April 8, 2004

STATE INCOME TAX BURDENS ON LOW-INCOME FAMILIES IN 2003
by Bob Zahradnik and Joseph Llobrera[1]

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Summary

Poor families in many states continue to face a substantial burden as they file personal income taxes for the 2003 tax year.  In a large number of the states that levy income taxes — in 18 out of 42 states — two-parent families of four with incomes below the federal poverty line continue to owe income tax.  In 16 of those states, poor single-parent families of three also pay income taxes.  In addition, 30 of the 42 states with an income tax still tax families with incomes just above the poverty line, even though such families typically have difficulty making ends meet.

In some states, families with poverty-level incomes face income tax bills of several hundred dollars.  For instance, a two-parent family of four in Kentucky with income of $18,811 — the 2003 poverty line for a family that size — owes $626 in income tax, the highest tax on such a family in the country.  A single-parent family of three in Kentucky with poverty-level income of $14,675 owes $383, second only to the tax on such a family levied in Alabama of $413.  Such amounts can make a big difference to a struggling family.  Other states levying tax of $200 or more on families with poverty-level incomes include Arkansas, Hawaii, Indiana, Michigan, Montana, Oregon, Virginia, and West Virginia.

Taxing the incomes of working-poor families runs counter to the efforts by policymakers across the political spectrum to provide more assistance to families seeking to work their way out of poverty.  Many states reduced income taxes on the poor in the 1990s, and a narrow majority of states now exempt poor families from the income tax.  The federal government has exempted such families since the mid-1980s.

Eliminating all or most state income taxes on working families with poverty-level incomes gives a boost in take-home pay that helps offset higher child care and transportation costs that families incur as they strive to become economically self-sufficient.  In other words, relieving state income tax burdens on poor families is making a meaningful contribution toward "making work pay.@  A dozen states go even further; they not only exempt poor families from income taxation, but also provide a tax rebate that can help such families meet their expenses.

Methodology This report takes into account income tax provisions that are broadly available to low-income families and that are not intended to offset some other tax. It does not take into account tax credits or deductions that benefit only families with certain expenses, nor does it take into account provisions that are intended explicitly to offset the burden of a tax other than the income tax. For instance, it does not include the impact of tax provisions that are available only to families with out-of-pocket child care expenses or specific housing costs, because not all families face such costs. It also does not take into account sales tax credits, property tax "circuitbreakers," and similar provisions, because this analysis does not attempt to gauge the burdens of those taxes C only of income taxes. Moreover, such provisions tend to be quite modest and in most cases do not affect greatly tax burdens on low-income families

States that choose to reduce or eliminate tax burdens on low-income families employ a variety of mechanisms to do so.  These mechanisms include state Earned Income Tax Credits (EITCs) and other low-income tax credits; no-tax floors; and personal exemptions and standard deductions that are adequate to shield poverty-level income from taxation.

Despite the economic slowdown and the associated state fiscal crisis, states are continuing to make some progress in the income-tax treatment of low-income families.  In 2003, the average state income tax threshold increased slightly relative to the poverty line, largely because Indiana enacted a new state EITC that reduced taxes on a family of four at the poverty line by nearly $200.  Illinois improved the tax treatment of low-income families by making its EITC fully refundable.  As result, in 2003 an Illinois family of four with minimum-wage earnings (which falls more than $8,000 below the poverty line) received a $129 refund to help meet work related expenses.  Rhode Island made a small portion of its EITC refundable, allowing a single-parent family of three with income at the poverty line to receive a $50 refund.

In a few states, the tax burden on poor families has increased over the last decade.  In Alabama, Arkansas, Iowa, Kentucky, Louisiana, Virginia, and West Virginia, the income taxes on families of four with poverty-level incomes have risen since 1994, even after taking inflation into account.  The increase after the adjustment for inflation has been as much as 53 percent in Louisiana, 49 percent in Virginia, and 45 percent in Arkansas.  In each of these states, the reason for the tax increase is that personal exemptions, credits, or other features of the tax code designed to protect the incomes of low-income families from taxation have eroded due to inflation.

