Fairness Matters: A Chart Book on Who Pays State and Local Taxes

Virtually every state tax system is fundamentally unfair, taking a much greater share of income from low- and middle-income families than from high-income families. On average, the poorest 20 percent of taxpayers spend 10.9 percent of their income on state and local taxes, which is double the 5.4 percent average effective rate for the top 1 percent.

While the reasons for this disparity vary by state, an overreliance on regressive consumption taxes and the lack of a sufficiently robust personal income taxare two of the most common features of state and local tax codes.

Note: These figures are a national average of total state and local tax payments over total income, grouped according to the nationwide distribution of income. They include the impact of the federal deduction for state and local taxes paid.

The nation’s income is concentrated at the top. For example, the top 1 percent alone have a combined income that exceeds the bottom half of individuals and families.

Despite this imbalance, state and local tax systems typically ask less of high-income families than of families of more modest means. The top 5 percent of earners pay a smaller share of state and local taxes than their share of income. The remaining 95 percent of families, by contrast, pay a larger share of state and local taxes than the share of income they earn.

Note: These figures are based on a national average of total state and local tax payments over total income, grouped according to the nationwide distribution of income. They do not include the impact of the federal deduction for state and local taxes paid.

A comparison of tax systems in South Dakota and Oregon illustrates how the presence, or absence, of different types of taxes affects the fairness of state and local tax codes.

South Dakota lawmakers’ decision not to levy a personal income tax is a major factor in the state having the fourth most regressive tax system in the nation, as determined by ITEP. The bottom 20 percent of South Dakotans face an effective tax rate (11.3 percent) more than six times as high as the rate paid by the top 1 percent of earners (1.8 percent).

In Oregon, by contrast, heavier reliance on personal income taxes and the lack of a sales tax contributes to the state having one of the least regressive tax codes in the nation.

While middle-income families in both states devote a similar share of their incomes to state and local taxes, South Dakota’s tax system asks far more of the poor while allowing high-income taxpayers to pay very low effective tax rates.

Notably, Oregon’s less regressive tax code also raises significantly more revenue per person than South Dakota’s, in part because taxes levied on families with large incomes tend to generate more revenue than taxes levied on families without much income to tax.

It is a common misconception that states without personal income taxes are “low tax.” In reality, to compensate for lack of income tax revenues these state governments often rely more heavily on sales and excise taxes that disproportionately impact lower-income families. As a result, while the nine states without broad-based personal income taxes are universally “low tax” for households earning large incomes, these states tend to be higher tax for the poor.

Note: The nine states without broad-based personal income taxes are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Five of the nine states without broad-based personal income taxes require their low- and moderate-income taxpayers (those in the bottom 40 percent of the income distribution) to pay more than 10 percent of their income in state and local taxes each year. Among states that levy personal income taxes, the average effective tax rate for this group is 9.7 percent.

Of the four non-income-tax states with lower tax rates on low- and moderate-income families, three (Alaska, Nevada, and Wyoming) have sizeable mining and tourism sectors that allow them to collect significant tax revenues from non-residents. Additionally, two of these four states (Alaska and New Hampshire) lack a statewide general sales tax. States that compensate for the lack of a personal income tax by levying higher taxes on consumption tend to be “high tax” states for low- and moderate-income families.

Without exception, the lowest state and local tax rates in the nation are confined to nine states that do not levy personal income taxes.

Among the 41 states that levy personal income taxes, the overall state and local tax rate (including income, sales, excise, and property taxes) applied to the top 1 percent of earners averages 5.6 percent. In states without personal income taxes, this rate is 3 percent or less.

Wyoming, which lacks both a personal and corporate income tax, is the lowest-tax state in the nation for high-income taxpayers.

States in this group with somewhat higher taxes on high-income earners often levy limited taxes on investment income (New Hampshire and Tennessee), significantly higher-than-average property taxes (New Hampshire and Texas), or notable corporate income taxes (Alaska, New Hampshire, and Tennessee).

Progressive personal income taxes provide an important counterbalance to other state and local taxes that often fall more heavily on low- and moderate-income families. The 10 states relying most on personal income taxes to fund government come closest to parity in tax rates across the income scale. States with little or no personal income tax, by contrast, charge the poorest 20 percent of taxpayers an average effective tax rate more than twice as high as the rate they charge their top 20 percent of taxpayers.

