State Income Tax Burdens on Low-Income Families in 1997:
Assessing the Burden and Opportunities for Relief

 

II. State Income Taxes on Poor Families in 1997

The income tax is a major component of state tax systems. Forty-two states levy an income tax, and income tax revenue makes up 32 percent of total state tax revenue nationally. Thus, the design of a state's income tax affects greatly the overall fairness of a state's tax system.

Because the income tax is calculated as a percentage of a taxpayer's income, it is relatively easy both to determine its impact on taxpayers of different income levels and to modify that impact. In general, state income taxes are designed to be at least modestly progressive — that is, to take a smaller share of income from lower-income taxpayers than from higher-income taxpayers. This progressivity results from either a rate structure with higher marginal rates as income rises, deductions or credits that reduce tax liability proportionately more for low-income taxpayers, or a combination of these features.

While all state income tax systems are at least somewhat progressive, each system has a different design. One way that income tax systems differ substantially among states is their treatment of families at the lowest end of the economic ladder. This report compares the treatment of poor taxpayers under each state's income tax structure and suggests ways that this treatment could be improved.

The relatively good fiscal condition that many states enjoy this year has resulted in widespread consideration of tax cuts. This is an opportunity for states to make changes in their income tax provisions that will relieve tax burdens on poor families. Unfortunately, most states with below-poverty thresholds have, thus far, failed to take full advantage of this opportunity.

This analysis is particularly important in light of the policy debates that are occurring in many states this year. Policymakers at the state and federal level, both liberal and conservative, have professed their interest in reducing welfare caseloads and helping welfare recipients to make the transition from welfare to work. With the enactment of federal welfare reform, states across the country have moved ahead. In most cases, the policy debate at the state level has focused on changing the provisions of the welfare program itself, while the impact of state tax policy on low-wage working families has been overlooked.

The failure to consider the impact of state tax systems on poor families as a part of the welfare reform debate is a serious omission. Low-income families often face high marginal tax rates; that is, as a family's income rises up to and beyond the poverty level, the combination of higher taxes and the loss of means-tested benefits (such as food stamps) consumes a significant share of these increased earnings.(1) In addition, the expenses of working, such as child care and transportation, often absorb a large proportion of the earnings of low-income workers. Thus, as part of a larger strategy to "make work pay" for low-wage workers, it is particularly important that state income taxes not be imposed on families whose earnings have not yet brought them above the poverty level.

More than a decade ago, the federal government recognized the inconsistency of encouraging poor families to work and then levying taxes that pushed them deeper into poverty. President Ronald Reagan spoke forcefully in the mid-1980's about the foolishness of taxing poor households deeper into poverty. In 1986, as part of an overall tax reform package, the federal government eliminated income tax liability for poor families. Since that time, some states have followed suit, but half still levy taxes on households with earnings below the poverty level.

The impact of state income tax systems on poor families has been increasing in importance in recent years because the number of working poor families has been growing across the United States. The increase in the number of families that have earnings from work but remain poor can be seen by comparing poverty rates in 1996 with those in 1979, two years when the economy was growing and unemployment rates were similar. The poverty rate for families with children in which the head-of-household worked climbed from 7.7 percent in 1979 to 11.0 percent in 1996, an increase of 40 percent.(2) In 1996, roughly 9.5 million poor children — two out of every three poor children — lived in a family with a working household member.

It is critical that more states address the problem of taxation of poor families, both in the interest of fairness and in order to further the objective of allowing parents who work to support their families adequately. The first step is understanding the extent of the burden families bear and the features of the tax system that affect those burdens.

 

Income Tax Thresholds

The tax threshold is the entry point into the income tax system. It is the income level at which a family begins to owe state income tax.(3) A state's threshold level is affected by two broad factors.

Income taxes generally are not imposed on total income. States typically allow nearly every taxpayer some subtractions from income, most often through personal and dependent exemptions and/or a standard deduction, before tax liability is calculated. Some states provide this broad tax relief through a tax credit — a dollar amount subtracted from the tax bill — for each household member or for each dependent. The size of these exemptions, deductions, and credits affects the income level at which families begin to owe tax.

In addition, 23 states target special deductions, exemptions, or tax credits on low-income families.(4) These features affect the tax threshold for low-income families without altering the tax structure for families with higher incomes. (For an explanation of how exemptions, deductions, and credits work, see Chapter IV.)

