Foundation

Is Your State's Tax System "Fair"?

by Michael Tasselmyer / /

Every two years, the Institute on Taxation and Economic Policy (ITEP) publishes a report that compares the distributional impact of each state's tax system. ITEP recently published the fifth edition of Who Pays? A Distributional Analysis of the Tax Systems in All Fifty States, and ranked each state according to how "fair" its tax systems are.

ITEP measures fairness according to how much of a state's total tax revenue is paid by various income groups. In other words, if the lowest income group in one state is subject to a higher effective rate than the same group in another (and all else is equal), its tax system would rank as less fair. The report also considers how heavily each state relies on sales and excise taxes, claiming that those taxes disproportionately impact lower income groups.

According to ITEP's methodology: 

  • The ten most regressive tax systems were found in Washington, Florida, Texas, South Dakota, Illinois, Pennsylvania, Tennessee, Arizona, Kansas, and Indiana.
  • The states/localities with the fairest tax systems were California, Delaware, Washington, D.C., Minnesota, Montana, Oregon, and Vermont.

Of course, there are many interpretations of what a "fair" tax system might actually be -- and defining it depends on how heavily one weights various economic inputs and outcomes. So while ITEP's report can provide valuable insights into how each state taxes its constituents, and its methodology is at least consistent in each examination, it is worth noting some of the limitations of such a comparison -- including the fact that it doesn't discuss the federal income tax system's impact on each income group.

The Tax Foundation's Liz Malm and Kyle Pomerleau have an excellent in-depth discussion of some of the flaws in ITEP's methodology that limit the scope of the report's conclusions. While it would take multiple posts to discuss each of their points in more detail, here's a quick rundown of what they are:

"1. The study isn’t focused on the distribution of taxes by income group, but rather, it is focused on how well state and local tax systems redistribute income.
2. The study includes one regressive portion of the federal income tax but fails to include any discussion of the federal income tax as a whole, even though it is highly progressive.
3. The study includes discussion of tax exporting in its explanation of property taxes but doesn’t discuss tax exporting as it relates to other taxes.
4. The study ignores severance taxes and broad-based business taxes other than corporate income taxes.
5. The study refers to a problematic report completed by Standard and Poor’s to prove its point.
6. The study recommends making tax policy changes that would cause tax revenue volatility and economic harm."

Their response is well worth reading in full at the link above. (Some of the Tax Foundation's critiques were also part of its response to the 2013 edition of the ITEP report.)

 

ITEP's report finds that every single state's tax system is regressive, while completely ignoring the very real and very significant impact that federal income and business taxes have on how states craft their own policies. The formula that ITEP uses to rank each state essentially compares how well they redistribute income, which is not without value, but it doesn't properly account for the complete economic context in which each state operates and cherry-picks which data to rely on. That makes it difficult to base any substantial policy recommendations on the report's conclusions.


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