Saturday, December 1, 2012

Income Tax Debate: State Taxes Matter, Too

For all the discussions about what tax rates would be "fair" there is a simple element missing: state income and sales taxes.

I've written that federal income tax rates weren't actually higher in terms of effective tax rates due to deductions (The 90 Percent Tax Rate Myth) and other factors. It's also easy to complain about the "400 richest families," but in the 1930s a mere three men owned 40% of all wealth in the United States (Carnegie, Morgan, and Rockefeller). If you wonder about concentrated wealth, buy The Men Who Built America from the History Channel.

Yes, the wealthy are paying (slightly) less in federal taxes than the historical norms. But, they are also paying much, much more to the states and local governments. How can we ignore the value of those contributions?

Nine states have no tax on regular income (wages), as of this blog entry:
  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming
— Source: http://taxfoundation.org/article/state-individual-income-tax-rates-2000-2012

But, other states love their income taxes. The majority of California's state revenues, 52 percent, are from personal income taxes. With the recent passage of Proposition 30, the top marginal tax rate is 13.3 percent. Thankfully, that applies "only" to annual income of $1 million, which even millionaires manage to avoid via creative (and legal) accounting methods. Still, if you earn $250,000 annually in California, the new top marginal rate is 10.3 percent.

States with high income taxes tend to have higher sales taxes. Add in property taxes, vehicle registration fees, and other assessments and it is obvious that the "rich" (at least the "annually rich via income") are paying up to 50 percent of wages to various taxes.

We know that the 90th percentile of annual household income starts at $143,611 and the 95th begins at $186,000, according to the IRS and the Census Bureau. But where do these families live? Not in Flyover Country. These high-tax states are also where the urban centers are, with higher costs of living. A couple earning $250,000 a year in New York City or San Francisco isn't exactly wealthy by local standards. Such a couple is probably going backwards financially.

According to CNN, a household would need an annual income of $545,000 in New York City to maintain the same lifestyle that $250,000 affords in Missoula, Montana. Imagine the taxes on that half-million annual income! New York City has city, county, state, and federal taxes. There are special assessment districts. There are so many taxes that a couple earning $545,000 is likely to pay 55 percent or more to various government coffers.

The Fiscal Times offers this reality check:
Is $250,000 a Year Rich? Let's Break It Down
http://www.cnbc.com/id/49807529Published: Tuesday, 13 Nov 2012

The bottom line: It's not exactly easy street for our $250,000-a-year family, especially when they live in high-tax areas on either coast. Even with an additional $3,000 in investment income, they end up in the red — after taxes, saving for retirement and their children's education, and a middle-of-the-road cost of living — in seven out of the eight communities. The worst: Huntington, N.Y., and Glendale, Calif. These are followed by Washington, D.C.; Bethesda, Md.; Alexandria, Va.; Naperville, Ill.; and Pinecrest, Fla. In Plano, Texas, the couple's balance sheet would end up positive, but only by $4,963.

Consider the tax profile of the Joneses when based in Huntington, a suburb of New York City. Thanks to all of their smart pretax contributions and a fat deduction for mortgage interest and state and local taxes, the couple's federal income tax is only $29,344. But what often goes overlooked is the toll taken by state and local taxes. In this case, it exceeds the federal income tax bill: $31,066.

State income taxes, taken alone, are just $10,557. But factor in the gas tax ($2,679), property tax ($15,222), phone service taxes and surcharges ($350) and sales tax ($2,258), and the picture looks very different. Their total tax bill, including the alternative minimum tax and payroll taxes: $78,276.
If the top federal rates are increased, along with divided taxes, health care taxes, and other new "revenues" planned for 2013, a "rich" family living in New York City or San Francisco can expect another $10,000 or more to vanish from their bank accounts.

Okay, maybe $90,000 of $250,000 is a "mere" 36 percent of the family's income, which is lower than the mythologized rates of the past (The 90 Percent Tax Rate Myth), but it is higher than the historical norms for effective taxes. Such families tend to have student loans, since they have higher educational attainments. They have higher mortgage payments, because of where they live. These "almost rich" are carrying a significant tax burden in this nation.

So, when we talk about the "rich" paying their "fair share" of taxes, let us at least count all the taxes these families pay and where they live, not merely the federal income taxes. What sounds like a lot of money in rural Alabama or Kansas doesn't buy an extravagant life in the big cities of the United States.