THE GUIDE TO Fair State and Local Taxes 2011 Institute on Taxation and Economic Policy 1616 P Street, NW, Suite 201, Washington, DC 20036 | 202-299-1066 | www.itepnet.org | [email protected] THE ITEP GUIDE TO FAIR STATE AND LOCAL TAXES: ABOUT III About the Guide The ITEP Guide to Fair State and Local Taxes is designed to provide a basic overview of the most important issues in state and local tax policy, in simple and straightforward language. The Guide is also available to read or download on ITEP’s website at www.itepnet.org. The web version of the Guide includes a series of appendices for each chapter with regularly updated state-by-state data on selected state and local tax policies. Additionally, ITEP has published a series of policy briefs that provide supplementary information to the topics discussed in the Guide. These briefs are also available on ITEP’s website. The Guide is the result of the diligent work of many ITEP staffers. Those primarily responsible for the guide are Carl Davis, Kelly Davis, Matthew Gardner, Jeff McLynch, and Meg Wiehe. The Guide also benefitted from the valuable feedback of researchers and advocates around the nation. Special thanks to Michael Mazerov at the Center on Budget and Policy Priorities. About ITEP Founded in 1980, the Institute on Taxation and Economic Policy (ITEP) is a non-profit, non-partisan research organization, based in Washington, DC, that focuses on federal and state tax policy. ITEP’s mission is to inform policymakers and the public of the effects of current and proposed tax policies on tax fairness, government budgets, and sound economic policy. Among its many publications on state and local tax policy is Who Pays? A Distributional Analysis of the Tax Systems in All 50 States Copyright© by the Institute on Taxation and Economic Policy, 2011. THE ITEP GUIDE TO FAIR STATE AND LOCAL TAXES: CONTENTS V THE GUIDE TO Fair State and Local Taxes CHAPTER 1 TAX FAIRNESS FUNDAMENTALS ............ 1 Corporate Income Tax Reform: Issues and Options........................................................... 47 Why Tax Fairness Matters ............................................... 3 Federal Taxes Matter, Too ............................................... 4 Corporate Minimum Taxes............................................51 Corporate Disclosure: An Important Tool CHAPTER 2 BASIC PRINCIPLES AND TERMS .............. 5 for Tax Fairness ......................................................................52 Tax Policy Principles: An Introduction ..................... 5 Nuts and Bolts: Basic Tax Policy Terms .................. 7 CHAPTER 7 OTHER REVENUE SOURCES ................... 53 The Interaction of State and Local Taxes with User Fees ................................................................................ 53 Federal Income Taxes.......................................................... 9 Estate and Inheritance Taxes ..................................... 54 Gambling Revenues ....................................................... 55 CHAPTER 3 SALES AND EXCISE TAXES..................... 11 Borrowing From the Future: How Sales Taxes Work .................................................. 11 Debt and Other Strategies .......................................... 56 Sales Tax on Business—Who Pays? ........................ 13 Sales Tax Reform: Issues and Options................... 15 CHAPTER 8 TAXES AND ECONOMIC DEVELOPMENT .. 57 How Excise Taxes Work .................................................. 21 Assessing Claims That Taxes Affect State Economies .............................................................................57 Excise Tax Reform: Issues and Options ................ 23 Low Tax Strategies Aren’t Effective ..........................58 CHAPTER 4 PROPERTY TAXES ................................... 25 Types of Tax Breaks Offered ........................................ 59 How Property Taxes Work ..............................................26 Ensuring Accountability in Economic Business Property Taxes ................................................ 27 Development Strategies .............................................. 60 Residential Rental Property ........................................ 28 Personal Property Taxes ..................................................28 CHAPTER 9 OTHER STEPS TOWARD Property Tax Relief Options ..........................................29 (or AWAY FRom) FAIR TAXES ............... 62 Property Tax Reform: Issues and Options .......... 33 Tax Expenditure Reports .............................................. 62 Tax Incidence Analysis ................................................... 63 CHAPTER 5 PERSONAL INCOME TAXES .................... 