This report calculates the tax burden on two types of low-income families: a married couple with two children and a single parent with two children. In each case, it is assumed the family has only one wage earner and that the family's income comes entirely from earnings. The tax thresholds are based on each state's personal and dependent exemptions, standard deductions, state earned income tax credits, and other deductions or credits that are available to all low-income taxpayers with children.

The threshold calculations do not incorporate low-income credits that are based in part on factors other than income, such as the dependent care credit, because not all low-income families qualify for these credits and because the value of the credit for the typical family is difficult to identify. For example, a family with pre-school children may have child care expenses that make them eligible for a dependent care credit, while a similar family with older children may not incur such expenses and thus would not be eligible for the credit. In addition, low-income sales tax and property tax credits, which appear on income tax forms in some states, are excluded from the threshold calculations because they are not administered through the income tax in all states and, like a dependent care credit, are based on factors other than income. These credits are administered through the income tax primarily for ease of administration.

Tables 1A and 1B present the 1997 state income tax thresholds for single-parent families of three and two-parent families of four, respectively. The maps on pages 13 and 14 group the states according to their tax thresholds for each type of family in relation to the poverty line. The tables and maps show that:

Table 1A
State Income Tax Thresholds for Single-Parent Families of Three, 1997
Poverty Line = $12,804
 
Tax Imposed Below Poverty Line No Tax Below Poverty Line
Rank State Threshold Rank State Threshold
           
1. Illinois $3,000 21. North Carolina $13,900
2. Alabama 4,600 22. Colorado 14,000
3. Hawaii 4,800 22. District of Columbia 14,000
4. Kentucky 5,000 22. Idaho 14,000
5. Virginia 5,400 22. New Mexico 14,000
6. Montana 7,300 22. South Carolina 14,000
7. Michigan 7,500 27. Pennsylvania 14,300
7. New Jersey 7,500 28. Mississippi 14,400
9. Indiana 8,000 29. Maine 14,500
10. Oklahoma 8,700 29. Nebraska 14,500
11. Missouri 9,000 29. North Dakota 14,500
12. Ohio 9,700 32. Wisconsin 15,100
13. West Virginia 10,000 33. Massachusetts 16,400
14. Georgia 10,500 34. Iowa 16,500
15. Delaware 10,600 35. Arizona 19,100
16. Arkansas 10,700 35. Connecticut 19,100
17. Louisiana 11,800 37. Minnesota 19,300
18. Oregon 12,000 38. California 20,400
18. Utah 12,000 39. New York 21,100
20. Kansas 12,400 40. Maryland 22,500
      41. Rhode Island 22,900
      41. Vermont 22,900
           
Average Threshold 1997 $8,525 Average Threshold 1997 $16,882
Amount Below Poverty 4,279 Amount Above Poverty 4,078

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 1997 poverty line is an estimate based on the actual 1996 poverty line calculated by the Census Bureau adjusted for inflation. The threshold calculations include earned income 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, 1997

Poverty Line = $16,405

Tax Imposed Below Poverty Line

No Tax Below Poverty Line

Rank State Threshold Rank State Threshold
           
1. Illinois $4,000 22. Iowa $16,500
2. Alabama 4,600 23. North Carolina 17,000
3. Kentucky 5,000 23. Wisconsin 17,000
4. Hawaii 6,100 25. Massachusetts 17,400
5. New Jersey 7,500 26. Colorado 17,500
6. Virginia 8,200 26. District of Columbia 17,500
7. Indiana 8,500 26. Idaho 17,500
8. Montana 8,800 26. Maine 17,500
9. Michigan 10,000 26. New Mexico 17,500
9. West Virginia 10,000 26. South Carolina 17,500
11. Missouri 10,200 32. Nebraska 17,900
12. Arkansas 10,700 33. North Dakota 18,000
13. Ohio 12,000 34. Arizona 20,000
14. Oklahoma 12,200 35. Pennsylvania 20,600
15. Louisiana 12,300 36. Minnesota 21,600
16. Delaware 12,700 37. New York 22,300
17. Kansas 13,000 38. Maryland 22,900
18. Georgia 13,100 39. California 23,800
19. Oregon 14,000 40. Connecticut 24,100
20. Utah 14,900 41. Rhode Island 24,400
21. Mississippi 15,900 41. Vermont 24,400
           
