Friday, January 16, 2015

On the Myth of State and Local Regressive Taxation


In an Op-ed entitled "How Government Helps the One Percent" in yesterday's Washington Post, E.J. Dionne claims that state and local taxes are "regressive" and have the effect of "exacerbating inequality," unlike federal taxes which, he concedes reduce inequality by redistributing income from rich to poor.  In support of his claim about state and local taxes, Dionne cites a study by the Institute on Taxation and Economic Policy (ITEP).  The study concludes that:

"[I]n 2015 the poorest fifth of Americans will pay, on average, 10.9 percent of their incomes in state and local taxes and the middle fifth will pay 9.4 percent.  But the top 1 percent will pay states and localities only 5.4 of their incomes in taxes."

From these figures, Dionne concludes that:  "[a]t the state and local level, government is indeed engaged in redistribution --- but it's redistribution from the poor and middle class to the wealthy."

Dionne's claim echoes what has become a Progressive article of faith, namely, that state and local taxes are, "extremely regressive" or "highly regressive," because the wealthy pay a smaller proportion of their income in taxes than the poor. However, like some other Progressive articles of faith, this nostrum lacks a factual basis.  That is, any claim that state and local taxation redistributes income from poor to rich is demonstrably false, ignoring as it does the distinction between tax rates, on the one hand, and actual taxes paid, on the other.  Yes, the "top 1 percent" might experience lower effective tax rates than individuals of more modest means.  However, those in the top 1 percent also (by definition) earn far more income to which these rates are applied.  As a result, these wealthy Americans pay far more in state and local taxes than their fellow citizens of more modest means. 

A simple numerical example using Dionne's own figures will help illustrate this point. According to this study by the Congressional Budget Office, the average household in the "top 1 percent" earned $1.22 million before taxes in 2009.  By contrast, individuals in what Dionne calls the "poorest fifth of Americans" earned an average of $23,500 per year before taxes. If we apply Dionne's assumed state/local tax rates to such individuals, we learn that the "top 1 percent" paid on average $65,880 in such taxes in 2009, while the poorest fifth of Americans paid $2561 in such taxes in the same year. In other words, despite paying lower tax rates, the average household in the "top 1 percent" paid more than twenty five-fold more in state and local taxes than the average household in the bottom one fifth of the income distribution.  (2009 is the most recent year for which I was able to locate data on the average income of individuals in the top 1 percent.)

To be sure, the mere fact that the top 1 percent pay on average twenty-five fold more in state and local taxes than the poorest fifth of Americans does not necessarily establish that states and localities are redistributing income from rich to poor.  Dionne's point would still survive scrutiny if states spent more than $65,880 on services provided to the top 1 percent, and less than $2561 on services provided to those in the lowest fifth of the income distribution.  Such spending patterns would, when combined with the taxes paid by each group, demonstrate the sort of redistribution from poor to rich that Dionne decries. However, neither Dionne nor the ITEP study he cites provides any evidence that, for instance, states and localities lavish more than $65,880 on the average member of the top 1 percent each year.  Nor can this blogger imagine what sort of programs would result in such skewed expenditures. Moreover, publicly-available data demonstrate that states and localities spend significantly more than $2561 per person on services provided to individuals in the poorest fifth.

Indeed, Medicaid alone seems to account for transfers to the poorest fifth that approach the amount these individuals pay in state and local taxes.  According this report by the National Association of State Budget Officers ("NASBO"), Medicaid covered 60 million people in 2009, a cohort roughly equivalent to Dionne's "poorest fifth."  (The U.S. Population in 2009 was 307 million.)  The same study concludes that states spent $132,540,000  on  Medicaid in 2009, an amount equal to $2209 per Medicaid recipient.  Of course, Medicaid is not the only program that confers benefits on individuals in the "poorest fifth."  States and localities also spend significant resources on: (1) other forms of public assistance, (2) K-12 education, (3) police protection, (4) fire protection, (5) roads, (6) public transportation, and (7) higher education.  Indeed, according to the NASBO report cited above, states and localities spent just over $280 Billion on K-12 education in 2009, or $912 per person.   States spent another $145 billion, or $472 per person, on higher education.  It may well be that individuals in the poorest fifth received less than a pro-rata share ($1384) of such expenditures.   Nonetheless, even if we assume that the poorest fifth receive the equivalent of $500 annually from this source, state and local expenditures on such individuals would substantially exceed the $2561 that the average individual in the poorest fifth of the income distribution pays in state and local taxes.

In short, any claim that states and localities are redistributing income from rich to poor is apparently false.  Instead, state and local taxation and the spending programs that such taxation supports redistribute income from rich to poor and are in this sense "progressive."  It may well be that the national government's policies are even more progressive, given the relative ease with which wealthy individuals may "exit" states that impose high taxes.  The threat of such exit, which drives competitive federalism, discourages redistributionist policies.   (It is, of course, more difficult for such individuals to exit the United States as a whole.)  Perhaps Dionne believes that state and local systems are not progressive enough.  Perhaps he is correct, but he should ground such an argument in data that reflect the actual impact of state and local systems.

Some might reply that Dionne and this blogger have erred in defining as "regressive" those systems, and only those systems, that redistribute income from poor to rich.  Instead, this argument might continue, a tax system is regressive whenever the poor pay higher tax rates than the rich.  However, such a definition of "regressive" would, by ignoring the uses that states make of tax revenue, rob the term of any useful meaning in policy debates.  After all, a tax system could be "regressive" in this sense even if the State spent every penny of tax revenue on transfer payments to the poor, thereby substantially reducing inequality. Such an approach would also label as "progressive" any system in which the rich paid higher tax rates than the poor, even if states spend all tax revenue on programs aimed solely at the rich.  Any useful definition of "regressive" or "progressive" should account for the actual distributional effect of the policies that scholars and pundits are evaluating.