Is it better to live in a state with no income tax?
It’s a great question to ask — especially while you pore over tax forms this year. Seven U.S. states currently don’t have an income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. And residents of New Hampshire and Tennessee are also spared from handing over an extra chunk of their paycheck on April 15, though they do pay tax on dividends and income from investments.
A handful of other states have considered joining the no-income-tax bandwagon recently.
The main benefit, proponents say, is that states with no income tax become a beacon for growth. They’re better at creating jobs and keeping a core of young, educated workers from moving to other states. Others, however, are not so sure.
“It’s a way to disguise taxes to people,” says Curtis Skinner, a labor economist at Columbia University. States still need to balance their budgets, and critics like Skinner say the substitute for income taxes tends to be a system that puts an unfair amount of pressure on the poor.
The issue is undoubtedly controversial. Public opinion usually swings with the size of one’s paycheck and the role people think governments should play in shaping society. Before taking a side, however, consider these factors.
There are other ways to get you
How does a state pay its bills without an income tax? The answer is all around you: the food you eat, the clothes you wear, the gasoline you put in your car. These goods are taxed by many state governments.
This is how they make ends meet.
Tennessee, for example, has the highest sales tax in the country. The Volunteer State, which reviles income taxes so much that voters changed the Tennessee Constitution last year to forbid these taxes for good, charges a 7 percent sales tax statewide. When combined with local sales taxes, the combined rate increases to an average of 9.45 percent, according to estimates from the Tax Foundation. That’s more than double the combined rate in super-touristy Hawaii.
In New Hampshire, homeowners pay some of the highest effective property taxes in the nation, according to an analysis by RealtyTrac. And average in-state tuition at New Hampshire’s public universities is the highest in the country, according to a Bankrate analysis of statistics from the Department of Education’s College Affordability and Transparency Center.
In Washington, pump prices are routinely among the highest in the country — in part because of a sky-high gasoline tax. The Energy Information Administration says Washington charges 37.5 cents per gallon in gas taxes, the fifth-highest in the country.
Elsewhere, Texas and Nevada have above-average sales taxes, and Texas also has higher-than-average effective property tax rates. Florida relies on sales taxes, and its property taxes are above the national average. Wyoming and Alaska make up for the lost income tax revenue through their natural resources. Both states enjoy hefty tax revenues from coal mining and oil drilling operations, respectively.
All of those extra taxes contribute to higher-than-average living expenses in some of those states. Florida, South Dakota, Washington and New Hampshire all have higher than the median cost of living, according to data compiled by the Center for Regional Economic Competitiveness. Alaska is among the most expensive places to live, but a big part of that is because it’s so remote.
The “Terrible 10” list
The most regressive state tax systems in the US
|Taxes as a percentage of income on the poorest to the wealthiest.|
|Rank||State||Poorest 20%||Middle 60%||Top 1%|
*Does not levy a personal income tax.
**Income tax only for interest and dividend income.
Source: Institute on Taxation & Economic Policy
Don’t expect an economic benefit
Gov. Bobby Jindal wants Louisiana to be the next state to get rid of the income tax.
“We need to do more to stay competitive,” Jindal told state lawmakers in 2013. “States with no income taxes are outperforming other states in terms of economic growth and population growth.”
And he’s not alone. Policymakers in several other states, including Kansas, Michigan, Nebraska, Ohio and Wisconsin, have either cut their state’s income tax or are considering eliminating them altogether.
They’re driven by the same line of thinking: Cutting the income tax will boost take-home pay for everyone. It’ll make the state more attractive than its neighbors, drawing new businesses, creating jobs and sparking an influx of talented workers.
But does this really happen? A variety of economic policy groups have pushed back over the past few years, raising questions about whether any of those claims are true.
The Institute on Taxation and Economic Policy points out, for example, that states with no income tax haven’t really created more jobs than others. Texas, which is at the center of America’s oil industry, has certainly outperformed the national average in job creation as energy prices surged over the past decade. But job growth trailed population growth in the other eight no-income-tax states, according to a 2013 ITEP report.
Meanwhile, the Center on Budget and Policy Priorities, or CBPP, noted that a state’s income taxes have little influence over whether people ultimately decide to live there.
“States should not cut their income taxes with the expectation that they will thereby significantly slow — let alone reverse — the flow of residents leaving their state,” CBPP’s Michael Mazerov said in the 2014 report. “Indeed, the opposite may well be true. Such cuts are more likely to reduce than enhance a state’s attractiveness as a place to live by leading to deterioration in the quality of critical public services.”
Bottom line: There simply isn’t enough evidence to prove that slashing income taxes is the secret to a better economy, says Bill Gale, a tax policy expert at the Brookings Institution.
“There’s no consistency in the findings,” Gale says. “That’s usually an indication that there’s just not enough information in the data.”
More pressure on the poor
While the jury’s still out on the benefits of living in a state with no income tax, experts agree that there is one clear result for those states that do levy an income tax.
It helps the poor.
An income tax is a classic tool for redistributing wealth. It’s usually “progressive” in nature, meaning that it taxes higher earners at a greater rate than lower earners. Other taxes typically don’t have that Robin Hood-like characteristic.
Sales taxes, for example, are considered “regressive.” They don’t change depending on the income level of the consumer. They treat everyone the same. So do levies on food, gasoline and other key consumable items.
These taxes place an unfair burden on the poor, Columbia’s Skinner says. The reason is the lowest earners in the state devote the lion’s share of their take-home pay to buying things that are subject to sales taxes. The wealthy, who are able to sock away a chunk of their income in their 401(k)s and other investments, have a much smaller exposure to the sales tax.
“So the bite is proportionally larger for the poor than it is for higher earners,” he says. “Especially for states that tax food and essentials like that.”
Altogether, states with no income tax tend to place a disproportionately high tax burden on the poor. Five of the no-income-tax states — Florida, South Dakota, Texas, Washington and Tennessee — are ranked in ITEP’s “Terrible 10” list for unfair taxing.
A matter of perspective
One way to look at the debate over income taxes is to simply consider the political ideology underpinning each side of the argument.
If you’re someone who thinks the government should take an active role in shaping society, then you’ll probably agree that a state income tax is a good thing. It allows the state to redistribute wealth from rich to poor, and policymakers can use state tax incentives to encourage people to give to charities, buy solar panels or promote other initiatives.
If you think the government should stay out of the society-shaping business, then you might very well be comfortable living in one of America’s nine no-income-tax states.
“If you don’t want the state to redistribute income, then you’re probably happy that it doesn’t have an income tax,” Gale says.