On Taxes on the Poor & the Rich

Source: 401(K) 2012

The State of State Taxes
President Obama's recent State of the Union speech consisted of a number of proposals and policy ideas, one of which touched on a point of great contention in this country: tax policy.  The left says that the rich don't pay their fair share, and the right argues that the poor get a free ride.  Sure, there's more nuance to the political differences--but not much!  This conflict makes Obama's proposal to "...extend tax credits to the middle class by hiking taxes on wealthier Americans and big banks..." (The Huffington Post) that much more interesting.

Lost in the vitriol about tax breaks and rates are the facts.  That's a shame, because facts happen to be useful when making policy decisions, especially those related to the nation's finances.  Fortunately, a fascinating report by the Institute on Taxation and Economy Policy provides just that information.  Titled Who Pays: A Distributional Analysis of the Tax Systems in All Fifty States, the report "...assesses the fairness of state and local tax systems by measuring the state and local taxes that will be paid in 2015 by different income groups as a share of their incomes."

Conclusions
So what conclusions are we to make? Simply put, the poor end up paying higher effective state and local tax rates than the rich, and this is true in all 50 states.  The extent of the inequality is striking: "...the poorest Americans are paying two times more of their income in taxes than the top 1 percent."  (see chart below)

Source: Institute on Taxation and Economy Policy

An Unfair Trend
The reasons for this disparity are fascinating.  The study notes that there are three types of state taxes--income, property and sales, and excise.  State taxes are the most progressive, meaning that the more you make, the higher your tax rates.  That said, some states have no income tax whatsoever, and others tax all income at the same rate; both result in greater tax disparity.

The last two, however, are almost always regressive: lower-income populations actually pay more in property and sales taxes than the wealthy.  Sales taxes, for instance, "inevitably take a larger share of income from low- and middle-income families than from rich families because sales taxes are levied at a flat rate and spending as a share of income falls as income rises."  In other words, wealthier families are able to steer more of their money into areas that are not affected by sales taxes, such as savings, stocks, and bonds.  But it turns out that taxing food "is a particu­larly regressive policy because poor families spend most of their income on groceries and other necessities."

I could go on quoting from the report, but I encourage you to check it out for yourself.  What I want is to repeat the main point here: the poor pay a higher effective tax rate than the wealthy in almost all 50 states.  Not only that, but at the federal level, even though the highest tax bracket pays 39.6% on income, the tax code includes all sorts of ways to reduce what you pay: mortgage interest payment deductions, lower rates on capital gains, charitable contributions, etc.  As a case-in-point, Warren Buffet has famously noted that his secretary pays a higher tax rate than he does (35.8%, compared to 17.4%, Source: The Atlantic).

As an interesting aside, to all those who say that undocumented immigrants are a financial burden to the nation, it's extremely important to keep in mind that they pay sales taxes and many pay payroll and even income taxes (as long as you have an ITIN, or Individual Tax Identification Number, the IRS is more than happy to take your money, regardless of legal status).  So next time you hear someone repeat the tired pablum about how the wealthy are taxed to death and the poor and undocumented mooch off the system, remember that the truth is exactly the opposite.  And guess what?  During the post World War II boom years, the highest marginal tax rate ranged from 94% to 70%, and somehow our economy didn't explode.*  Maybe it's time to go back to a system that meets a minimum standard of fairness and ensures we have the tax revenues to cover our nation's expenses. We could pay down the national debt; take care of our veterans; improve our roads, bridges, and schools; and create jobs for the poor and middle class--all without taxing to death the most vulnerable among us.


* It's amazing how many people don't realize this, but a 94% marginal tax rate doesn't mean that 94% of all your income goes to taxes; rather, it means that only your income over a certain amount gets taxed at that rate.  In 1945, for instance, one would pay 94% on income over $2.55 million.  In other words, a progressive tax structure does NOT mean that one's post tax income decreases the more one makes!  Click here to see America's federal income tax rates from 1862 - 2013.