In his State of the Union speech, President Obama will outline a plan to overhaul the federal tax code. His objective will be to reduce inequality in the tax structure, but even if these reforms are enacted, they might only help marginally, says Matthew Gardner, executive director of the Institute of Tax and Economic Policy. That's because they wouldn't address unfair tax systems at the state and local levels.
"At the state level, we're redistributing income away from poor people and giving it to rich people," says Gardner.
A new report released by ITEP illustrates just how bad the problem has become. The chart below, from the report, shows that the poorest Americans pay nearly 11 percent of their income in taxes. By comparison, the wealthiest only pay a 5.4-percent tax share.
Of the three main forms of state taxes—sales, property, and income—the sales tax hurts the poor most, says Gardner. State sales taxes are highly "regressive," he says. That is, they end up taking a bigger chunk of change from people that have smaller sums of money and slower income growth.
Let's say that a rich person and a poor person each spend $100 on taxable grocery items. This $100 expenditure—and the sales tax on that $100—both deal heavier blows on the poor person's income because it's smaller. The report backs up this hypothetical example: as a share of their income, the poor pay a 7 percent rate on sales and excise taxes, while middle-income families pay 4.7 percent rate, and the wealthy pay less than one percent, on average.
Understandably, then, low-income Americans living in states that rely more on sales tax are worse off. In Washington State, for example, the poor pay nearly 17 percent of their income in state taxes, while the rich only pay 2.4 percent. On the other hand, in D.C. and California, more reliance on personal income taxes and better Earned Income Tax Credit policies make the tax system more equitable. (Though even there, low- and middle-income groups pay higher proportions of their comparatively smaller incomes).
Giving too much weight to sales taxes isn't just bad for those living below the poverty line, it's bad for local economies. "You simply aren't going to be able to raise revenue from folks who have the least income," says Gardner. "That's a recipe for fiscal disaster."
Still, local governments have lacked the political will to lean more on income taxes, which are considered more fair and progressive, Gardner says. He thinks it's partly because sales taxes seem innocuous compared to income taxes.
"There's a bit of sticker shock with the personal income tax that makes it more visible than sales tax," he says. By comparison, taxpayers look at the small amounts at the bottom of their grocery receipt and think that sales taxes are a good deal. But they're not.