Raising Revenue Through Fair Tax Systems

As states look to expand education funding and provide health care for their citizens-- along with paying for other social needs-- the hardest challenge is figuring out what taxes need to be raised to accomplish this.

Here's the first step.  Almost every state tax system requires working families to pay a higher percentage of their income in taxes than their wealthier citizens.  In fact, as the Institute on Taxation & Economic Policy detailed in their 2003 study, Who Pays?:

[O]nly four states require their best-off citizens to pay as much of their incomes in taxes as middle-income families have to pay. Only eight states tax their wealthiest residents at effective tax rates as high as the poorest taxpayers are required to pay...Most states tax the wealthy at rates that are much lower than the rates on middle- and low-income families.

As this Stateside Dispatch will detail, if wealthier citizens and corporate shareholders are just asked to pay their fair share, states can raise much of the revenue they need for social needs and even to give tax relief to working families.

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Fair Income and Estate Taxes

Since most sales taxes and property taxes are regressive and burden working families more than the wealthy, the states that create a fair tax system balance those regressive taxes with an income tax with higher tax brackets for the very wealthy.  As this Tax Policy Center table highlights, there is a wide disparity in state income tax systems, but a number of states in recent years have been seeking ways to make their tax systems more progressive.

Creating High-Income Tax Brackets: As one example, in 2004, as New Jersey struggled with both a budget deficit and calls to lower the property tax burden, the state created a new 8.97% tax bracket for those making $500,000 per year or more.  This plan raised taxes on just 30,000 households, while providing tax relief for 1.8 million households-- a sign that in an economy where income is skewed increasingly to the top, a fairer tax system can raise a lot of revenue even while giving tax relief.  Along with property tax relief, a rising number of states are using State Earned Income Tax Credits to ease the tax burden on lower-income working families as well.

Estate Taxes: Another area where states are working to maintain tax fairness (and raise some needed revenue) is by preserving taxes on wealthy estates.  While some states have followed federal law as the estate tax has been rolled back, many others are "decoupling" their estate tax from federal law changes.  And while a few high-income folks duck out of state to avoid state estate taxes, "the number is modest and not nearly enough to offset the revenue gained by keeping an estate tax" as one research report detailed.

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Reforming the Corporate Income Tax

An effective corporate income tax has two large advantages for states: it taxes corporate owners, the majority of whom are in the richest 1% of the population, and many of those owners are not state voters.  Corporate income taxes are often the main tax where those out-of-state owners pay for the public benefits enjoyed by those companies.

Unfortunately, since 1980 state corporate income tax revenues have dropped from 9.7% or all state taxes down to just 5.7% by 2000.   A 2005 study by Citizens for Tax Justice found that 252 of America's largest corporations failed to include two-thirds of their U.S. profits on state tax returns, avoiding an estimated $41.7 billion in state corporate income taxes over three years.

Combined Reporting: Part of the problem is that in the age of Enron, business enterprises use a complex combination of subsidiaries to manipulate where they have to report profits.  Traditionally, states allowed each separate subsidiary to file separate tax returns, which encourages all sorts of tax manipulations.  At least eighteen states now have enacted "combined reporting" rules that require corporations to aggregate all profits from those separate subsidiaries and then pay a specific portion of those profits to a state -- an approach the Supreme Court affirmed as a legal approach in Barclay's Bank PLC v. Franchise Tax Bd.

Decoupling from Federal Corporate Loopholes: Another problem in recent years has been the proliferation of federal corporate loopholes passed as part of President Bush's big corporate tax cuts.  In response, many states have "decoupled" their tax codes from federal definitions of corporate income: less than a week after Congress passed one corporate giveaway in 2002, the Virginia legislature passed a measure that rejected the new federal depreciation rules, a move followed quickly by six other states.  A number of states have acted to reject one particular federal loophole, the "Qualified Production Activities Income" (QPAI) deduction, because it threatens to cost states over $1 billion per year as it is phased in.

Taxing Windfall Oil Profits:  With massive profits for large oil companies in recent years as they have benefitted from MidEast troubles and the runup in oil prices, a number of groups have advocated state Windfall Profits Taxes.  Even if states capture just a small portion of the hundreds of billions of dollars in windfall profits, this would create a large source of new revenues of the states, $600 million per year for the State of Washington alone according to the Equal Opportunity Institute, revenues which could be used to offset many of the environmental costs of fossil fuel use.

For other reforms of corporate tax subsidies, see our June 2006 Reforming Failed Tax Subsidies.

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Better Enforcement of Tax Law

If some lost tax revenue is due to loopholes, manipulation and untaxed windfall profits, a lot of it is also due to straight-up tax cheating by both corporations and rich individuals.  States are responding with a variety of strategies for catching these tax cheats-- and recovering this revenue:

Cracking Down on Abusive Tax Shelters: A 2001 Multistate Tax Commission report estimated that tax shelters designed to illegally evade taxes cost states as much as $12 billion per year.  Facing the largest losses in the nation, California pioneered legislation requiring new reporting on the details of suspicious shelters, enacting heavy fines for using illegal shelters, and creating an amnesty program to promote voluntary compliance.  The amnesty program brought in a cascade of revenue: over $1.4 billion from 1,202 taxpayers, or an average payment of over $1 million per taxpayer reflecting the widespread tax cheating among this wealthy population.   Other states are following suit.

Multi-State Collaboration: Going beyond the occasional cooperation between state auditors, eight states led by Massachusetts created a new multi-state agreement to share data in a project called the Clearinghouse, which will compare information on people who work in one state and earn income in another in order to reveal tax cheating.

Shaming Tax Cheats: To encourage payment by taxpayers caught violating the law or delinquent in their taxes, more than a dozen states have begun publishing lists of businesses and individuals owing taxes on the Internet. Connecticut pioneered this high-tech shaming strategy in its Top 100 list, which collected more than $161 million in overdue tax debts over its first seven years and other states have been collecting similar amounts with their own programs.

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Taxes and Economic Growth

The usual objection to raising taxes on the wealthy or corporations is that such taxes undermine economic growth, yet there is remarkably little evidence to back up those claims.  Studies instead have emphasized that neither business tax cuts nor estate tax cuts play any significant role in local economic growth.

In Rethinking Growth Strategies, author Robert Lynch highlights the fact that state and local taxes are too small a part of a typical company's costs to determine plant location, so cuts in public services are likely to cost more jobs than any jobs potentially attracted by low taxes.  Worse, by failing to invest in education, university research and infrastructure, low tax states can undermine the worker training and infrastructure factors that DO determine where companies want to do business.

Similarly, CFED's A Progressive Economic Development Agenda for Shared Prosperity: Taking the High Road and Closing the Low, describes low-tax strategies as a "get poor" strategy where the better approach to "local competitiveness needs to focus on meeting the workforce and infrastructure requirements of the New Economy..."

All of which emphasizes that states can best pay for those investments in public services by creating effective state tax systems where the wealthy and corporations pay their fair share.

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