The New Federalism and State Tax Policies Toward the Working Poor

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About the Series

Assessing the New Federalism is a multi-year Urban Institute project designed to analyze the devolution of responsibility from the federal government to the states for health care, income security, employment and training programs, and social services. Researchers monitor program changes and fiscal developments. In collaboration with Child Trends, Inc., the project studies changes in family well-being. The project aims to provide timely, nonpartisan information to inform public debate and to help state and local decisionmakers carry out their new responsibilities more effectively.

Key components of the project include a household survey, studies of policies in 13 states, and a database with information on all states and the District of Columbia, available at the Urban Institute's Web site. This paper is one in a series of occasional papers analyzing the information from these and other sources.

Introduction

In evaluating how government programs affect the poor, researchers have traditionally interpreted the redistributive role of government in two separate categories—revenue-side taxes that higher-income households pay and expenditure-side transfers that lower-income households receive. As transfer policy begins to be accomplished increasingly through the tax system, these lines become blurred. Yet little research has been done on the general effects of taxes on low-income families, and particularly little on the role of state-level taxes.¹

State taxes do affect low-income families—in ways that have changed in recent years and will continue to change, especially in light of the "new federalism" approach to the redistributive function of government. While some state tax systems only affect the poor through sales and excise taxes, others have income tax thresholds low enough such that the poor pay personal income taxes. Meanwhile, certain states have begun to use the tax system as a means of transferring resources to low-income families through refundable tax credits—that is, credits that people can receive even if they do not owe taxes.

The tax system provides an important vehicle for studying a growing group of people—the working poor. In the wake of welfare reform, some states have emphasized expenditure-side transfer policies that provide assistance—such as child care subsidies and job training programs—for families on or recently leaving welfare. Subsidies made through the tax system are different from welfare in that a family's prior experience with welfare does not determine if they qualify for benefits. Rather, these tax policies are based solely on income or certain expenditures, thus providing support to a broader base of people. In addition, assistance provided via the tax system may provide a more permanent source of support. While this assistance may be subject to a state's current economic conditions, it is not subject to the same time limits as welfare benefits.

This paper discusses some of the ways in which state tax systems affect low-income families. Since the income tax system primarily affects people with earned income, our focus here is the working poor.², ³ We first explain why state tax policy matters for these families, describing some general trends in state tax structure among all 50 states. We then focus our attention to details on personal income and sales taxes in a subset of 13 states that the Urban Institute has been studying in a major, multiyear project titled Assessing the New Federalism (ANF).⁴ These states represent a wide variety of income distributions and tax structures. We discuss the implications of these tax policies for different types of families in terms of their after-tax income levels and work incentives. Finally, we examine the various policy options states have to increase tax relief for low-income families and the issues states must consider in evaluating those alternatives.

Notes from this section of the report

1. Some studies that have focused on this issue, however, are Gold and Liebschutz (1996) and Johnson, Fitzpatrick, and McNichol (1999). Other than being a more current look at the rapidly changing state tax policies, our paper differs from those other studies in focusing more clearly on the explicit, effective tax rate structures facing low-income families; the contributions of particular features of the tax systems to those effective rates; and changes in the tax burdens facing these families as they increase participation in the labor market. We also define low-income families in terms of their relative positions in the income distributions of the various states, in addition to the absolute standard of the federal poverty levels. Earlier analyses typically made comparisons across states based on absolute measures of income only.

2. All of our calculations assume a family has earned income. We focus on two family types—a single-parent family and a married-parent family, both with two children. We choose our single-parent family to be representative of a welfare "leaver"—a family with two children and earnings at the poverty level, as described by Loprest (1999). We also look at a single-parent family at median earnings by state. Married-parent families are studied with respect to earnings at the federal poverty level as well as earnings at the 15th percentile by state.

3. This paper focuses only on state-level sales and income taxes and the differences across states in those taxes. Because states vary in their state and local tax mixes, our calculations and comparisons cannot be interpreted as evaluations of how the overall tax burdens facing these families vary by state. Also, we do not look at the structure of other types of state-level taxes, such as corporate income and property taxes. Corporate income and property taxes are not likely to be a significant burden on low-income, young families, however, because the incidence of these taxes falls primarily on capital income.

4. These 13 states are Alabama, California, Colorado, Florida, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, New York, Texas, Washington, and Wisconsin.

Note: This report is available in its entirety in the Portable Document Format (PDF).

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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