Adding tax insult to injury for the poor (state sales taxes)

by pdxblake

There is a lot of ink spilled on the Federal tax code and its equity or inequity, but much less that gets the headlines about state taxes, which makes sense because it is more of a local issue.  However, Jared Bernstein at the Center on Budget & Policy Priorities has a few fascinating charts on his blog that show that state taxes are regressive (they are more of a burden as a percentage of income on lower-income people).  Here’s one example.

What is important to look at is the “State & local taxes” column, which shows the taxes paid as a percentage of total income.  This is the most important number, not the statutory tax rate (i.e. what the law says you pay at a given level of income) because it factors in the deductions from income, and looks at what comes out of people’s pockets for taxes.  It incorporates income taxes, sales taxes, payroll taxes, property taxes, estate taxes, etc. In a progressive tax system, the percentage paid would rise as a person’s income rises.  A flat tax (not surprisingly) would have an equal percentage across income levels.

What the data shows is that rich people pay lower taxes as a percentage of their income than poor people, which is perverse, but entirely understandable since many states rely on sales taxes to raise revenue.  Unless rich people suddenly decide to start spending more of their income on goods, they will pay less in taxes than poor people, which is inequitable since the people with the highest ability to pay are asked to pay less than those to whom the dollars are more needed.  This applies to all states with sales taxes, but some states add inequity further in sales taxes.

To take a specific example, Tennessee has sales tax rates that decline with the size of the purchase.  If you buy something under $1,600, you pay a sales tax of 9.25% (a 7% state sales tax and 2.25% maximum in local sales taxes).  Between $1,600 and $3,200, the sales tax rises to 9.75%, but above that level, only the 7% sales tax applies.  Here’s an example (from Tennesseans for Fair Taxes)

Example 1: A $3,000 used car is taxed at 9.5%

  • The first $1,600 of the purchase is taxed at 9.25% ($148).
  • The next $1,400 of the purchase is taxed at 9.75% ($137).
  • In the end, the total tax of $285 is an effective tax rate of 9.5%.

Example 2: A $40,000 SUV is taxed at 7.2%

  • The first $1,600 of the purchase is taxed at 9.25% ($148).
  • The next $1,600 of the purchase is taxed at 9.75% ($156).
  • The remaining $36,800 of the purchase is taxed at 7% ($2,576).
  • In the end, the total tax of $2,880 is an effective tax rate of 7.2%.

From this example, it shows how the regressiveness of the sales tax is accentuated to put an even higher burden on the poor.  If you buy a beater car, you are going to pay a 9.5% tax rate, but if you buy a new SUV with all the bells and whistles, your tax rate is 7.2%.

Making  the tax system work better is not just about closing the loopholes, it is also about picking and choosing between the types of taxes, as well as whether the state should adjust the rates to avoid taxing those who are least able to afford it the heaviest.  Sales taxes are much more regressive by their structure, and while theoretically you could find ways to offset the regressiveness (by setting a lower limit on the amount of spending that is subject to taxation) but in practice that is nearly impossible.  If a sales tax is going to be used, the least we should expect is that it will not be made more regressive, like it is in Tennessee.

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