Tax Policy in the Wrong Direction: Eliminating or Reducing State Income Tax

Oklahoma, Nebraska, and my home state of Kansas are debating proposals to sharply reduce or eliminate their personal income tax. That raises important questions about how they’ll make up the revenue. And it’s bad news for low-income families, who may end up paying higher taxes and losing critical safety net programs.

In 2009 (the latest year for which data are available), income taxes accounted for 27 percent of revenue in Kansas, 24 percent in Nebraska, and 17 percent  in Oklahoma, according to TPC’s State and Local Finance Data Query System (SLFDQS). Even if these states desire smaller government, it seems unlikely they’ll be able to make ends meet without the income tax as a significant source of revenues.

If other states without an income tax are any guide, it may mean these states will move to replace lost revenues with property and sales taxes, according to a report released by the Center on Budget and Policy Priorities.

That may be problematic.  Low- and middle-income families tend to spend a greater proportion of their income on sales and property taxes than higher-income families. That’s because they typically spend more of their income on basic goods, while higher income families have the luxury of saving a larger share of their money. Many states with an income tax – including Kansas, Nebraska, and Oklahoma – exempt families in poverty from the income tax. Without an income tax, these states lose an easy way to exempt low-income families from some tax. And even if income taxes are just scaled back considerably, the case with some proposals, opportunities to support low-income families dwindle. In the end, states that don’t have a personal income tax system tend to rely more on low- and middle-income families to pay for government.

None of these states is so flush with cash that large cuts ought to be considered. In 2010, Kansas raised its sales tax and cut spending to cover a projected shortfall. Nebraska projects a surplus this year, but enacted substantial budget cuts in the two prior years and Oklahoma is just starting to turn the corner on year over year revenue declines in FY09 and FY10.

Before going through with tax reform that could seriously limit or eliminate state incomes taxes, states ought to undergo a thorough analysis of exactly how much lost revenue will need to be replaced, and should give constituents an idea of how the replacement revenues will be raised – or what services will be cut. It could cause people to think a lot differently about the possibly exciting elimination or reduction of their state income tax.