States with the worst taxes on average earners

Thomas C. Frohlich | 24/7 Wall St.

Show Caption Hide Caption States with the worst taxes for the average Joe Douglas McIntyre from 24/7 Wall St. discusses the states where tax disparities between lower and middle income and high-incomes are the greatest.

While a certain degree of income inequality might be expected, the difference between rich and poor Americans has grown dramatically in recent years. As of 2013, the wealthiest 20% of Americans had more income in aggregate than the bottom 80% combined.

State and local tax systems play a significant role in redistributing income among people. The nationwide average effective tax rate for the poorest 20% of Americans was 10.9%, roughly double the 5.4% rate for the top 1%.

When looking at taxes paid as a share of the income earned, all states have a regressive tax system, which means poorer residents are taxed more than the wealthiest ones. The difference in effective tax rates between income groups, however, varies widely between states. According to "Who Pays? A Distributional Analysis of the Tax Systems in All 50 States," a report released by the Institute on Taxation and Economic Policy (ITEP), Washington has by far the most regressive tax system nationwide. Based on the index score, a ratio calculated from a range of factors to measure income inequality before and after taxes, these are the states with the most unfair tax systems for the average American.

In fact, the poorest 20% of individuals paid at least 12% of their total incomes in state and local taxes in seven of the 10 states with the most regressive tax systems. In contrast, the wealthiest 1% of residents paid no more than 3% in state and local taxes as a share of income in six of the 10 states. In an interview with 24/7 Wall St., Meg Wiehe, state tax policy director at ITEP, said that in most states, and these 10 especially, "tax distribution looks very much like a staircase going down, where as your income goes up, your effective tax rate goes down."

State residents earning average incomes also often bore a higher tax burden compared to the richest residents. The middle 60% of earners in all of the 10 states paid at least three times what the wealthiest 1% paid, as a share of income, in state and local taxes — all of these ratios were also among the highest nationwide. Middle earners in Washington and Florida, the two most regressive taxation states, paid as a share of their income more than 400% what the richest 1% of residents paid as a share of their income.

Often, it's the presence or absence of a particular kind of tax that determines the extent to which state tax systems are regressive. For example, taxing goods and services consumed daily such as food is especially regressive because food makes up a much larger share of poorer Americans' income. A graduated income tax is far more progressive, on the other hand. Five of the 10 states with unfair tax systems taxed food at the state and local level. Also, all but one of the 10 states had relatively low or flat income tax rates, and four had no personal income tax.

According to Wiehe, these states "rely heavily on taxes that are paid disproportionately by low- and middle-income households, and have very little reliance on taxes that the top 1% or top 5% would be responsible for paying." In other words, states have to make up for that revenue in one way or another. Nationwide, personal and corporate income taxes accounted for an average of nearly 18% of state revenue. Yet in five of the 10 states, the contribution to revenue from income taxes was less than 5%. And while sales and excise taxes accounted for less than one quarter of state revenue on average across the nation, they accounted for more than 30% of revenue in six of the 10 states with the most regressive tax policies.

While it is difficult to know the exact degree that these tax policies impact income inequality, the states with the most regressive tax systems also had relatively uneven income distribution even before taxes were applied. In six of the 10 states, the 2013 Gini coefficient — which has values between zero and one, where one means all income belongs to a single person and zero means uniform income distribution — was higher than in the majority of states.

To identify the 10 states with the worst tax systems for average Americans, 24/7 Wall St. reviewed ITEP's Tax Inequality Index scores for the 50 states. The index incorporated effective tax rates for the poorest 20%, middle 60%, top 1%, as well as ratios comparing these rates, among other measures. Effective tax rates were based on total state and local taxes as a share of family income for non-elderly taxpayers in all 50 states. ITEP's model used 2012 income figures, and considered tax laws from 2014 and 2015. Contributions to state revenue by tax type were also provided by ITEP. We reviewed the Gini coefficient from 2013 — which is based on pre-tax income — as well as additional economic data from the Census Bureau's 2013 American Community Survey.

These are the states with the worst taxes for the average American.

