The Tax On Being Poor


Posted by Bob Lord

The NY Times has a great piece from Katherine Newman in the Sunday Review section, In the South and West, a Tax on Being Poor. Unfortunately, there was no mention of the connection between federal and state tax policy. There should have been.

Newman's piece outlines very clearly how tax policy in the South and West has a devastating effect on poor people in those states. Those states, including Arizona, rely more heavily on sales taxes, which fall more heavily on the poor. One devastating statistic: "For every $100 increase on taxes at the poverty line, we saw an additional 7 deaths and 78 property crimes per 100,000 people, and a quarter of a percentage point decrease in high school completion."

Newman explains:

Southern states have far higher rates of strokes, heart disease and infant mortality than the rest of the country. Students drop out of high school in larger numbers. These outcomes are not just a consequence of a love of fried food or higher poverty levels. Holding all those conditions constant, the poor of the South — and increasingly the West — do worse because their states tax them more heavily. They have less money to buy medication, so their health problems get worse. High sales taxes make meals more expensive, so they shift to cheaper, unhealthy food. If people can’t make ends meet, they may turn to the underground economy or to crime.

The ill-conceived tax policies of the Southern and Western states also burden the remaining states:

The fact is, the more the poor are taxed, the worse off they are, whether they are working or not. We all pay a huge price for this shortsightedness. Medicaid payments, food stamps, disability benefits — all of these federal programs swoop in to try to patch up a frayed safety net. Consequently, the Southern states reap more dollars in federal benefits than they pay in taxes (like Mississippi, which saw a net gain of $240 billion between 1990 and 2009), while the wealthier states — which do more to take care of their own — lose out for every dollar they pay (like New Jersey, which handed over a net of $706 billion over that same period). As noble as the federal effort to rescue the poor in the “mean states” may be, it is not enough to reverse the impact of regressive taxation. 

Policy makers at the federal level could address this, but they've gone in the opposite direction. I inquired about this with a progressive DC think tank, and learned that there's pretty much no appetite for using federal tax policy to impact state tax policy. I doubt that's true for conservatives. They've been hard it work tweaking federal tax policy to pave the way for ALEC, the Goldwater Institute and others to make mishchief at the state level.

In the upcoming tax reform debate, the Obama proposal regarding the deduction for state income taxes is to limit the rate of benefit to 28%, whereas the Republican proposal apparently will be to impose a cap on all itemized deductions, like the Romney "deduction bucket" from his 2012 campaign. Whichever proposal is adopted, ALEC's work at the state level will be made easier. Yes, the Obama proposal is not as bad, but it's still bad.

Why? Because both proposals reduce the federal tax benefit for paying state income taxes for those in the upper brackets. When that benefit is reduced, a reduction in state income tax rates becomes more meaningful for those at the top. If state income tax payments reduce federal taxable income dollar for dollar, a reduction in state income taxes increases federal taxable income by the same amount. Thus, at the top federal bracket of 39.6%, when a state reduces the income tax dollars it collects from those at the top, 39.6%  of the reduction flows to the US Treasury, not the intended beneficiaries of the state's largesse, its wealthy citizens. That's a nice incentive for states not to swap income taxes for sales taxes. But the Obama proposal would limit the federal tax benefit to 28% of every dollar paid in state tax and the Republican proposal would reduce it to zero.

And there already are in place measures that reduce the federal tax benefit for state income tax payments. Taxpayers now get to choose whether to deduct their state income tax payments or their state sales tax payments. That means a taxpayer benefits fedreally from his state income tax payments only to the extent those payments exceed his state sales tax payments. There also is a limitation, commonly known as the Pease limitation, that reduces the benefit of all itemized deductions, including state tax payments, for high income earners. And for those who are subject to the alternative minimum tax, the benefit for paying state income tax is eliminated entirely.  

Thus far, all of the movement at the federal level has been in the direction of making it easier for conservatives to sell harmful changes in policy at the state level. And progressive federal policy makers don't think it's worthwhile to consider this relationship. Shame on them.