The ‘low-tax’ lie: States hyped for low taxes are low-tax only for the rich

It is hard to go even a week without seeing a politician or a news article hype up a state as the place that everyone is moving to — or should move to — because of low taxes. However, there’s a big problem with these proclamations: They aren’t true.

In reality, the states that get the most attention — such as Florida, Tennessee and Texas — have low taxes only for the wealthy. These states have average taxes for middle-class families, and levy some of the highest rates in the nation on low-income and working-class families. That’s because their state tax codes are regressive, meaning that those who have the highest incomes pay the lowest share of their income in taxes, and vice versa.

That’s one of the important takeaways in “Who Pays?” a recent study published by the Institute on Taxation and Economic Policy, where I serve as deputy director. It’s the only 50-state analysis of how state and local tax codes affect families across the income scale.

Take Florida. Despite its reputation for stealing away hordes of people from northeastern states with its low taxes (we won’t mention the beaches and warm weather), Florida features low taxes only for those at the top of the income scale. The lowest effective tax rates as a percentage of income are reserved for the wealthiest 1 percent of households.

The state’s lowest-earning 40 percent of families, on the other hand, pay higher taxes as a percentage of their income than either Florida’s highest 1 percent of earners or their peers nationwide in the bottom 40 percent of earners. And they often pay far more than low-income families in many states that are typically known as “high-tax,” such as California, Massachusetts and New Jersey.

According to our study, Florida is the worst state in the country when it comes to tax fairness. Its tax code worsens income inequality in a more dramatic way than any other state’s. It’s no wonder why, since the lowest-income 20 percent of families pay nearly five times as much in taxes relative to their income as the wealthy do.

The story is the same in Tennessee and Texas, which like Florida have no personal income tax. Their consequent reliance upon sales and other taxes means that the top 1 percent of earners in these states pay much less as a percentage of income than the poorest families pay. By our reckoning, Tennessee’s tax code is third-worst for inequality, and Texas’s is seventh-worst.

A state’s lack of a personal income tax is the biggest driver of inequality in its tax system, making those who have the least pay the most. Of the 10 states with the most regressive tax codes, six lack a personal income tax, whereas two have an income tax with a flat rate.

The lack of a state income tax has two major effects. First, it forces state and local governments to rely more heavily on other types of taxes — most frequently sales or excise taxes — to raise the money required to pay for government services.

But sales and excise taxes tend to be regressive, requiring a larger share of income from low- and middle-income families than they do from wealthier families, because wealthier families spend a smaller share of income than poorer ones do. This is why, as our report put it, “poor families pay almost seven times more as a share of their incomes in these taxes than the best-off families.”

Second, a personal income tax — in particular, a graduated tax with rates that rise as income rises — is the most progressive a state can levy, the tax most clearly based on ability to pay. Without an income tax, a state not only must rely more heavily on other regressive taxes, but also cannot use the progressivity of its income tax to even out the total tax distribution.

While these “low-tax” states exacerbate inequality, a number of states are doing the opposite, creating opportunity for all with a fairer tax system. Minnesota and Vermont, for instance, are pairing progressive, graduated-rate income taxes with robust policies for workers and their families, such as the Child Tax Credit and Earned Income Tax Credit. This eases reliance on regressive sales taxes and creates a system based more on the ability to pay.  

As our in-depth analysis of state tax systems makes clear, whenever you hear about a state having low taxes, it’s important to ask the simple question: “Low for whom?” More often than not, the answer will be “the rich.” But as many other states have shown, it doesn’t have to be this way.

Jon Whiten is deputy director of the Institute on Taxation and Economic Policy, a non-profit, non-partisan organization that works to shape equitable and sustainable tax systems.