Friday, July 29, 2011

After 2011 Tax Reforms, Connecticut's Wealthy Still Pay Smallest Share of Income in State and Local Taxes

Despite recent efforts to make the Connecticut tax system fairer, the wealthiest 1% of our residents will still pay only half as much of their income in state and local taxes as the poor and middle class, according to a new analysis by the Institute for Taxation and Economic Policy.

The state and local tax reforms approved in 2011 made Connecticut’s tax system more equitable by generally reducing taxes for lower-income residents, through the earned income tax credit, and raising them among higher-income residents.

These changes were essential to a balanced approach to our economic and fiscal problems that helped protect vital education, health, and other services for families and position Connecticut for long-term economic growth. But even after these changes, our tax system remains highly imbalanced. After accounting for federal deductions, estimates show that Connecticut’s low- and middle-income families will pay between 9.6% and 11.4% of their incomes in state and local taxes, while the top 1% of income earners will only pay about 5.5%.

Few would agree that those most able to pay should contribute less of their income than those least able to pay.

The decision by Connecticut policymakers to increase revenues as part of a balanced approach to the state’s deficit crisis has elicited fierce debate, so it is important to put these changes in proper context. In late 2009, the gap between what the wealthiest 1% paid in taxes as a percentage of income and what the poorest 20% paid was higher in Connecticut than in most other states.Connecticut ranked among the ten states with the highest taxes on the bottom 20%, and among the twenty states with the lowest taxes on the wealthiest 1%. Recent revenue reforms will decrease the proportion of income the bottom 20% of residents pay to 11.4%, from 12.0%, and increase the proportion that wealthier taxpayers pay (for amounts by income group, see table below). Even after these changes, the poorest residents are estimated to pay over twice as much of their income in state and local taxes as the top 1%.

As the table above shows, some taxes, such as sales and property taxes, are regressive, meaning that low income people must pay a greater share of their income on them than high income people. Other taxes, such as the income tax, are the opposite, progressive. Currently, regressive taxes in Connecticut outweigh progressive taxes, which places a higher overall tax burden on low- and middle-income households. The progressive state income tax changes recently passed have brought better balance to Connecticut’s tax system, though the very wealthiest residents still pay far lower proportions than anyone else.

Anti-tax advocates often claim, without strong evidence, that raising taxes on the very wealthy would hamper economic growth and cause a decrease in revenue because of wealth migration. The majority of the evidence in fact points to opposite conclusions. An upcoming review of the literature on so-called “tax flight” finds that the effects of tax increases on migration are, at most, small and lead to significant net increases in state revenue. Taxes, it finds, are simply not a significant factor in decisions about where to move compared to much more important factors like home prices, employment opportunities, and community networks.

Another recent report by the Political and Economy and Research Institute at UMASS Amherst explored tax migration in New England and came to similar conclusions, finding that by raising state revenue and using that revenue to create job opportunities states could actually draw new residents to their states. Finally, a study published in the Summer 2011 issue of Connecticut Economy magazine found that states with an income tax had similar long-term economic growth as states without an income tax.

In wealthy states like Connecticut, regressive taxes are especially troubling because they make the problem of rising income inequality worse. As we continue to reform our state and local tax systems to be more fair and effective, more should be done to equitably distribute state and local taxes.

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