When we think of taxes, often we focus on federal income taxes. However, the reality is that state and local taxes are likely to have an impact as well. And, even though there is much discussion of people who don’t pay federal income tax, the reality is that local taxes often hit these low wage earners.
The Institute on Taxation and Economic Policy takes a look at tax burdens around the country, and how local taxes impact consumers. According to the most recent study, the poorest fifth of America is likely to pay about 10.9 percent of their income in state and local taxes. Due to the nature of state and local taxes, it’s often the low wage earners that pay these taxes. Indeed, the top 1 percent are likely to see an average state and local tax rate of 5.4 percent.
Why are State and Local Taxes Regressive?
A tax system in which those with lower incomes pay a more significant percentage of their taxes than higher earners is considered regressive. The reason that state and local taxes are so often regressive has to do with the way taxes are collected at the state and local level. Yes, most states collect income tax. However, low wage earners are getting hit due to sales taxes and excise taxes.
Sales tax is the same, whether you are rich or poor. However, the impact on the poor is higher. When you buy gas and pay the state taxes on that gas, it’s the same amount of money. However, if you have a higher income, that amount of money is a lower percentage of your income. The same is true when you pay sales tax. Another reality is that property taxes can often hit working-class and middle-class families more than the wealthier families because most lower-income families that own homes don’t have other assets.
States that don’t have an income tax, and instead rely on revenue from sales taxes and excise taxes can be even harsher toward low wage earners — at least concerning what percentage of income goes toward taxation.
Does a More Progressive Federal System Balance it Out?
Of course, some insist that the federal income tax system, which is more progressive in general, balances this out to some degree. The overall effective tax rate is likely to be lower for everyone, because of the way things work with the federal tax system.
However, one does have to consider the fact that there are loopholes. For example, many in the top tier of wealth don’t receive a lot of their income from wages earned. Instead, they receive money from dividends and long-term investments, which are currently taxed at favorable rates. Additionally, they might also have the ability to take advantage of tax deductions that can further lower taxable income — and effective tax rate. The result is the famous example of Mitt Romney paying less than 15 percent of his income in federal taxes, and assertions by Warren Buffett that he is in a lower tax bracket than his secretary.
Where you get your income, and what you spend it on, has a significant impact on your overall tax rate, and it’s important to keep that in mind as you move forward with your tax planning.