Federal lawmakers over the last few weeks have proposed a slew of tax policies that would require the nation's wealthiest residents to pay more. Pundits and policymakers are debating the merits of a higher marginal tax rate, a wealth tax and expanding the estate tax, with a keen focus on how more progressive tax policies can both raise needed revenue and also address economic inequality.
The historic role tax and other policies have played in exacerbating the wealth divide and discussions about how to remedy this injustice is a national conversation that is long overdue. Examining the federal policy landscape is a logical place to start, but state policymakers are missing a key opportunity if they don't join this national conversation and take a hard look at how their tax codes are affecting individuals and families across the income spectrum.
Late last year, my colleagues and I at the Institute on Taxation and Economic Policy published a distributional analysis of every state's tax system. The analysis considers all major state and local taxes, including personal and corporate income taxes, property taxes, sales and other excise taxes, and estate and inheritance taxes. Most state tax systems capture a greater share of income from their lowest-income residents than from higher-income taxpayers. The national average state and local tax rate for the poorest 20 percent is 11.4 percent, which is 50 percent higher than the 7.4 percent average rate paid by the top 1 percent. Tax structures in 45 states exacerbate the income gap between low- and high-income households.
To better explain how state tax systems make income inequality worse, we compared tax systems in New Jersey and Texas which, before taxes, have similar levels of income inequality. Average income for the top 1 percent in both states is more than 120 times that of the poorest 20 percent (the multiple is 126 in New Jersey and 124 in Texas.) After taxes, the wealth gap in Texas swells to a multiple of 140, but in New Jersey, it slightly closes to 124.
This vast, post-tax difference is due to each state's tax structure: New Jersey has a progressive income tax with substantial refundable tax credits while Texas does not levy an income tax.
Most state tax systems are like Texas and largely regressive because they rely more heavily on sales and excise taxes to raise revenue and less or not at all on progressive, graduated income taxes. To put the lack of personal income tax and reliance on sales and excise tax into perspective, consider this: A family of four in the bottom 20 percent of households in Texas with income of $20,000 a year likely spends every cent they earn trying to make ends meet, whereas a family of four in the top 1 percent earning $1.5 million likely has money to save and invest. Without a personal income tax, a significant percent of the wealthy family's annual income is shielded from state and local taxes. This explains why the average tax rate paid by Texas taxpayers in the bottom 20 percent is 13 percent, four times higher than the 3.1 percent average rate paid by taxpayers in the top 1 percent.
New Jersey is among only five states and the District of Columbia that do not tax their lowest-income residents at a higher rate than the rich. The poorest 20 percent in New Jersey pay an average rate of 8.7 percent and richest 1 percent pay an average rate of 9.8 percent. But the state fails the test of true progressivity because it taxes some middle-income taxpayers at higher rates than the top 1 percent.
Policy decisions that have moved New Jersey and other less regressive state tax systems (California, Delaware, Minnesota, Vermont, District of Columbia) closer to progressivity include implementing graduated personal income tax structures, meaning the states have multiple tax brackets and the rate progressively increases as income increases. Also, low-income New Jerseyans benefit from a significant refundable Earned Income Tax Credit (EITC.)
This comparison of Texas and New Jersey provides an example of how policymakers' decisions affect the economic wellbeing of their constituents. New Jersey, for example, expressly created tax provisions to ensure their lowest-income residents pay less in taxes. From a policymaking perspective, this makes sense. Relying on higher tax rates on poor people is not the most effective way to raise revenue, and it leaves them with fewer resources for their daily needs.
States should not only follow the lead of some national policymakers and begin having serious discussions about how tax policies can better serve all of their citizens, they also should weigh real reforms that will right their upside-down tax systems and ask more of those who have reaped the greatest benefits from the robust economy that our collective tax dollars make possible.
Ms. Wiehe is the deputy director of the Institute on Taxation and Economic Policy.
The views expressed in this article are the author's own.
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