Note: Reliance on personal income taxes is measured relative to state and local own-source revenue in Fiscal Year 2013, as reported by the U.S. Census Bureau. The ten most reliant states are Maryland, Massachusetts, Connecticut, Oregon, New York, California, Kentucky, Minnesota, the District of Columbia, and Virginia. The ten least reliant states are Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming, Tennessee, New Hampshire, and North Dakota.

States taxing personal income take one of two general approaches: a flat rate applied to all taxable income or a graduated system in which tax rates rise on larger incomes.

Graduated-rate income taxes tend to be more progressive than flat-rate taxes. Because they allow states to collect more revenues from high-income taxpayers, graduated-rate taxes also typically allow for lower tax bills for low- and middle-income families. The middle 20 percent of individuals and families in states with flat-rate taxes, for example, tend to pay 3.0 percent of what they earn in income taxes. In states with graduated-rate taxes, by contrast, that figure is just 2.4 percent.

Note: These figures do not include the impact of the federal deduction for state income taxes paid. Of the 41 states with broad-based state personal income taxes, eight levy flat-rate taxes and thirty-three (plus the District of Columbia) levy taxes with a graduated rate structure. The states with flat-rate taxes are Colorado, Illinois, Indiana, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah.

Flat-rate income taxes apply one consistent rate to most taxpayers. But when other, often regressive, taxes are taken into account states with flat taxes tend to have significantly more lopsided tax codes than states with graduated-rate taxes. Low- and middle-income families generally pay more in flat tax states while high-income taxpayers pay substantially less in those states on average.

Note: Of the 41 states with broad-based state personal income taxes, eight levy flat-rate taxes and thirty-three (plus the District of Columbia) levy taxes with a graduated rate structure. The states with flat-rate taxes are Colorado, Illinois, Indiana, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah.

For individuals and families in the bottom 40 percent of the income distribution, lawmakers’ decisions to fund government primarily through sales and excise taxes, or through some other means, are particularly consequential. Among the 10 states most reliant on sales and excise tax revenues, the bottom 40 percent of earners face an overall effective state and local tax rate of 11.1 percent. This is 1.4 percentage points higher than the average rate faced by this group across all states and 2.8 percentage points higher than in the states least reliant on sales and excise taxes.

Note: Reliance on general sales taxes is measured relative to state and local own-source revenue in Fiscal Year 2013, as reported by the U.S. Census Bureau. . The ten most reliant states are Washington, Hawaii, Arizona, South Dakota, Tennessee, Nevada, Arkansas, Louisiana, New Mexico, and Texas. The ten least reliant states are New Hampshire, Delaware, Oregon, Montana, Alaska, Vermont, Virginia, Maryland, Massachusetts, and Illinois.

Nine of the 10 states most reliant on general sales tax revenue to fund government require the bottom 40 percent of earners to devote 10 percent, or more, of their income to paying state and local taxes each year. Among the other 40 states, state and local taxes average 9.3 percent of income for this group. Choosing to fund government largely through sales taxes affects low- and moderate-income families most since they tend to spend a larger share of their earnings on items subject to sales tax.

Note: Reliance on general sales taxes is measured relative to state and local own-source revenue in Fiscal Year 2013, as reported by the U.S. Census Bureau. Note that Louisiana increased its sales tax after the publication of ITEP’s Who Pays? report and that the state’s effective tax rate on the bottom 40 percent of earners would be higher if this increase were included in the data.

While there is no single determinant of whether a state is “low tax” or “high tax” for the bottom 40 percent of earners, the level of reliance on sales and excise taxes has a major impact.

In states where sales and excise taxes account for 30 percent or more of state and local revenue, effective tax rates on lower-income people almost always exceed 10 percent.

In states deriving 15 percent or less of their revenue from these sources, effective tax rates on this group are 8 percent or less.

Note: Reliance on state and local sales and excise taxes is measured relative to state and local own-source revenue in Fiscal Year 2013, as reported by the U.S. Census Bureau.

Personal income tax returns reveal how much individuals and families pay in income taxes. But most taxpayers cannot measure how much sales and excise tax they pay on the purchases made in a given year. As it turns out, middle- and low-income taxpayers typically pay more taxes to their state and local governments based on what they buy (sales and excise taxes) than on what they earn (income taxes).

