Death of a Thousand Taxes?

December 5th, 2012

by Eric Schaefer

Taxes are a controversial and emotional subject. One of the many schisms rending American politics is the split between those who contend we do not pay enough taxes to maintain the range of services the government should provide, versus those who maintain we are taxed enough already, thank you, for services of questionable value.

Confounding the issue is the absence of comprehensive and consistent data. This want is due in part to the federal structure of the United States. The cost of having a decentralized political system, responsive to local and regional concerns, is a Balkanized-tax structure. To be truly independent and responsive, the officials overseeing our towns, cities, counties and states must be empowered to raise revenue — otherwise they would in the end be subservient to Washington.

As a consequence, the U.S. — compared to many other industrialized, developed democracies — has a more complicated tax regime. This not only frustrates comparisons of the tax bite between the United States and other nations, but it hampers comparisons across the fifty states. In our quilt work of municipalities and states, there is wide latitude in, one, defining what constitutes income or property to be taxed, and, two, the rates to be levied. For example, seven of the fifty states (AK, FL, NV, SD, TX, WA and WY) make no provision for a personal income tax. Sales tax is another revenue form which varies widely in its take.

To facilitate comparisons in personal tax burden between states, we assembled data from a variety of sources. We purposely excluded corporate taxes and focused instead on calculating standardized, inclusive estimates of the average tax burden on personal income. There were three reasons for this exclusion. First, it is individuals who vote and in the end determine fiscal policy. Second, corporate income taxes — whether on the federal or state level — may be a significant source of revenue, but they are eclipsed in size by personal income tax receipts. In 2009, the IRS reported corporations had a total tax liability of $205.0 Billion compared to an aggregate bill of $968.1 Billion for individuals. And, finally, apportioning corporate income between states (particularly for firms with operations in more than one state) is difficult given the data available.

As the denominator we used the Bureau of Economic Analysis (BEA) estimates of aggregate personal income by state. The personal income statistic is from the National Income and Product Account (NIPA) series. It is defined as the income received by persons from all sources, including transfer payments (such as Social Security or Disability Income). Although corporate and government entities are excluded, not-for-profit institutions and foundations (which predominantly serve or benefit the public) are included. This is a reason why total personal income taxes due to total income (12.3 percent) as computed by the IRS in 2009 is higher than the same tax due to personal income (8.1 percent) as computed by the BEA. When all is said and done, every method of computing income is arbitrary; personal income is no exception, but it has the virtue that tax avoidance is not a determining factor.

Overall, taxes consume almost 22 percent of American's personal income. Residents of South Dakota face the lowest overall bill (at 17.7 percent), while citizens of Delaware pay the most (30.1 percent). For 32 of the 50 states (plus the District of Columbia), the range falls between 20 and 24 percent. Despite the outliers, there is a reasonably broad consistency in personal tax burden across states.

It is no surprise that the federal take accounts for almost 70 percent of the total. This share — the lion's share — is split between general revenues (8.1 percent) and transfer programs (7.0 percent). This split complicates the debate on what is the tax burden we are prepared to bear. So does ignoring taxes paid to state and local governments. It is as if for Congress these taxes somehow do not count in their calculations of what is fair.

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