Making State and Local Taxes Fair Game

This piece is the second in a six-part series on taxation, and a joint project by The American Prospect and its publishing partner, Demos.

“Tax fairness” is defined very differently by Americans from various walks of life. Despite this divide, there is a substantial shared vision: A majority of Americans believe that the government should be doing more to help people, and the vast majority believe that wealthier Americans should be the ones paying higher taxes to support those priorities.

If that is the case, why do we have a state and local tax system that is the polar opposite of those beliefs, one where the better-off pay about half as much in taxes as the less-well-off? This inequity both contradicts our country’s shared beliefs on tax fairness and is the major cause behind the critical lack of state and local investment in social capital that I wrote about in my last piece. We need to correct this inequality immediately if we are going to maintain needed levels of investment in social capital in the face of a rapidly aging society that will require progressively larger expenditures in the next two decades.

So, just how unequal are state and local taxes? In its comprehensive 2009 report, the Institute on Taxation and Economic Policy analyzed the tax systems of all 50 states and major localities and found that, as a whole, state and local tax systems are extremely regressive. As the graphic shows, the poorest 20 percent of Americans pay, on average, a combined state and local tax rate of 11 percent, while the wealthiest 1 percent pay less than half that: 5.3 percent. This disparity is even more pronounced in the most regressive states: in Washington state, which has the most regressive tax system, the poorest 20 percent pay an average tax rate of 17.3 percent while the top 1 percent pay just 2.3 percent.

Why are state and local tax systems so regressive? The primary culprits are sales and excise taxes. Sales taxes are regressive because they’re flat taxes on consumption, i.e. everyone, rich and poor, pays the same rate on their purchases. And because wealthier Americans spend a far lower percentage of their income on consumption, they pay a much lower effective tax rate. Many states exempt certain essential goods—particularly groceries—from sales taxes, but in many of the states with the most regressive tax systems, including South Dakota, Tennessee, and Alabama, groceries are taxed as well, imposing an even higher tax burden on the poor. Even more regressive, however, are excise taxes, which are additional flat consumption taxes on a special set of goods, most commonly gasoline, alcohol, and tobacco products. Because, among other reasons, the amount of these goods that each person can consume has a very natural or biological limit, Americans on the lower end of the income scale spend a much larger portion of their income than those on the higher end, and thus pay a higher effective tax rate as well.

The cost of these radically unfair tax regimes to our states and localities is staggering. In fiscal year 2009, according to the census’s 2009 survey of state and local finances, the total state and local individual tax revenue collected was $1.12 trillion. According to ITEP’s figures, the average total state and local tax rate was 9.2 percent. If states and localities made their tax systems fairer so that everyone just paid the same tax rate as the poor—11 percent—states and localities would have taken in an extra $220 billion in revenue in 2009, more than enough to fill the aggregate state budget shortfalls of $110 billion in that year, and even enough to fill the larger FY 2010 deficits of $191 billion, in total. To give another example of what this revenue could do, consider that states collected just $99 billion in tuition and fees in 2009 from students enrolled in higher education; thus, creating “fairer” tax systems would generate enough revenue to provide free tuition at all public higher-education institutions more than twice over.  I said “fairer” tax systems because the $220 billion in extra revenue would be generated just by making state and local taxes truly flat; many (myself included) might argue for progressive state and local taxation, a policy that most Americans would support as well, if the Pew poll cited above is any guide.

State and local taxes fund many of the most critical investments in our country’s future, including education, infrastructure, and housing; investments that all Americans, rich or poor, rely on. And right now, wealthier Americans, because of the unfairness of state and local tax systems, aren’t paying close to their fair share of the costs of those investments. How can we remedy this? Reforming the most regressive taxes—sales and excise taxes—seems like the logical place to start. The end result of any tax reform, however, needs to be revenue-positive reform that both lowers the tax rates of lower- and middle-income families and raises those of the well-off, resulting in a progressive, not regressive, system overall. Whether we get there through lower sales and excise taxes, increased carve-outs of those taxes for necessities like clothing and medication, or higher and more progressive income taxes can and should be left up to the creativity of our states and localities.