Average Threshold 1997 $10,176 Average Threshold 1997 $19,662
Amount Below Poverty 6,229 Amount Above Poverty 3,257

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 1997 poverty line is an estimate based on the actual 1996 poverty line calculated by the Census Bureau adjusted for inflation. The threshold calculations include earned income 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

 

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There were some common patterns among states that helped determine whether a state had a high threshold or a low threshold. Not surprisingly, the states with the lowest thresholds tended to have very low personal and dependent exemptions and standard deductions. For example, in the eight states with the lowest thresholds, the combined amount of the personal and dependent exemptions and standard deduction for a single-parent family of three averaged only $4,996, or 39 percent of the poverty line, compared with an average of $11,023, or 86 percent of the poverty line, for the other 34 states with an income tax.(5) A similar pattern held for the deductions and exemptions available to a two-parent family of four.

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Similarly, most of the states with low income tax thresholds provided little or no targeted income tax relief for low-income residents. Of the eight states with the lowest thresholds for families of three, only Kentucky had an income tax credit for low-income families. New Jersey had a no-tax floor set at $7,500 — less than half the poverty level for a family of four. The pattern was similar for states that had the lowest thresholds for families of four.

In contrast, the states with the highest thresholds tended to use tax credits and more generous personal and dependent exemptions and standard deductions to raise the threshold level.(6) The average combined value of the personal and dependent exemptions and standard deduction in the seven states with the highest tax thresholds was higher than the poverty line for both families of four and families of three.(7) In other words, these states generally set basic deductions at a level sufficient to exempt poor families from owing income tax. In addition to these basic deductions, all but one of these states — California — also offered substantial tax credits or deductions targeted specifically on low-income families that either raised the income tax threshold or lowered taxes for low-income families.

 

Taxes at the Poverty Line

Levying an income tax on the poor pushes families deeper into poverty, compounding the challenge of making ends meet. The amount of state income tax owed by families with incomes just equal to the poverty line can be quite substantial. In the states with below-poverty tax thresholds, the tax bill for poor families varied greatly in 1997, from as little as a few dollars to more than $500. By contrast, poor families who lived in states with tax thresholds above the poverty line did not owe any income tax, and in a handful of these states, such families actually qualified for a state tax refund.

 

Table 2B
State Income Tax at Poverty Line
for Two-Parent Families of Four, 1997

  State

Income

Tax
 
1. Kentucky $16,405 $555
2. Hawaii 16,405 501
3. Arkansas 16,405 427
4. Alabama 16,405 398
5. Indiana 16,405 388
6. Illinois 16,405 372
7. Michigan 16,405 282
8. Virginia 16,405 281
9. West Virginia 16,405 254
10. Oregon 16,405 240
11. Montana 16,405 219
12. Delaware 16,405 215
13. Oklahoma 16,405 184
14. Missouri 16,405 181
15. New Jersey 16,405 160
16. Kansas 16,405 120
17. Georgia 16,405 108
18. Ohio 16,405 102
19. Louisiana 16,405 83
20. Utah 16,405 37
21. Mississippi 16,405 15
22. Arizona 16,405 0
22. California 16,405 0
22. Colorado 16,405 0
22. Connecticut 16,405 0
22. District of Columbia 16,405 0
22. Idaho* 16,405 0
22. Iowa 16,405 0
22. Maine 16,405 0
22. Maryland 16,405 0
22. Nebraska 16,405 0
22. New Mexico 16,405 0
22. North Carolina 16,405 0
22. North Dakota 16,405 0
22. Pennsylvania 16,405 0
22. Rhode Island 16,405 0
22. South Carolina 16,405 0
38. Wisconsin 16,405 (48)
39. Massachusetts 16,405 (117)
40. Minnesota 16,405 (407)
41. New York 16,405 (487)
42. Vermont 16,405 (678)
*The income tax threshold for a two-parent family of four in Idaho was $17,500 in 1997 but there was a $10 permanent building fund tax on each filing household.
Source: Center on Budget and Policy Priorities

 

Taxes at Minimum Wage

A third measure of the burden of state income taxes on poor families is the tax owed by families with minimum wage earnings, an income level that is well below the poverty line. In most states, full-time minimum wage income in 1997 amounted to

$10,157 per year, or 79 percent of poverty for a family of three and just 62 percent of poverty for a family of four.(9) Some eight states that levy income taxes set the minimum wage higher than the federal standard during some or all of 1997. Yet even in these states, minimum wage earnings fell significantly below the poverty line for families of three or four.

