Income Tax Credits to Reduce the Regressivity of State‐Local Tax Systems

Abstract

AT LEAST FOURTEEN STATES and the District of Columbia currently offer some of their residents refundable credits against personal income taxes designed to reduce the regressivity of their state-local tax systems. This paper reviews existing credit plans and their economic effectiveness, and offers various suggestions for improvement. Credits for sales taxes are discussed in Part II and property tax credits in Part III. These credit plans are an outgrowth of a number of state tax system studies which uniformly demonstrated that state sales and property taxes are most burdensome on that segment of the population least able to pay (1). That is, both sales and property taxes are regressive with respect to current income. This relationship is accepted without reservation for the sales tax since the percentage of family income spent on items subject to the general sales tax has been shown to decrease as income increases. This occurs both because of proportionately higher saving among higher income families and because of the lack of sales taxes on many services which are predominantly purchased by those with higher incomes. Although the residential property tax is regressive with respect to current income, several recent studies have shown it to be approximately proportional to permanent income. This result is explained by the infrequency with which individuals change housing, with the result that many families consume either more or less housing than is justified by their current income (2). Many families with temporarily low income do experience cash flow problems which make property tax payments difficult. For this reason alone, some form of property tax relief for those with low current incomes may be justified (3). In addition, for those with permanently low incomes, the property tax does constitute a major outlay which may not be considered equitable by society. This is particularly true of the elderly poor who may own a home but have insufficient cash income to buy food after paying their taxes. Individuals who rent tend to be worse off in that they do not even own a home as an asset. Both property and sales tax credit plans have been referred to as little negative income taxes, since in most cases the taxpayer is eligible for a refund if his credit is larger than his income tax liability. If a person pays