Proponents of state income tax cuts often overlook this fact, and sometimes even propose policies that would intensify it by swapping lower income taxes for higher sales and excise taxes. Proposals to decrease income taxes that largely impact the wealthy while increasing the less visible sales and excise taxes that impact families of more modest means would exacerbate the upside-down nature of state tax codes.

Note: These figures are a national average of total state and local tax payments over total income, grouped according to the nationwide distribution of income. They do not include the impact of the federal deduction for state and local taxes paid—a deduction which primarily reduces the final impact of state income taxes on upper-income taxpayers.

The outsized impact that sales and excise taxes have relative to income taxes for most taxpayers is remarkably consistent across states.

The bottom 40 percent of individuals and families in every state except Oregon, which lacks a general sales tax, pay more in sales and/or excise taxes than in income taxes. Even Delaware and Montana, which levy personal income taxes but not general sales taxes, ultimately collect more in excise taxes than in income taxes from their low- and moderate-income residents.

In most states, the bottom 80 percent of earners pay higher taxes on what they buy (sales and excise taxes) than on what they earn (income taxes).

Note: “Income taxes” refers to personal and corporate income taxes levied by each state and the localities within that state. The District of Columbia (DC) is excluded from this analysis. In DC, income tax payments exceed consumption tax payments for the bottom two income groups.

The ITEP Tax Inequality Index measures the effects of each state’s tax system on income inequality. Essentially, it examines whether the gap in families’ shares of income is wider or narrower after state and local taxes are applied. States with regressive tax structures have negative inequality index scores, meaning that incomes are less equal in those states after state and local taxes than before. The farther the score falls below zero, the more regressive the tax code.

Of the 15 most regressive state and local tax systems in the nation, 10 exist in states levying either a flat income tax or no personal income tax at all. By contrast, the 15 least regressive states all utilize a graduated-rate personal income tax.

Note: An explanation of how the ITEP Tax Inequality Index is calculated is available in Addendum 2 of ITEP’s Who Pays? report.

While every state’s tax system is regressive, states in the South and Midwest tend to have more lopsided systems than average, asking far more of lower-and middle-income families relative to what is asked of the wealthy. But the relationship between tax fairness and geography is not ironclad. Every major region of the country has states that rank among the most regressive, and least regressive, in the nation.

Note: An explanation of how the ITEP Tax Inequality Index is calculated is available in Addendum 2 of ITEP’s Who Pays? report.

Many features of state and local tax systems contribute to the fairness, or lack thereof, in those systems. One of the most important of such features is how heavily sales and excise taxes are relied upon in funding government. Those states where a significant share of revenue is derived from these taxes on consumption tend to receive lower scores in ITEP’s Tax Inequality Index, meaning that they fall disproportionately on low- and middle-income families rather than on families with large incomes.

Note: Reliance on state and local sales and excise taxes is measured relative to state and local own-source revenue in Fiscal Year 2013, as reported by the U.S. Census Bureau. An explanation of how the ITEP Tax Inequality Index is calculated is available in Addendum 2 of ITEP’s Who Pays? report.

The gap in tax rates faced by low- and high-income residents varies considerably by state. At one end of the spectrum, states such as Wyoming and Washington tax their low-income residents at rates almost seven-fold higher than the rates charged to their high-income residents. At the other end of the spectrum, California, Delaware, Minnesota, Oregon, Vermont, and the District of Columbia each come close to taxing their highest and lowest-income residents at the same rate.

Without exception, the largest disparities exist in states that fail to levy personal income taxes but that do levy general sales taxes. States with smallest gaps, by contrast, levy graduated-rate personal income taxes.

While state and local tax laws are not the primary cause of income inequality, they do play a role in exacerbating existing gaps in income.

Because low- and middle-income individuals and families face above-average state and local tax rates, their share of total income falls after state and local taxes are collected. Low-income families, for example, see their share of income fall by 2.5 percent (from 3.0 to 2.9 percent). High-income families, by contrast, experience a 1.8 percent gain in their share of income after these taxes are collected (from 20.5 to 20.8 percent of personal income).

In other words, incomes are less equal after state and local taxes are applied than before.

Note: These figures are based on a national average of total state and local tax payments over total income, grouped according to the nationwide distribution of income. They do not include the impact of the federal deduction for state and local taxes paid. Note that figures are expressed as percentages rather than percentage point change