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Comments

It is absolutely untrue that taxes/revenue must increase. Look at the 1992 Medicare home health data of average cost per beneficiary as a function of state. The cost in Iowa was $2,220 and the cost in Mississippi was $22,200, a full order of magnitude. It is common in government statistics for the variance to be a factor of 4 to 6. The U.S. government initially published that the cost of the Medicare home health program at $24 billion, then several months later changed the number to $20 billion while changing the definition. Around 1997 there were about 38 million beneficiaries. Dividing $20 billion by 38 million and then again by 12 yields a capitated cost of about $43 per month. In 1997 in Palm Beach County Florida, the private sector in the form of Humana was paying $2.50 per month per Medicare beneficiary for over 50,000 Medicare patients in Palm Beach County and surrounds. Normalized, that is 6 centsw for every dollar the the governemnt was spending. The problem is actually far wrse than my one example. Low revenures are not the problem.

Ahh, Tom, pulling the ol' conservative bait-and-switch: frantically wave the tired, debunked "inefficient-big-government, benevolent-sleek-private-sector" card while ignoring the article's entire argument. Look, I haz examples too! 401(k) savers paid average fees of 1.8% of assets in 2010, while Social Security's overhead costs were just 0.25% of its assets; in fact, this overstates SS's overhead costs because SS is a PAYGO system while 401(k)s are mini-fully-funded pensions. See, now evil financial sector bad, government good!

We can keep playing this game, or we can actually address the argument at hand: do you possibly think it's fair that a poor person in Washington pays 6 times the tax rate of a rich person?

Baloney.  During the last year a Republican budget controlled Congress (fiscal year 2007) the deficit stood at a minuscule $161 billion dollars, $161 billion! That’s at least five years into the tenure of Bushes evil tax cuts. Moreover, federal tax receipts actually went up while the tax cuts were accelerating. In other words, the US Treasury received more money not less because of the Bush tax cuts that Democrats allege ruined America’s economy.

Of course the greatest contribution to the budget deficit was the economic collapse that came under Bush. If tax cuts were the economic panacea that Republicans believe them to be, there should have been no economic collapse. Democrats let Bush cut taxes (even while waging two wars), so you cannot suggest that tax cuts have not been tried. It would have been nice if the Republicans had returned the favor and allowed Obama more room to try a larger stimulus (which the Republicans fought tooth and nail, and even forced Obama's stimulus to have a large percentage of tax cuts instead of government spending), but that would require an opposition party that was interested in improving the country, rather than simply defeating Obama. Tax receipts grow naturally as the economy grows, but tax cuts reduced that growth. Clinton demonstrated that higher taxes do not hurt economic growth, and had the Bush tax cuts never been implemented, government receipts would have been much higher than they were. So parse it any way you want, but tax cuts during wartime were irresponsible, and we're paying the price of that irresponsibility now.

"Reforming the most regressive taxes—sales and excise taxes—seems like the logical place to start." -- yes, I agree. A progressive tax would be so much fairer. So - just where does a citizen start the reform?

Progressive tax systems can be as unfair, or even more unfair than the "regressive" systems that are mentioned. A flat tax is fair. Or, are you all Atheist? The Old Testament shows three tithes for a 23 1/3% tax rate and offerings were still given above and beyond that. Do you doubt that God is fair? If the opposite of wealth is debt and the opposite if deficit is income, then perhaps we should have a progressive 'Wealth tax' to pay down the debt and learn how to balance a friggin' budget with an appropriate flat tax on income. However, be aware that the American dream suffers under any progressive tax system; instead, under progressive tax systems we come closer to Marx and Lenin's dreams.

The Bible is not an argument. And yes, I'm an atheist.

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