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<i>The Week in Public Finance</i>: Most States' Tax Systems Worsen Income Inequality

A new report ranks the most and least fair tax systems.

Some people pay more than their fair share of taxes -- and it’s not the rich.

According to a new report by the progressive-leaning Institute on Taxation and Economic Policy (ITEP), the lowest-income households pay 50 percent more, on average, of their income in state and local taxes than the wealthiest. That leads to worsening inequality in four out of every five states.

“While state and local taxes can’t eliminate income inequality, well-designed systems can help lessen the problem,” says Meg Wiehe, ITEP’s deputy director. “Meanwhile, it’s clear that steeply regressive systems only make it worse.”

A regressive tax takes a proportionally larger share of income from lower- and middle-income residents than from wealthier taxpayers. When factoring incomes in, ITEP found the national average effective state and local tax rate is 11.4 percent for the poorest 20 percent, 9.9 percent for the middle 20 percent and 7.4 percent for the richest 1 percent.

The state where tax inequality is the greatest is Washington state. It's followed by Texas, Florida, South Dakota, Nevada, Tennessee, Pennsylvania, Illinois, Oklahoma and Wyoming. Most of these states make the list because of their reliance on regressive consumption taxes like the sales tax. Most also don’t tax income. And in those that do (Illinois, Oklahoma and Pennsylvania), the rates tend to be flat or nearly flat.

On the other end of the spectrum, five states and the District of Columbia are deemed “somewhat” more equitable. Those states are California, Vermont, Delaware, Minnesota and New Jersey.

“To varying degrees,” the report says, “these states have used their tax codes to promote opportunity and lessen inequality -- or at the very least, not make it worse.”

ITEP’s analysis, however, has been criticized for not considering how states spend the tax revenue they receive and whether that may help lessen inequality. In 2014, the nonprofit Federal Funds Information for States (FFIS) warned that fairness is just one feature of a good tax system. Others are adequacy, simplicity, transparency and ease of administration. For example, FFIS pointed out that while Washington ranks poorly in tax fairness, it puts more of its revenues toward programs that support low-income families.

“Sometimes the policies that satisfy one feature run contrary to another, making it important that a system be evaluated in its entirety rather than in a piecemeal fashion,” the group said.

But ITEP's Wiehe noted at the report’s release this week that, in general, many of the most regressive states have a smaller-government ideology and therefore fewer social services. For instance, six of the 10 have opted not to make more low-income people eligible for Medicaid, the government-run health insurance program for the poor.

If states want to improve their tax fairness, the report suggests enacting a refundable tax credit for grocery taxes or a state-level earned income tax credit for the federal income taxes that low-income residents pay. 

Overall, Wiehe and co-author Carl Davis said they are encouraged by recent trends of lawmakers from across the political spectrum prioritizing revenue-raising to balance budgets. Even in states that have opted for more regressive methods, many have done so while delivering targeted tax cuts to middle- and low-income working families. It’s a far cry from five years ago when lawmakers in conservative states were using sales tax hikes to pay for income tax cuts.

Kansas illustrates this shift: In 2017, a bipartisan group of lawmakers repealed income tax cuts that largely benefitted the wealthy after the move led to massive, annual budget shortfalls. Thanks to that decision, ITEP says Kansas dropped from one of the most regressive states to the middle-of-the-pack.


In other public finance news this week:


Report: State Laws Put Shoppers at Risk

Consumers pay for major products in installments, for everything from refrigerators to entertainment systems. But a new report this week warns that state laws regulating this understudied area of consumer finance may be putting shoppers at risk of spending more than they realize or have.

Approximately 10 million Americans use installment loans a year, spending more than $10 billion on fees and interest to borrow amounts ranging from $100 to more than $10,000, according to the Pew Charitable Trusts report. While the pricing, affordability and structure of installment loans are far more consumer-friendly than those of other subprime credit products, like payday loans, Pew says state laws could make installment loan terms clearer for consumers.

For example, the “all-in” APR on these loans -- the annual percentage rate a borrower actually pays after all costs are calculated -- is often higher than the APR that appears in the contract. And stores can charge origination or acquisition fees and push for consumers to buy ancillary products, like club memberships, along with the loan. While such line items are listed in the loan contract, it's not made clear that their costs are included in the total amount financed. So, the consumer ends up paying more in interest fees.

Pew recommends states mandate that the sale of ancillary products be separate from the issuance of credit, and that regulators set transparent maximum allowable costs and interest rates that are fair for borrowers and viable for lenders.


Atlantic City's Credit Rating Upgraded

While it’s not out of junk territory yet, Atlantic City's credit rating received a boost this week from S&P Global Ratings. It's now rated at B, from a CCC-plus.

It’s a signal that the beleaguered city’s finances are on the upswing after teetering on the brink of bankruptcy three years ago. Ultimately, New Jersey stepped in with a state bailout.

There were many reasons for the upgrade. S&P noted that the city had reached a 10-year agreement with its casinos on their overdue and ongoing tax payments, had begun fully funding its retiree pension and health-care benefits, and had reigned in its spending with modest budgets.

While the city’s position is still “tenuous,” S&P analyst Timothy Little said in a statement that he expected it to continue to improve.

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Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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