The Impact of State Income Taxes on Low-Income Families in 2007
October 29, 2008
Poor families in many states faced substantial state income tax liability for the 2007 tax year. In 18 of the 42 states that levy income taxes, two-parent families of four with incomes below the federal poverty line were liable for income tax. In 15 states, poor single-parent families of three paid income tax in 2007. And 26 states collected taxes from families of four with incomes just above the poverty line. In 2007, the federal poverty line for a family of four was $21,203, and the line for a family of three was $16,530.
Some states levy income tax on working families in severe poverty. Nine states -- Alabama, Georgia, Hawaii, Illinois, Indiana, Michigan, Montana, Ohio and West Virginia -- tax the income of two-parent families of four earning less than three-quarters of the poverty line ($15,902). And six states -- Alabama, Hawaii, Louisiana, Michigan, Montana, and West Virginia --tax the income of one-parent families of three earning less than three-quarters of the poverty line ($12,398).
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 $423 in income tax, while such a family owes $409 in Hawaii, $325 in Oregon, and $258 in West Virginia. Such amounts can make a big difference to a family struggling to escape poverty. Other states levying tax of more than $200 on families with poverty-level incomes include Illinois, Indiana, Iowa, Michigan,and Montana. At the other end of the spectrum, a growing number of states offer significant refunds to low-income working families, primarily through Earned Income Tax Credits.
Between 2006 and 2007, states' tax treatment of poor families improved in a number of states, but worsened in others. Twelve states implemented measures to shield more low-income families from the income tax or to reduce the taxes they owe. Alabama, Arkansas, New Jersey, and West Virginia -- which in 2006 levied some of the highest taxes on low-income families -- made major improvements in 2007.
Unfortunately, a number of other states increased income taxes on poor families, though by smaller amounts. 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 -- were not increased to keep up with inflation.
Future years are set to bring continued improvement. A number of states have enacted reforms that will reduce taxes on low-income families in the near future. Between 2008 and 2010, the District of Columbia, Indiana, Louisiana, Maryland, Michigan, New Jersey, North Carolina, Oklahoma and West Virginia each will improve their income tax treatment of the poor. If these changes were in effect in 2007, the number of states taxing poor families of four would have been 15 rather than 18, and the number taxing poor families of three would have been 11 rather than 15.
Despite these upcoming improvements, there remains much to do. Some of the harshest states have not improved their income tax treatment of the poor for many years, and some recent improvements were not enough to exempt very poor families from 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."
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 provide a substantial income supplement to families struggling to escape poverty, and they are relatively inexpensive to states, since these families have little income to tax.
 Additional data analysis for this report was provided by Jeremy Koulish, Katherine Lira, Phil Oliff, Elizabeth McNichol, and Michael Mazerov.