1. Washington

> ITEP index score: -12.6%

> Effective tax rate lowest 20%: 16.8% (the highest)

> Effective tax rate top 1%: 2.4% (5th lowest)

> 2013 Gini coefficient (pre-tax): 0.46 (19th lowest)

Washington's score of -12.6% was the worst in the nation. The poorest 20% of families paid nearly 17% of their income in state and local taxes, the highest such rate nationwide. With the wealthiest 1% of state households paying just 2.4% — nearly the lowest such rate — Washington's tax system helped widen the income gap more than any other state. Washington's poorest residents paid nearly seven times what the wealthiest 1% paid as a share of income, one of the highest such ratios nationwide. While Washington's tax code is considered by many to be among the nation's most unfair, residents are better-off financially than in many other states. A typical household earned $58,405 in 2013, one of the higher household median incomes. And while 15.8% of Americans lived in poverty that year, 14.1% did in Washington.

2. Florida

> ITEP index score: -9.5%

> Effective tax rate lowest 20%: 12.9% (4th highest)

> Effective tax rate top 1%: 1.9% (4th lowest)

> 2013 Gini coefficient (pre-tax): 0.48 (5th highest)

As in other states ITEP identified as having state and local tax systems that exacerbate income inequality, the lack of a personal income tax in Florida disproportionately benefits the wealthiest residents of the state. The lack of income tax also means the state relies more heavily on sales taxes for its revenues. In fiscal 2012, sales and excise taxes accounted for 30.8% of the state's revenue, the 10th highest such share, and well above the average national rate of 23.7%. The wealthiest 1% of Florida families paid an effective tax rate of less than 2%, nearly the lowest rate in that income group.

3. Texas

> ITEP index score: -8.5%

> Effective tax rate lowest 20%: 12.5% (5th highest)

> Effective tax rate top 1%: 2.9% (8th lowest)

> 2013 Gini coefficient (pre-tax): 0.48 (9th highest)

Texas is one of a handful of states levying no income tax. While the state collects a gross receipts tax — which is a tax on business transactions — it does not collect a tax on any corporate profits. As is common in states with abundant natural resources, the oil and gas industry in Texas stimulates the economy and helps the state raise revenues from other sources. Yet, this may not be enough, as the state relies heavily on sales and excise taxes. These consumption taxes accounted for nearly 32% of the state's revenue, the ninth highest nationwide in fiscal 2012. The state also does not provide low-income residents with any tax credits, which help offset sales, excise and property taxes in other states. Partly as a result, the poorest 20% of Texas families paid an effective state and local tax rate of 12.5%, higher than in all but a handful of states, while the wealthiest 1% of families paid less than 3%, one of the lowest rates.

4. South Dakota

> ITEP index score: -8.4%

> Effective tax rate lowest 20%: 11.3% (12th highest)

> Effective tax rate top 1%: 1.8% (3rd lowest)

> 2013 Gini coefficient (pre-tax): 0.44 (7th lowest)

With an effective tax rate of 1.8%, South Dakota's wealthiest residents paid less in state and local taxes as a share of their income than their peers in nearly every other state. The poorest 20% of families, on the other hand, paid among the higher effective tax rates. The difference is due in large part to the complete lack of an income or corporate tax in the state. While even states with regressive tax systems often exclude groceries from the sales tax, this is not the case in South Dakota. In fact, the state relies on consumption taxes as an important revenue source. Sales and excise taxes accounted for 35.6% of the state's tax revenue, higher than the contribution in all but four other states. Unlike many other state tax systems identified as regressive, income inequality in South Dakota — measured before taxes — was not nearly as prevalent compared to most states in 2013.

5. Illinois

> ITEP index score: -8.1%

> Effective tax rate lowest 20%: 13.2% (3rd highest)

> Effective tax rate top 1%: 4.6% (19th lowest)

> 2013 Gini coefficient (pre-tax): 0.48 (8th highest)

The poorest 20% of Illinois households paid 13.2% of their incomes in state and local taxes, and the middle 60% of earners paid 10.9% of their incomes, both nearly the highest effective tax rates respectively. Meanwhile, the state's wealthiest residents paid 4.6% of their incomes in state and local taxes, one of the lower effective tax rates. Looking just at income tax, the wealthiest 1% paid a slightly higher effective income tax rate than the poorest 20% of state households. However, Illinois uses a flat income tax rate, which is widely considered to be a regressive feature. The state's wealthiest residents had especially high incomes. A typical Illinois household in the top quintile earned more than $200,000 in 2013, the ninth highest compared to the wealthiest households in other states.

24/7 WALL ST.: The rest of the states with the worst taxes on average Americans

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