March 27, 2007
THE IMPACT OF STATE INCOME TAXES ON LOW-INCOME FAMILIES IN 2006
By Jason Levitis<![if !supportFootnotes]><![endif]>
Poor families in many states face substantial state income tax liability for the 2006 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 15 of the 42 states, poor single-parent families of three pay income tax. And 29 of these states collect taxes from families of four with incomes just above the poverty line.
Some states levy income tax on working families in severe poverty. Six states — Alabama, Hawaii, Indiana, Michigan, Montana, and West Virginia — tax the income of two-parent families of four earning less than three-quarters of the poverty line such families. All of these states except Indiana also tax the income of one-parent families of three 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 $573 in income tax, while such a family in Hawaii owes $546, in Arkansas $427, and in West Virginia $406. 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 Indiana, Iowa, Michigan, Montana, New Jersey, and Oregon. In 2006, the federal poverty line for a family of four was $20,615, and the line for a family of three was $16,079.
States’ tax treatment of low-income families for 2006 has improved in some states since 2005 but gotten worse in others. Between 2005 and 2006, Oklahoma and Oregon reduced the income tax liability of poor families, Delaware entirely stopped taxing the incomes of poor families of three, and Virginia entirely stopped taxing the income of poor families of four. But four other states increased their taxes on poor families by 25 percent or more, and New Jersey began taxing poor families of four for the first time since 1998. 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. Overall, there was virtually no change this year in the number of states levying income taxes on families with incomes below the poverty line.
The outlook for the future is somewhat better. A number of states have recently enacted significant reforms that will reduce taxes on low-income families. Between 2007 and 2010, Alabama, Arkansas, Hawaii, Michigan, Oklahoma, Oregon, and West Virginia each will improve their income tax treatment of the poor. In Arkansas, Michigan, Oklahoma, and West Virginia, the changes will wipe out or dramatically reduce tax liability that now costs poor families hundreds of dollars. Overall, the number of states taxing poor families of four could decline from 19 to 16. And quite a few other states are currently considering similar measures.
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, 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.
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<![if !supportFootnotes]><![endif]> Additional data analysis for this report was provided by Sarah Farkas, Brian Filipowich, Nicholas Johnson, Sloane Kuney, Karen Lyons, Michael Mazerov, Elizabeth C. McNichol, and Ifie Okwuje.