The Impact of State Income Taxes on Low-Income Families in 2005
February 22, 2006
Poor families in many states face substantial state income tax liability for the 2005 tax year. In 19 of the 42 states that levy income taxes, two-parent families of four with incomes below the federal poverty line are liable for income tax. In 16 of the 42 states, poor single-parent families of three pay income tax. And 31 of these states collect taxes from two-parent families of four with incomes just above the poverty line.
Some states levy income tax on working families in severe poverty. In Alabama, families with two children owe income tax when their earnings reach $4,600. This amount is less than one-third of the 2005 federal poverty line for one-parent families of three ($15,577), and less than one-quarter of the poverty line for two-parent families of four ($19,961). Alabama plus six other states -- Hawaii, Indiana, Louisiana, Michigan, Montana, and West Virginia -- tax the incomes of three- or four-person families earning less than three-quarters of the poverty line.
In some states, families living in poverty face income tax bills of several hundred dollars. A two-parent family of four in Alabama with income at the poverty line owes $538 in income tax, while such a family in Hawaii owes $470 and in Arkansas $406. Such amounts can make a big difference to a family struggling to escape poverty. Other states levying tax of $200 or more on families with poverty-level incomes include Indiana, Michigan, Montana, Oregon, Virginia, and West Virginia.
Some states have achieved progress in improving their income-tax treatment of the poor, but others have not. Between 2004 and 2005, Kentucky, Montana, Ohio, the District of Columbia, and Rhode Island implemented policies that reduce the income tax liability of poor families. The number of states that tax poor families, however, has increased since 2004. Since the early 1990s, the number of states that tax poor two-parent families of four has declined from 24 to 19, but in Alabama, Arkansas, Iowa, Louisiana, Mississippi, Virginia, and West Virginia poor families' tax liability has increased, even after accounting for inflation. The reason for these tax increases is that provisions designed to protect low-income families from taxation -- including standard deductions, personal exemptions and low-income credits -- have not been increased to keep up with inflation.
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 taxes 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 impact of those taxes -- only of income taxes.
Taxing the incomes of working-poor families runs counter to the efforts of policymakers across the political spectrum to help families work their way out of poverty. The federal government has exempted such families from the income tax since the mid-1980s, and a majority of states now do so as well.
Eliminating 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 taxes on poor families can make a meaningful contribution toward "making work pay." Several states -- including Alabama and Hawaii -- are considering measures in their current legislative sessions that would considerably improve their income-tax treatment of the poor.
States seeking to reduce or eliminate income taxes on low-income families can choose from an array 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. Some states go beyond exempting poor families from income tax by making their EITCs or other low-income credits refundable. These policies mean a lot to a family struggling to escape poverty, but they are relatively inexpensive to states, since these families have little income to tax.
Despite some progress, there remains much to do before state income taxes adequately protect and assist families working to escape poverty.