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State with no income tax: Better or worse?

Taxes » Income Taxes » State with no income tax: Better or worse?

Hand holding income tax stamp in the office © Gunnar Pippel/Shutterstock.com

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.
RankStatePoorest 20%Middle 60%Top 1%
1Washington*16.910.52.8
2Florida*13.28.32.3
3South Dakota*11.68.22.1
4Illinois13.811.14.9
5Texas*12.68.83.2
6Tennessee**11.28.62.8
7Arizona12.99.74.7
8Pennsylvania12.09.84.4
9Indiana12.310.75.4
10Alabama10.29.43.8

*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.

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