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State Tax Systems Aren’t Helping to Close Income Inequality Gap, Study Finds

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Apr 6th 2015
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Busy season is drawing to a close, but taxes are forever. And so, some might say, is the disparity in how high- and low-income earners are taxed.

A new report by the Institute on Taxation and Economic Policy (ITEP) indicates that state tax systems are indirectly contributing to increasing income inequality. How? Low- and middle-income earners are taxed at much higher rates than the wealthy, according to ITEP, a bipartisan think tank based in Washington, DC.

“In recent years, multiple studies have revealed the growing chasm between the wealthy and everyone else,” Matt Gardner, ITEP executive director, said in a written statement. “Upside-down state tax systems didn’t cause the growing income divide, but they certainly exacerbate the problem. State policymakers shouldn’t wring their hands or ignore the problem. They should thoroughly explore and enact tax reform policies that will make their tax systems fairer.”

The report indicates that, on average, the lowest-paid 20 percent of taxpayers pay more than double (10.9 percent) the effective tax rate than the highest-paid 1 percent do (5.4 percent).

ITEP considered all major state and local taxes, including personal and corporate income taxes, property taxes, and sales and other excise taxes.

ITEP describes state and local tax systems as unfair, or regressive, because the lower a taxpayer’s income, the higher the tax rate. That’s because states rely more on sales taxes to raise revenues and less on personal income taxes. On the other hand, personal income taxes are more progressive because the higher a taxpayer’s income, the higher the effective personal income tax rate is.

It’s no secret that there’s been much talk about tax reform that would cut taxes for the wealthy and for businesses. But that would worsen regressive taxation because that method often relies on tax increases that fall more on low- and middle-income households to pay for tax cutbacks on top earners, according to ITEP. And tax cuts can affect funding for basic programs, such as education.

“Americans generally have a visceral reaction to taxes, but the truth is we need them to make state governments work for all citizens,” Meg Wiehe, ITEP state policy director, said in a written statement. “The problem with our state tax systems is that we are asking far more of those who can afford the least.”

Key takeaways from the report include:

  • The most regressive state tax systems rely heavily on sales and excise taxes.
  • State personal income taxes generally are more progressive than other tax levies.
  • Personal income taxes vary in fairness according to states’ differences in deductions, rates, and exemptions.
  • State consumption taxes are highly unfair.
  • States regarded as low-tax often are high-tax for low- to middle-income earners.

The 5 Worst and Best States in Tax Disparity
The following is a snapshot of the five worst and best states in tax, including the District of Columbia, according to ITEP. The full list and more rate information can be found here.

5 States with Greatest Disparity

  1. Washington: 16.8 percent (lowest 20 percent of earners), 2.4 percent (top 1 percent)
  2. Florida: 12.9 percent, 1.9 percent
  3. Texas: 12.5 percent, 2.9 percent
  4. South Dakota: 11.3 percent, 1.8 percent
  5. Illinois: 13.2 percent, 4.6 percent

5 States with Lowest Disparity

  1. Delaware: 5.5 percent (lowest 20 percent of earners), 4.8 percent (top 1 percent)
  2. District of Columbia: 5.6 percent, 6.4 percent
  3. California: 10.5 percent, 8.7 percent
  4. Oregon: 8.1 percent, 6.5 percent
  5. Montana: 6.1 percent, 4.7 percent
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