 

Many States Continue to Levy Substantial Income Taxes on Poor Families in 2003

This analysis assesses the impact of each state=s income tax in 2003 on poor and near-poor families with children.[2]  (Forty-two states, counting the District of Columbia as a state, levy income taxes.)  One important measure of tax burdens on poor families is the income tax threshold — the point at which, as a family=s income rises, it first begins to owe income tax.  Tables 1A and 1B show the thresholds for a single parent with two children and for a married couple with two children, respectively.

Comparing Income Tax Thresholds in Poor States with Those in Wealthier States Relieving income taxes on poor families can be a greater challenge for states with low median incomes and higher poverty rates than it is for wealthier states, because poorer states generally have more potential beneficiaries of such tax relief and a smaller overall tax base to absorb the loss of revenue. Yet both high-income states and low-income states have been able to exempt poor families from the income tax. In fact, of the 26 states that exempt from taxation the income of a single-parent family of three with income at or below the poverty line, 12 have median incomes below the U.S. median, including three of the nation's 10 poorest states: New Mexico, North Dakota and Oklahoma.

• In 16 states, the income tax threshold for a single-parent family of three is less than $14,675, the Census Bureau=s official poverty line for a family of three in 2003.  In the remaining 26 states with income taxes, the threshold is above the poverty line; in those states, poor families pay no income tax.

• In 18 states, the threshold for a two-parent family of four is below the $18,811 poverty line for such a family.  In the remaining 24 states with income taxes, the threshold is above the poverty line.

• Two states, Alabama and Kentucky, impose income tax on very poor families, those with incomes less than one-half of the poverty line.  Those states and six others — Hawaii, Michigan, Montana, Ohio, Oregon and West Virginia — tax families of three with full-time minimum wage earnings.

• The state with the highest threshold is California, where the threshold is $38,200 for a family of three and $40,200 for a family of four — more than twice the poverty lines for families of those sizes.

 

Taxes on Poor Families

Where states tax the wages of poor families, those tax burdens can be several hundred dollars — a substantial amount for a struggling family.  These amounts are shown in Tables 2A, 2B, 3A and 3B.

Why Focus on Income Taxes When Other Taxes Are More Burdensome for Poor Families? In most states, poor families pay more in consumption taxes such as gasoline, sales, and other taxes than they do in income taxes. Property taxes and other taxes and fees also impose substantial burdens on poor families. Nonetheless, income tax burdens on poor families are significant for two primary reasons. First, it is administratively easier for states to target income tax relief to poor families than it is to provide sales or property tax relief to those families; the great majority of the low-income tax relief enacted in the last decade at the state level has been administered through the income tax. Second, policymakers are often concerned about the negative message that high taxes on earnings send to families trying to work their way out of poverty. States that rely heavily on income taxes for revenue still can exempt poor families from taxation. Of the 10 states that receive their largest share of state tax revenue from personal income taxes, seven — California, Colorado, Maryland, Massachusetts, New York, Virginia and Wisconsin — exempt poor families of three or four from the income tax.

• The average 2003 tax bill for a family with income at the poverty line in the states with below-poverty thresholds is $139 for a family of three and $245 for a family of four.  In 10 states, the tax bill for a poor family of four exceeds $200, and in one state — Kentucky — reaches as high as $626.

• As noted, a majority of states do not tax families with poverty-level income.

• Twelve states go further than simply not taxing poor families.  These states offer tax credits that provide refunds to families with no income tax liability.  These credits act as a wage supplement and income support, helping support families= work efforts and reduce poverty.  The amount of refund for families with income at the poverty line is as high as $1,282 for a family of three in Vermont and $1,472 for a family of four in Minnesota.

Taxes on Near-poor Families

Many families with earnings just above the poverty line continue to find it difficult to make ends meet.  Federal and state governments recognize the challenges faced by families with incomes slightly above the poverty line and have set eligibility for some assistance programs, such as energy assistance, school lunch subsidies, and in many states health care subsidies, at 125 percent of the poverty line ($18,344 for a family of three, $23,514 for a family of four) or above.