A popular stereotype holds that minimum wage workers are mostly teenagers or secondary earners in families that are not poor. Yet the reality is very different from this conception. In 1993, fewer than one in three minimum-wage workers were teenagers, while nearly half were 25 and older. An analysis of the recent increase in the federal minimum wage shows that 40 percent of the additional earnings resulting from the increase will benefit the lowest-income 20 percent of families.(10) Given the reliance of many low-income families on a parent earning the minimum wage, relieving income taxes on families at this income level should be a priority.(11)

Despite the difficulty of supporting a family on minimum wage earnings, a number of states in 1997 levied an income tax on families in which a parent earns at this level. Tables 3A and 3B indicate the income tax liability for single-parent families of three and two-parent families of four with one full-time year-round minimum wage worker. In the eight states with an income tax that also had a minimum wage higher than the federal requirement during some or all of 1997, the tax is calculated for the state-specific minimum wage.

Table 3A
State Income Tax at Minimum Wage for
Single-Parent Families of Three, 1997

 
  State Income* Tax
 
1. Hawaii** $10,920 $272
2. Kentucky 10,157 221
3. Illinois 10,157 215
4. Alabama 10,157 188
5. Indiana 10,157 147
6. West Virginia 10,157 125
7. Michigan 10,157 117
8. Virginia 10,157 113
9. New Jersey** 10,573 92
10. Montana 10,157 69
11. Oklahoma 10,157 53
12. Missouri 10,157 22
13. Ohio 10,157 7
14. Arizona 10,157 0
14. Arkansas 10,157 0
14. California** 10,504 0
14. Colorado 10,157 0
14. Connecticut** 10,206 0
14. Delaware 10,157 0
14. District of Columbia** 12,237 0
14. Idaho*** 10,157 0
14. Iowa 10,157 0
14. Kansas 10,157 0
14. Louisiana 10,157 0
14. Maine 10,157 0
14. Maryland 10,157 0
14. Mississippi 10,157 0
14. Nebraska 10,157 0
14. North Carolina 10,157 0
14. North Dakota 10,157 0
14. Oregon** 11,440 0
14. Pennsylvania 10,157 0
14. Rhode Island 10,157 0
14. South Carolina 10,157 0
14. Utah 10,157 0
36. Georgia 10,157 (7)
37. New Mexico 10,157 (30)
38. Massachusetts** 10,920 (366)
39. Wisconsin 10,157 (430)
40. Minnesota 10,157 (548)
41. New York 10,157 (731)
42. Vermont** 10,608 (914)
*Income reflects full-time, year-round minimum wage earnings for one worker (52 weeks at 40 hours per week).
**Eight states had a minimum wage higher than the federal minimum wage in all or part of 1997.
***The income tax threshold in Idaho was higher than minimum wage earnings in 1997, but each filing household paid a $10 permanent building fund tax.
Source
: Center on Budget and Policy Priorities

 

Table 3B
State Income Tax at Minimum Wage for
Two-Parent Families of Four, 1997

       
  State Income* Tax
       
1. Kentucky $10,157 $206
2. Illinois 10,157 185
3. Alabama 10,157 162
4. Hawaii** 10,920 135
5. Indiana 10,157 113
6. New Jersey** 10,573 73
7. West Virginia 10,157 65
8. Virginia 10,157 39
9. Montana 10,157 28
10. Michigan 10,157 7
11. Arizona 10,157 0
11. Arkansas 10,157 0
11. California** 10,504 0
11. Colorado 10,157 0
11. Connecticut** 10,205 0
11. Delaware 10,157 0
11. District of Columbia** 12,237 0
11. Idaho*** 10,157 0
11. Iowa 10,157 0
11. Kansas 10,157 0
11. Louisiana 10,157 0
11. Maine 10,157 0
11. Maryland 10,157 0
11. Mississippi 10,157 0
11. Missouri 10,157 0
11. Nebraska 10,157 0
11. North Carolina 10,157 0
11. North Dakota 10,157 0
11. Ohio 10,157 0
11. Oklahoma 10,157 0
11. Oregon** 11,440 0
11. Pennsylvania 10,157 0
11. Rhode Island 10,157 0
11. South Carolina 10,157 0
11. Utah 10,157 0
36. Georgia 10,157 (32)
37. New Mexico 10,157 (40)
38. Massachusetts** 10,920 (366)
39. Wisconsin 10,157 (512)
40. Minnesota 10,157 (548)
41. New York 10,157 (731)
42. Vermont** 10,608 (914)
*Income reflects full-time, year-round minimum wage earnings for one worker (52 weeks at 40 hours perweek).
**Eight states had a minimum wage higher than the federal minimum wage in all or part of 1997.
***The income tax threshold in Idaho was higher than minimum wage earnings in 1997, but each filing household paid a $10 per manent building fund tax.

