State Income Tax Burdens on Low-Income Families in 1997:
Assessing the Burden and Opportunities for Relief
Seven years into the current economic recovery, states are making modest new progress in relieving the income tax burden on working families with incomes below the poverty line. Three fewer states levied income taxes on poor working families in 1997 than in 1996. As a result of the changes in these three states Maine, Massachusetts, and Pennsylvania it can no longer be said that the majority of states tax the incomes of working poor families. In 1997, the income tax threshold the income level at which income tax is first owed was above the poverty line for two-parent families with two children in exactly half of the 42 states imposing income taxes.(1) The 1997 income tax threshold for a single working parent with two children was above the poverty line in a majority of states.
At a time when states are urging more families to make the transition from welfare to work, such progress in relieving state income tax burdens is welcome. Eliminating all state income taxes on working families with below-poverty incomes results in 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 families below the poverty line is making a meaningful contribution toward "making work pay."
The progress that was made last year in removing income taxes from poor families in three states is part of a longer and broader trend. Four states that imposed income taxes on families with below-poverty incomes in 1991 no longer do so. Six additional states with tax thresholds below the poverty line in 1991 have since increased the thresholds by amounts greater than the increase in the poverty line in the 1991-97 period. As a result, the share of poor families' income subject to tax in these six states is smaller today than it was in 1991.
Still, progress has by no means been universal. Of the 24 states that taxed the income of some poor families in 1991, at the deepest point of the last recession, 20 continue to tax them today, seven years into the economic recovery.
More than a decade ago, the federal government recognized that taxing poor families was counterproductive and unfair. As part of federal tax reform in 1986, virtually all families below the poverty line were relieved of federal income tax liability. By 1997, approximately half of the states implemented this same policy.
Many of the states that have not yet removed state income taxes from poor families have not made it a priority to do so. Most state economies expanded through the 1990s and most states experienced robust fiscal condition. As a result, 20 states enacted significant personal income tax cuts in the last four years. But nine of the 12 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. Four of the states Michigan, New Jersey, Ohio and Oregon that have enacted the largest personal income tax cuts in recent years still have income tax thresholds below the poverty line.
Further tax reductions are under consideration or discussion in many states. Today's generally healthy fiscal conditions provide an opportunity for many more states to remove poor families from the income tax rolls, if they make such action a priority.
This report assesses the impact of each state's income tax on poor families. It focuses on the income tax threshold in each state, which is the income level at which a family would begin to owe state income tax.
- In 21 of 42 states with income taxes, the income tax threshold for a family of four with two children was above the poverty line in 1997. For single-parent families of three, the state income tax threshold was above the poverty line in 22 states. In these states, families with below-poverty income were not required to pay income taxes.
- In the states that did levy income taxes on some poor families, the average level at which a two-parent family of four began to owe tax was more than $6,200 below the 1997 poverty line of $16,405 for a family of four. For a single-parent family of three, the average tax threshold in these states was $4,300 below the poverty line of $12,804.
- 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. Thirteen states imposed an income tax on poor families of three or four with a worker earning the minimum wage, an income level several thousand dollars below the poverty line.
- The two states with the highest thresholds were Rhode Island and Vermont, the states that conform most completely to the federal tax system. In Rhode Island and Vermont the threshold was $24,400 for a family of four and $22,900 for a family of three. Illinois had the lowest income tax threshold, $4,000 for a family of four and $3,000 for a family of three.(2)
Taxes on Poor Families
The impact of state income tax policy on poor families' budgets can be significant. Levying an income tax on the poor pushes families deeper into poverty, compounding the challenge of making ends meet.
- The average 1997 income tax bill for a family with income at the poverty line in the states with below-poverty thresholds was $243 for a two-parent family of four and $167 for a single parent with two children. The 1997 tax bill was as high as $555 on a family of four (in Kentucky) and $406 on a family of three (in Hawaii).
- By contrast, a number of states levied no income tax until a family's income was well above the poverty line. Nine states Arizona, California, Connecticut, Maryland, Minnesota, New York, Pennsylvania, Rhode Island, and Vermont had tax thresholds of $20,000 or higher for two-parent families of four, thus eliminating taxes for families with income up to approximately 125 percent or more of the poverty line.
- Six states with tax thresholds above the poverty line went even further. These states Massachusetts, Minnesota, New Mexico, New York, Vermont, and Wisconsin had state tax credits that provided refunds to low-income families with no tax liability.(3) The refundable credits acted as a wage supplement and/or as an offset to the other state and local taxes paid by low-income families. In five of these states, the refundable credits were state earned income tax credits that piggy-backed on the federal earned income tax credit. The 1997 refunds provided to families with poverty-level income in these states were as high as $678 for a two-parent family of four and $868 for a single parent with two children.
