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The Inclusive Economy
Let's Talk Tax Policy
By Ethan Geiling on 11/18/2011 @ 10:00 AM
I’ve been really into state and local tax policy recently. I think it’s a phase we all go through at some point.
It’s a really interesting topic, especially in these tough budget times when state policymakers are making difficult decisions about how to balance budgets. A lot has happened with state Earned Income Tax Credits (EITC) over the past year. These policy changes were captured in our newly released Scorecard Resource Guide on Tax Credits for Working Families.
The biggest change happened in Connecticut, where after more than a decade of near-misses, the state successfully enacted an EITC at 30% of the federal credit. We wrote a great case study that tells the story behind this change. Unfortunately, a couple states went in the opposite direction: Michigan reduced its EITC from 20% to 6% and Wisconsin reduced its EITC for families with two or more children.
But state and local tax policy is about more than just the EITC (although it is a powerful credit that helps millions of families struggling with financial security every year). Almost every state’s overall tax system taxes low-income families far more heavily than wealthy families. A report by the Institute on Taxation and Economic Policy (ITEP) quantifies exactly how regressive states’ tax systems are.
In particular, the report points out the “terrible ten” most regressive states. In these states, the poorest residents pay a substantially higher portion of their income in taxes than the wealthiest residents. For example, in Washington State, the poorest 20% pay 17.3% of their income in taxes, while the wealthiest 1% pay only 2.9% of their income in taxes. In other words, the poorest pay almost six times more of their income in taxes than the wealthiest.
Source: Institute on Taxation and Economic Policy, 2009
So what makes the tax systems in these states so regressive? First, most of these states do not have an income tax (or if they do, it is a flat income tax rather than a tax with graduated rates). Second, these states have high sales and excise taxes, which disproportionately tax the lowest income residents. And finally, these states do not have strong targeted tax credits that benefit low-income families. For example, out of the “terrible ten” states above, only Illinois has a fully-funded EITC, and it’s a mere 5% of the federal credit.
And if we want to get into federal tax policy, we should start by talking about the “upside down” nature of federal expenditures aimed at encouraged savings and investment. A report by CFED and the Annie E. Casey Foundation found that, of the nearly $400 billion spent by the federal government in 2009, most funds went toward tax breaks. However, more than half of these breaks went to the wealthiest five percent of taxpayers, who averaged a net benefit of $95,000 each. On the other hand, less than 5% of the federal expenditures benefitted the Americans earning the least. The bottom 60% of taxpayers averaged just $5 each.
There are two main takeaways from all of this:
- First, talking about taxes is super interesting and something we should do all the time. This blog post barely scratched the surface of these issues. (We didn’t even get into how taxes affect aspiring entrepreneurs.)
- And second, the tax system is a powerful force that touches virtually everyone in the country. We should not underestimate the power of tax policy as a means to create economic opportunity for low- and moderate-income residents.
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