February 22, 2006
THE IMPACT OF STATE INCOME TAXES ON LOW-INCOME FAMILIES IN 2005
By Jason A. Levitis and Nicholas Johnson
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
Click here for the PDF of the full report.