Tax Relief Strategies
States used a variety of methods to relieve income tax burdens on the poor. States generally chose the strategies that fit best with their overall policies and philosophies of taxation.
- Most of the 21 states that did not tax the working poor in 1997 allowed relatively large deductions from income through personal and dependent exemptions and standard deductions. For example, the average combined value of these deductions in eight of the nine states with tax thresholds above $20,000 was higher than the poverty line for families of both three and four.
- Twenty-three states adopted measures that specifically target tax relief on low-income families. Due to the limited size of some of these measures, however, some of these states continued to tax poor families.
- Of particular note, six states went beyond eliminating tax liability and offered credits that provided tax refunds to some or all families with poverty-level incomes. The refunds from these credits were intended to boost the incomes of families with low-wage workers and to offset the burden of other state and local taxes paid by low-income families, primarily sales taxes and property taxes.
Recent Changes in Taxation of Poor Families
States have made noteworthy progress in relieving state income tax burdens on the poor during the last two years.
- In 1996 or 1997, four states implemented legislation to raise income tax thresholds above the poverty line. The four states were Massachusetts, North Carolina, Maine, and Pennsylvania. A fifth state, Mississippi, has taken action to raise its income tax threshold above the poverty line in 1998.
- A number of states with income tax thresholds that are still below the poverty line have nonetheless significantly increased the thresholds during the past two years. Indiana more than doubled its income tax threshold between 1996 and 1997, and Oregon enacted a new, non-refundable earned income tax credit that raised its income tax threshold for families of four from $11,400 in 1996 to $14,000 in 1997.
- Several other states with below-poverty thresholds are phasing in increases, including Arkansas, Georgia, Kentucky, Michigan, and Ohio.
Changes in Thresholds 1991-1997
Between 1991 and 1997, the dollar amount of the income tax threshold increased in the majority of states. Small changes in the nominal value of a threshold, however, will not necessarily protect a working poor family from taxation. The poverty line is adjusted upward each year as the cost of supporting a family rises. Changes in income tax thresholds must be judged by whether the change has been sufficient to relieve families living in poverty from taxation or to maintain such relief.
- Seventeen of the 24 states with below-poverty thresholds for families of four in 1991 raised those thresholds between 1991 and 1997, but in only four states was the amount of increase large enough to bring the state's threshold above the poverty line. Massachusetts, North Carolina, Pennsylvania, and Iowa were the only states that raised their thresholds enough since 1991 to eliminate income taxes on poor families of four.
- In seven states with below-poverty thresholds in 1991 Alabama, Arkansas, Hawaii, Illinois, Kansas, Kentucky, and Virginia the dollar amount of thresholds did not increase at all.(4) Because the poverty line increases each year as it is adjusted for inflation, income tax thresholds in these states fell further and further below poverty. In these states, families with incomes at increasingly smaller percentages of a poverty-level income became subject to taxation.
- States that had already removed poor families of four from their income tax rolls by 1991 were much more likely to target additional income tax relief to near-poor families. These states almost universally increased their thresholds between 1991 and 1997 by amounts greater than the increase in the poverty line over that period. These increases served to provide tax relief to near-poor as well as poor families in these states.
- Only one state Mississippi did not tax families of four living in poverty in 1991 but does so now. However, as a result of changes enacted last year, Mississippi's tax threshold for families of four is again expected to be above the poverty line in tax year 1998.
End Notes 1. The District of Columbia is treated as a state in this report. The two states that tax only interest and dividends (New Hampshire and Tennessee) are not included among the 42 states with income taxes for purposes of this report.
2. Despite having the lowest threshold, Illinois did not impose the highest tax bills on families at the poverty line or minimum wage income. Some states that had thresholds higher than Illinois but that still taxed families with minimum-wage or below-poverty income levied taxes at higher tax rates than did Illinois. Those higher rates resulted in higher tax bills.
3. Georgia's low-income credit is also refundable and leads to a net refund to families with a minimum wage income. However, the maximum credit is not sufficient to fully offset tax liability at a poverty-level income, so that families with incomes at the poverty line pay Georgia pay income tax.
4. Two of these states Arkansas and Kentucky have enacted tax changes scheduled to go into effect in 1998 or later that would raise the income tax threshold, but the changes will be insufficient to raise thresholds above the poverty line. Other states are considering similar changes.
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