A majority of states, however, continue to levy income tax on families with incomes at 125 percent of the poverty line.  Some 30 states, for instance, tax the incomes of such families of four, with the tax bill exceeding $500 in eight states — Alabama, Arkansas, Hawaii, Iowa, Kentucky, Oregon, Virginia, and West Virginia.  Some 25 states tax the incomes of families of three with income at 125 percent of the poverty line.  See tables 4A and 4B.

 

Modest Improvement in Income Tax Thresholds Since Last Year

States made modest progress in the 2003 tax year in reducing taxes on poor families.

• The average threshold among all states rose from 106 percent of the poverty line to 107 percent.

• In the 16 states that still tax the poor, the average income tax on a family of three with poverty-level income fell from $150 in 2002 to $139 in 2003.

The most significant improvement in the income-tax treatment of poor families was registered in Indiana, where a new state Earned Income Tax Credit raised the income tax threshold for a family of four from $9,500 to $14,400 and cut the tax for a family at the poverty line from $387 to $201.  The new Indiana credit increases the income tax threshold for a family of three from $9,000 to $13,400 and cut the tax for such a family from $284 to $55.

 

Most but Not All States Have Made Substantial Progress since the Early 1990s

Over the last decade, states generally have improved their tax treatment of working poor families.  From 1991 to 2003, for example, the number of states levying income tax on poor families of four declined from 24 to 18.  And among those remaining 18 states, many reduced taxes on poor families.  From 1994 to 2003 the average income tax for a family of four at the poverty line fell by about 15 percent in inflation-adjusted terms.  Tables 5 and 6 show changes over time.

States have used a variety of mechanisms to reduce income taxes on poor families.  Nearly all states offer personal exemptions and/or standard deductions, which reduce the amount of income subject to taxation for all families including those with low incomes; in a number of states, these provisions by themselves are sufficient to lift the income tax threshold above the poverty line.  In addition, many states have enacted provisions targeted to low- and moderate-income families.  In 2003 some 16 states offered Earned Income Tax Credits based on the federal EITC, which are tax credits for working-poor families, mostly those with children.[3]  Other states offer other types of low-income tax credits, such as New Mexico's "Low-Income Comprehensive Tax Rebate."  Finally, a few states have "no-tax floors," which set a dollar level below which families owe no tax but do not affect tax liability for families above that level.

Future Changes in Income Tax Thresholds This report shows income tax thresholds for tax year 2003. As a part of legislation enacted in 2003 and in previous years, some states have adopted changes to their income tax systems that will lead to increased thresholds in 2004 and beyond. These changes will not change the number of states that levy income tax on poor families. Colorado statutes provide for a 10 percent refundable EITC in years in which total state revenues exceed a certain limit. The credit is presently suspended due to insufficient revenues, and is projected to be reinstated no earlier than 2005. Reinstatement of the credit will raise the threshold further above the poverty line and improve the income-tax treatment of low- and moderate-income families. Indiana’s 6 percent refundable EITC, which has a significant impact on the threshold and reduces tax burdens up to $250, is set to expire at the end of 2005. If the credit does expire, the threshold for a two-parent family of four will fall from its current level of 77 percent of the poverty line to less than 37 percent of the poverty line. Maryland’s EITC will increase from 18 percent to 20 percent in 2004. Maryland’s tax threshold is already above the poverty line, and this change will further improve the income-tax treatment of low- and moderate-income families. North Carolina's standard deduction for married couples will increase by $500 in 2004. The change will not lift North Carolina's threshold above the poverty line Changes in the federal Earned Income Tax Credit enacted in June 2001 will increase thresholds in those states that piggyback on the federal credit. The EITC increase took effect in tax year 2002, with additional increases scheduled for 2005 and 2008. Some 17 states piggyback on the federal EITC.

 

A Few States Tax the Incomes of the Poor More Heavily than in the Early 1990s

A smaller number of states stand out for their lack of progress over the last dozen years in reducing income tax burdens on the poor.

