Most States Now Exempt Poor Families From Income Tax,
But Tax Relief is Overdue in Many Others

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Despite widespread tax reductions and a strong economy, 19 of the 42 states with income taxes continue to tax poor working families, according to a new study of state income-tax thresholds. But 23 others now exempt from income taxation families of three or four with incomes at or below the federal poverty level, the highest number of states in recent history.

The annual report, published by the Center on Budget and Policy Priorities, assesses the impact of each state's income tax on low-income families in 1998. It focuses on income tax thresholds, the income level at which a family would begin to owe state income tax. This year's report also evaluates trends in state income tax policies since 1991.

The biggest changes have come in the last two years, as five states stopped taxing the incomes of poor families, and six others brought their thresholds up closer to the poverty line. Still, in six states even very poor families with incomes below half of the poverty line remain liable to taxation.

The 1998 poverty line was $16,655 for a family of four and $13,001 for a family of three.

"Overall, we see a dramatic and heartening trend, but it does not go far enough," said Elizabeth McNichol, director of the Center's State Fiscal Project and co-author of the report. "Income tax relief is one of the simplest ways states can help low-income working families to meet the costs of child care, transportation and other expenses and thereby become self-sufficient."

The new reductions for the working poor reflect, in part, a growing awareness among policymakers of the importance of "making work pay" for low-income families. Many states are urging more families to make the transition from welfare to work, and welfare caseloads are declining.

"The majority of states have recognized the inconsistency of encouraging poor families to work and then taxing them back under the poverty line," said Nicholas Johnson, co-author of the report. Still, he added, "many parents are working long hours for little money as they struggle to make the transition from welfare to work. At a time when most states no longer tax the poor, to continue to do so is unconscionable and counterproductive."

Recent evidence from a number of states shows that while welfare caseloads are declining and more families have earnings from work, the earnings of welfare recipients who find jobs are rarely sufficient to lift their families out of poverty. A number of studies show that welfare recipients who find jobs are working a substantial number of hours but have average earnings of only $2,000 to $2,700 per quarter, or $8,000 to $10,800 per year. Many earn less.

The report notes that states have made more progress toward relieving the tax burden on working poor families in the last two years than they made over the previous six years. From 1991 to 1996, the number of states that taxed the incomes of poor families did not change, and only six of the states that taxed the poor in 1991 increased their thresholds by amounts greater than the increases in the poverty line during that time. By contrast, in the past two years, six states brought their thresholds substantially closer to the poverty line, while five other states ceased taxing the incomes of poor families altogether. In particular:

• Kansas and Mississippi are the most recent states to exempt the poor from income tax. The Kansas income tax threshold for a two-parent family of four rose from $13,000 in 1997 to $20,700 in 1998. The Mississippi threshold rose from $15,900 to $17,200. The other three states that raised their thresholds above the poverty line since 1996 were Maine, Massachusetts, and Pennsylvania. Several additional states have adopted new tax provisions aimed at helping low-income families.

• Between 1996 and 1998, three states — Kansas, Maryland, and Massachusetts — enacted new tax credits that offer refunds to poor families with no tax liability. Three other states, Minnesota, New Mexico and Wisconsin, substantially increased the value of existing refunds for families with incomes at the poverty line. Such credits help offset the impact on poor families of state and local sales and property taxes and boost the income of low-wage working families.

Not all poor families are benefitting from this trend. In some states, the burden of the income tax on the poor is rising. Of the 19 states that continue to tax the incomes of poor families of three or four, 11 have allowed their thresholds to decline relative to the poverty line during the 1990s. The poverty line is adjusted each year to reflect the increasing cost of supporting a family, but many states' income tax thresholds are not similarly adjusted.

In 1998, low-income families in states with below-poverty thresholds were pushed deeper into poverty. The report finds:

• The average level at which a two-parent family of four began to owe tax in these states was about $10,400, well below the 1998 poverty line of $16,655 for a family of four.

• In 1998 six states — Alabama, Hawaii, Illinois, Kentucky, New Jersey, and Virginia — imposed an income tax on very poor families of three or four, those with incomes below half the poverty line. Those six states and eight others also levied income taxes on poor families earning no more than the minimum wage for full-time work.

• For families of three with incomes at the poverty line, the average income tax liability was $162 in states with below-poverty tax thresholds. In six states — Alabama, Hawaii, Illinois, Indiana, Kentucky and Virginia — working families with poverty-level earnings paid a tax of $250 or more.

• Working families of four with incomes at the poverty line paid an average state tax bill of $245 in the states with below-poverty tax thresholds. In eight states, including Alabama, Arkansas, Hawaii, Illinois, Indiana, Kentucky, West Virginia, and Virginia, the income tax bill for such a family exceeded $250.

• Several states with income tax thresholds that were still below the poverty line nonetheless significantly increased the thresholds since 1996. Arkansas, whose threshold for a family of four was $10,700 from 1991 to 1997, raised it to $15,600 in 1998, slightly below the poverty line. The threshold in Georgia for a family of four rose from $11,100 to $15,300 over the two years. Indiana and Oregon also enacted substantial increases.

By contrast, the report finds a substantial number of states assisted low- and moderate-income working families by levying no income tax until a family's income was well above the poverty line or by offering refundable tax credits for low-income families.

• Ten states — Arizona, California, Connecticut, Maryland, Massachusetts, Minnesota, New York, Pennsylvania, Rhode Island, and Vermont — had tax thresholds of $21,000 or higher for two-parent families of four, eliminating taxes for families with incomes up to approximately 125 percent or more of the poverty line.

• Nine states — Georgia, Kansas, Maryland, Massachusetts, Minnesota, New Mexico, New York, Vermont and Wisconsin — provide tax credits that offer refunds to poor families with no tax liability which help offset the impact of state and local sales and property taxes. The 1998 refunds provided to families with incomes at the poverty line in these states were as high as $1,127 for a two-parent family of four in Minnesota and $900 for a single parent with two children in Vermont.

States used a variety of policies to relieve income tax burdens on the poor. Most of the states that did not tax the working poor allowed relatively large deductions from income through personal and dependent exemptions and standard deductions. In addition, 25 states had adopted measures that specifically target tax relief on low-income families.

Although most state economies expanded through the 1990s and more than half of the states enacted significant personal income tax cuts in the last four years, somewhat fewer states made it a priority to end the taxation of the poor. Thirteen of the 15 states with the largest income tax cuts in recent years chose to cut top tax rates or cut all tax rates in ways that provide a disproportionate benefit to higher-income taxpayers. Six of the 15 states that enacted the largest personal income tax cuts in recent years — Delaware, Hawaii, Michigan, New Jersey, Ohio, and Oregon — still have income tax thresholds below the poverty line.

This report was issued by the State Fiscal Project of the Center on Budget and Policy Priorities, a national nonpartisan research organization and policy institute that conducts research and analysis on a range of government policies and programs, with an emphasis on those affecting low- and moderate-income households. The State Fiscal Project, which was founded in 1992, prepares analyses and provides technical assistance on state tax and budget issues. The Center on Budget and Policy Priorities is supported primarily by foundation grants.

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