Source: Center on Budget and Policy Priorities

End Notes

1. At some income levels, particularly those modestly above the poverty line, workers face marginal tax rates ranging from 67 percent to 79 percent from the combination of federal income and social security taxes, the phaseout of the federal earned income tax credit, and the loss of food stamps.

2. Part of this increase reflects growth in the share of working families with children that are headed by a single female parent, since this group is much more likely to be poor than are two-parent families. Nevertheless, the poverty rate among families with a working parent has grown for both single-parent and two-parent families.

3. A state's threshold tax level is not necessarily the same as the income level above which families are required to file an income tax return. For example, many states require families to file a state income tax return if they are also required to file a federal income tax return. (Federal filing requirements in 1997 for most taxpayers under age 65 were gross income of at least $8,550 for a head of household and at least $12,200 for a married couple filing jointly.) Most other states specify a minimum amount of income above which families are required to file that is lower than or equal to the tax threshold level.

4. In one state, Pennsylvania, a low-income "tax forgiveness" credit is the only method used to reduce taxes for low-income residents. The state income tax does not include personal or dependent exemptions, nor a standard deduction.

5. These calculations reflect the combined personal and dependent exemptions and standard deductions at the income tax threshold in each state. They include the relevant amounts allowed on federal income taxes for those states that implicitly incorporate the federal personal and dependent exemptions and standard deduction by using federal taxable income or federal tax liability as the starting points in their state income tax systems. They also include the implicit amounts for Connecticut and Louisiana, states that build some exemptions and standard deductions into their tax tables.

In most states, personal and dependent exemptions were specified amounts that tax filers deduct from their adjusted gross income before computing their tax liability. A small number of states had personal and dependent exemption credits, under which tax filers subtracted a specified amount per exemption or dependent from their calculated tax liability. For states with personal or dependent exemption credits, the credit amount was converted to an equivalent income deduction amount based on the marginal tax rate for a low-income family for purposes of this comparison.

6. The exception was Pennsylvania, which offered neither exemptions nor a standard deduction but still had a relatively high threshold. Pennsylvania relied entirely on a low-income tax credit to avoid levying the income tax on low-income families.

7. The average value of these combined deductions for a family of three equaled 116 percent of the poverty line. The average value of these deductions available to families of four equaled 107 percent of the poverty line.

8.Four other states — Iowa, Maryland, Oregon, and Rhode Island — also had a state EITC in 1997, but these non-refundable credits could be used only to eliminate taxes on low-income families and not to provide refunds.

9. The federal minimum wage increased from $4.75 an hour to $5.15 an hour on September 1, 1997.

10. Jared Bernstein and John Schmitt, The Sky Hasn't Fallen: An Evaluation of the Minimum Wage Increase, Economic Policy Institute, 1997.

11. It should be noted that states typically do not allow teenagers who can be claimed as a dependent on their parents' income tax return to enjoy the full benefit of personal exemptions, standard deductions, and tax credits on their own income tax returns. Therefore, states can raise income tax thresholds for families with minimum wage income levels without unduly benefitting teenagers in high-income families.


Chapter I. Summary
Chapter II. State Income Taxes on Poor Families in 1997
Chapter III. Recent Changes in State Income Tax Burdens on the Poor
Chapter IV. Strategies for Relieving State Tax Burdens on Poor Families
Chapter V. Conclusion
Appendix I: State Earned Income Tax Credits in 1997