• The Alabama threshold remains at $4,600, the lowest in the nation and the same level — without adjustment for inflation — that it has been since the 1960s.  Because the threshold has not changed while the cost of living and the poverty line have increased, the threshold as a percentage of the poverty line has fallen from 33 percent to 24 percent since 1991.

Over the last ten years, the Alabama tax burden on families with poverty-level incomes has risen.  The income tax on a family of four with income at the poverty line in 2003 is $493, compared with $348 eight years ago — a 14 percent increase after adjusting for inflation.

• In Kentucky, Ohio and West Virginia, as in Alabama, the income tax threshold is further below the poverty line than it was in 1991.  In Kentucky, for instance, the threshold for a family of four has fallen from 36 percent of the poverty line in 1991 to 29 percent.

• In Arkansas, Iowa, Kentucky, Louisiana, Virginia, and West Virginia, as in Alabama, the income taxes on families of four with poverty-level incomes have risen since 1994 even after taking inflation into account.  As Table 6 shows, the increase after adjustment for inflation has been as much as 53 percent in Louisiana, 49 percent in Virginia, 45 percent in Arkansas, and 25 percent in West Virginia.  In each of these states, the reason for the tax increase is that personal exemptions, credits, or other features designed to protect the incomes of low-income families from taxation have eroded due to inflation.

State Fact Sheets

Alabama Arkansas Colorado Hawaii Indiana Kentucky Michigan Montana Oregon Virginia West Virginia

 

Table 1A
State Income Tax Thresholds for Single-Parent Families of Three, 2003
Poverty Line (estimated): $14,675

Rank	State	Threshold		Rank	State	Threshold
1	Alabama	4,600		17	Delaware	$14,700
2	Kentucky	5,000		18	Virginia	15,300
3	Montana	8,300		19	Oklahoma	15,600
4	Hawaii	9,800		20	Colorado	16,200
5	West Virginia	10,000		20	Idaho	16,200
6	Ohio	10,300		20	Utah	16,200
7	Michigan	10,500		23	Nebraska	16,400
8	Louisiana	11,000		24	North Dakota	16,600
9	Georgia	12,700		25	Iowa	17,700
10	Arkansas	13,000		26	New Mexico	19,000
10	Illinois	13,000		27	Connecticut	19,100
10	Missouri	13,000		28	South Carolina	19,200
13	Indiana	13,400		29	Wisconsin	19,400
14	Oregon	13,500		30	New Jersey	20,000
15	Mississippi	14,400		31	Arizona	20,100
15	North Carolina	14,400		32	District of Columbia	20,300
				33	Maine	21,800
				34	Massachusetts	22,600
				35	Kansas	23,100
				36	Pennsylvania	24,500
				37	New York	25,400
				38	Rhode Island	26,400
				39	Maryland	27,100
				40	Vermont	27,600
				41	Minnesota	27,700
				42	California	38,200
Average Threshold 2003		$11,100		Average Threshold 2003		$21,000
Amount Below Poverty		$3,575		Amount Above Poverty		$6,325
Note: A threshold is the lowest income level at which a family has state income tax liability. In this table thresholds are rounded to the nearest $100. The 2003 poverty line is a Census Bureau estimate based on the actual 2002 line adjusted for inflation.  The threshold calculations include earned income tax credits, other general tax credits, exemptions, and standard deductions. Credits that are intended to offset the effects of taxes other than the income tax or that are not available to all low-income families are not taken into account. Source: Center on Budget and Policy Priorities

 

Table 1B
State Income Tax Thresholds for Two-Parent Families of Four, 2003
Poverty Line (estimated): $18,811

Rank	State	Threshold		Rank	State	Threshold
1	Alabama	4,600		19	Mississippi	$19,600
2	Kentucky	5,500		20	New Jersey	20,000
3	West Virginia	10,000		21	Delaware	20,300
4	Montana	10,100		22	District of Columbia	20,700
5	Hawaii	11,500		23	Colorado	21,700
6	Ohio	13,000		23	Nebraska	21,700
7	Michigan	13,600		23	Utah	21,700