The dictionary definition of a regressive tax is one that takes a larger percentage of a lower income and a smaller percentage of a higher income.
With a sales tax that accounts for a disproportionate 60 percent of state revenues and a combined state and local tax rate of a weighted 9.45 percent that’s the highest in the land, Tennessee is a poster child for regressiveness.
That’s because lower-income families spend a much higher percentage of their income on taxable goods than the well-to-do. According to the Institute on Taxation and Economic Policy, Tennessee families with incomes below $31,000 spend 8.5 percent of it on sales taxes compared to 6 percent for middle-income families (between $31,000 and $78,000) and only 2.5 percent for families above $157,000.
Now comes a study by three Federal Reserve economists evidencing that Tennessee is the worst state in the nation in terms of exacerbating income inequality. The study, entitled “The Role of Taxes in Mitigating Income Inequality Across the U.S. States,” measures the extent to which taxes reduce the percentage difference between the incomes of high-income families and low-income families.
The study’s complex methodology compares the percentage difference between the incomes of taxpayers at the 90th and the 10th percentiles of the income distribution on a before-tax and after-tax basis. It concludes that “the federal tax system compresses the income distribution by about 30 percentage points.” To better understand how this comparison is being measured, one of the study’s authors offers the following example: Family H earns $100,000 and Family L earns $50,000. After taxes are applied, the incomes are H = $60,000 (tax rate of 40 percent) and L = $40,000 (tax rate of 20 percent. After tax, the high-income family is earning 50 percent more than the low-income family. The compression metric is simply the difference between the pre- and post-tax differences: 100 percent – 50 percent = 50 percent.
Where state taxes are concerned, the study concludes that “on average, the influence of state taxes on income inequality is small relative to federal taxes.” However, a few states stick out like sore thumbs, and Tennessee’s is the sorest of the lot. Its taxes widen income inequality by 10 percent, topping Mississippi at 9.5 percent and West Virginia at 9.1 percent for the most regressive and “reversing about one-third of the compression caused by federal taxes.”
These disparities are being worsened by the phase-out of one of the state’s two progressive taxes and the prospective repeal of the other. Inheritance taxes, which fall exclusively on the wealthy, yielded the state $150 million in fiscal year 2012 but will go poof when the tax is repealed in 2016. Many legislators are also targeting for repeal the state’s one semblance of an income tax; namely, the 6 percent Hall tax on dividend and interest income, which yielded $302 million this past fiscal year.
According to the Institute on Taxation and Economic Policy, over 80 percent of the benefit from a Hall tax repeal would flow to the wealthiest 5 percent of Tennessee taxpayers. The notion that it hurts senior citizens living on fixed incomes is refuted by the $59,000 income exemption for seniors from the tax.
The appetite for tax cuts is being whetted by the remarkable growth in state revenues over the past two years. Much of a $600 million surplus from fiscal 2015 has yet to be committed, and the State Funding Board is now projecting a $350 million surplus for the current fiscal year with further revenue growth of about the same amount in the fiscal year ahead. Sales tax revenues that keep growing by more than 7 percent year-over-year are the biggest contributor to these projections.
If there is room for state tax reduction, it should start with the sales tax on food.
Tennessee is one of only five states that imposes such a tax at all. And while it was reduced to 5 percent in 2013, it’s still double the rate of the next highest state, Virginia.
The study by the Federal Reserve economists estimates that exempting food from sales tax reduces income inequality by about 3 percentage points. While the $500 million cost of a state exemption, before even taking local option sales taxes into account, is beyond the realm, anyone who cares a whit about tax equity should insist that a food tax reduction should take precedence over a Hall tax cut.
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