35 Rainy Day Funds ................................................................ 64 How Personal Income Taxes Work ......................... 35 Tax and Expenditure Limitations (TELs) .............. 64 Local Income Taxes .......................................................... 40 Personal Income Tax Reform: CHAPTER 10 ACHIEVING TAX REFORM: NEXT STEps . 66 Issues and Options.............................................................41 Why Tax Reform is Necessary ......................................66 Strategies for Tax Reform ............................................. 67 CHAPTER 6 CORPORATE INCOME TAXES .................. 44 Resources for Further Investigation ...................... 68 Why Tax Corporations? .................................................. 44 How Corporate Income Taxes Work ...................... 45 GLOSSARY ............................................................... 71 ONE: TAX FAIRNESS FUNDAMENTALS 1 CHAPTER ONE TAX FAIRNESS FUNDAMENTALS he subjects of every state ought to contribute toward the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state . [As Henry Home (Lord Kames) has written, a goal of taxation should be to] ‘remedy inequality of riches as much as possible, by relieving the poor and burdening the rich.’ ” 1 “T — Adam Smith, An Inquiry Into The Nature and Causes of the Wealth of Nations (1776) A fair tax system asks citizens to contribute to the cost of ■ A regressive tax makes middle- and low-income families government services based on their ability to pay. This is a pay a larger share of their incomes in taxes than the rich. venerable idea, as old as the biblical notion that a few pennies ■ A proportional tax takes the same percentage of income from a poor woman’s purse cost her more than many pieces of from everyone, regardless of how much or how little they gold from a rich man’s hoard. In discussing tax fairness, we use earn. the terms regressive, proportional and progressive. As the chart ■ A progressive tax is one in which upper-income families below illustrates: pay a larger share of their incomes in tax than do those with lower incomes. REGRESSIVE TAXES PROPORTIONAL TAXES PROGRESSIVE TAXES POOR u u RICH POOR u tRICH POOR u u RICH 2 THE ITEP GUIDE TO FAIR STATE AND LOCAL TAXES Few people would consider a tax system to be fair if the middle- and low-income families to pay a much greater share poorer you are, the more of your income you pay in taxes. of their incomes in taxes than the wealthy. Fairness is, of But that’s exactly what regressive taxes do. They require course, in the eye of the beholder. Yet almost anyone would agree that the best-off families should pay at a tax rate at least A Regressive Tax equal to what low- and middle-income families pay. State Florida’s General Sales Tax and local taxes pay for the schools, safe neighborhoods, clean water and air, public transportation and other things that make for a better community and enhance quality of life. Because these investments benefit everyone, it is imperative that every household pay its fair share. The sales tax is a regressive tax, as can be seen in the chart Taxes as Share of Income as Share Taxes at left of Florida’s sales tax. Because sales taxes are levied at a flat rate, and because low-income families spend more of their income on items subject to the sales tax than do wealthier taxpayers, sales taxes inevitably take a larger share of income from low- and middle-income families than they take from POOR INCOME RICH the wealthy. Excise taxes on cigarettes, gasoline and alcohol are also quite regressive, and property taxes are generally somewhat regressive. An Almost Proportional Tax Some believe that a proportional, or “flat,” tax structure is Alabama’s State Income Tax fair. They argue that if everyone pays the same share of income in taxes, then everyone is treated equitably. But this view ignores the fact that taking the same share of income from a middle- or low-income family as from a rich family has vastly different consequences for each. Low-income families must spend most (or all) of their income just to achieve the most Taxes as Share of Income as Share Taxes basic level of comfort. Even middle income families spend most of what they earn to sustain only a modest standard of living. A tax on these families can cut directly into their ability to make ends meet. In contrast, the same tax will hardly affect POOR INCOME RICH the life style of the wealthiest families at all. An almost-flat personal income tax (like Alabama’s, shown in the chart at left) is an example of a tax that can be proportional.2 A Progressive Tax Progressive taxes are the fairest taxes. Personal income Georgia’s State Income Tax taxes are the only major tax