywords: poverty, state and local taxes, sales taxes, excise taxes, state earned income taxes, antipoverty, federalism, property taxes, regressive taxes, progressive taxes

JEL Classification: K34, H21, H24, H71