Yesterday, the Institute on Taxation and Economic Policy (ITEP) issued the sixth edition of its “Who Pays?” report, which attempts to quantify the distributional impact of the tax A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. codes of all 50 states and the District of Columbia. The publication’s “Inequality Index” is widely cited, particularly since many states which are widely touted as having competitive tax codes rank poorly on ITEP’s measure of income inequality. Given the prominence of this study, it is worth considering what it can and cannot tell us.
In practice, the “Who Pays?” report is overwhelmingly a measure of the progressivity of the individual income tax An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , and not of the tax code as a whole. States with flatter income taxes, or which forgo an income tax altogether, rank very poorly under ITEP’s methodology regardless of what the rest of their tax code looks like—because, to a significant extent, the rest of the tax code is omitted from ITEP’s analysis.
All distributional analyses are estimates and require certain stylized assumptions to be made, assumptions which won’t perfectly correspond with the real world. It’s important, though, for those assumptions to be as realistic as possible, and in this, ITEP’s approach has some serious shortcomings and relies on extremely outdated taxpayer data. Here are some points to bear in mind when considering ITEP’s results.
Although ITEP has generally favored higher corporate income taxes and clearly regards them as progressive, a state’s corporate income tax does almost nothing to improve the state’s progressivity in “Who Pays?” That’s because ITEP rightly observes that the burden of corporate income taxes is borne by owners/investors, wage earners, and customers, and that much of the burden is “exported” to investors, customers, and even employees in other states and around the world. So far, so good. This assumption is certainly correct. But ITEP’s solution to this problem is to take a significant fraction of corporate income tax burdens allocated to out-of-state payers and simply exclude it entirely from the analysis. The excluded portion disproportionately falls on higher-income owners of capital, thus making state tax codes look significantly less progressive by its omission.
ITEP does deserve credit for an important methodological improvement in the latest edition. In the past, we have criticized their inclusion of what they term the “federal offset”–in fact, the state and local tax deduction A tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. –as if it were a state, rather than a federal, tax policy. By cherry-picking one regressive provision in an otherwise highly progressive federal tax code and applying it in an analysis of state taxes, ITEP made every state’s tax code look significantly more regressive.
Now that the state and local tax deduction is capped at $10,000 under the new federal tax law, ITEP made the decision to remove the “federal offset” from its methodology altogether rather than scaling it down based on a $10,000 cap. This change is likely responsible for the fact that five states and the District of Columbia are now shown as having mildly progressive state tax codes, whereas prior editions unconvincingly asserted that every single state had a regressive tax A regressive tax is one where the average tax burden decreases with income. Low-income taxpayers pay a disproportionate share of the tax burden, while middle- and high-income taxpayers shoulder a relatively small tax burden. code.
The “Who Pays?” study undoubtedly tells us something about the relative progressivity or regressivity of state tax codes, but by omitting so much of the tax code and relying so heavily on outdated taxpayer data, it ultimately tells us very little about who really pays state and local taxes.
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