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REGRESSIVE STATE AND LOCAL TAX SYSTEM

State tax policymakers are constantly forced to reconcile the potential tax overburdens that can develop from excessive reliance on levies of a regressive character with the potential harm to their citizens that can result from short-changing public needs.

The States have been especially sensitive to the regressivity issue in two specific areas: the local residential property tax, and the State and local general retail sales tax.

The basis for this sensitivity is revealed in the distribution of the estimated State and local sales and property tax burden by adjusted gross income classes (Table 18). From the standpoint of ability to pay, the general sales tax in its unadulterated form is an upside down revenue measure. The burden (especially if food is taxed) declines as income rises. The property tax is even more regressive and is particularly burdensome to the low income homeowner or renter. (However, if the sales tax and the property tax are coupled with an income tax credit arrangement as discussed subsequently, their regressive aspects can be mitigated substantially.)

Sales Tax Action

From the very beginning of the State sales tax movement, that tax encountered criticism because in concept at least, it applied to such necessities as food, clothing, shoes and drugs. While some States were able to counter this argument by pleading that the revenue would be spent on expenditures to help the poor, other States felt impelled to concede exemptions in order to obtain enactment. Fourteen States now exempt purchases of food for home consumption, and the District of Columbia taxes food at a preferential 1 percent rate whereas other sales are taxed at 3 percent. Twenty-one States provide complete or partial sales tax exemption for purchases of prescription drugs and medicine.

Recent tax credit innovations for the State sales tax have almost squared the revenue circle--that of maximizing consumer tax yields while minimizing the burden which these levies impose on low income families. Until recently only the costly approach--that of exempting food and drugs--was used to minimize regressivity of the general sales tax. Such exemptions can cut sales tax collections by as much as 25 percent or more where tax enforcement is not effective.

Income Tax Credits for Sales Tax Payments

In 1963 Indiana adopted personal income tax credits for food and drug tax payments with cash refunds for those persons with incomes either too low to take full advantage of the tax credit or with incomes below the filing requirement. Under the Indiana system each person is granted an $8 sales tax credit. This figure is based on an "assumed" food and drug purchase of $400 for each person multiplied by Indiana's 2 percent sales tax rate. Thus, a family of four is automatically entitled to a $32 reduction on its Indiana individual income tax or a cash refund of $32 if it has no State income tax liability.

This "first generation" Indiana type of flat rate tax credit helps on both the revenue and regressivity fronts. The income tax credit for sales tax

Adjusted Gross
Income Class

Number of

Amount
(millions)

TABLE 18.--ESTIMATED TAX BURDEN FOR SELECTED DIRECT PERSONAL TAXES, BY AGI CLASS, 1964

Returns
(thousands)

Federal Adjusted Gross Income

Distribution
(Cumulative from
Lowest AGI Class)

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TABLE 18 (CONT' D).--ESTIMATED TAX BURDEN FOR SELECTED DIRECT PERSONAL TAXES, BY AGI CLASS, 1964

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TABLE 18 (CONCL'D).--ESTIMATED TAX BURDEN FOR SELECTED DIRECT PERSONAL TAXES, BY AGI CLASS, 1964

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1/ Grossed-up AGI = Federal adjusted gross income plus: excludable capital gains, OASDI benefits, and excludable dividends; less capital loss in excess of statutory limitations 2/ Including an imputed residential property tax payment made by renters. 3/ Deficit.

4/ Adjusted gross income less deficit.

Source:

Internal Revenue Service; Statistics of Income, Individual Income Tax Returns, 1964, and ACIR staff estimates based on individual income tax returns 1964, unpublished IRS tables from 1963 returns, and Subproject B, (special tabulation by Treasury Department) of BLS 1960-61 Consumer Expenditure Survey.

payments definitely solves more administrative problems on the sales tax front than it creates on the income tax side. For example, the manager of a supermarket is not required to maintain two sets of sales records for tax exempt and taxable items and State sales tax administrators are freed from the tedious task of auditing retail sales transactions for possible violations of the exemption provisions. It largely eliminates the expensive leakage problem.

On the tax distribution side it can be readily seen that the flat rate credit converts the sales tax into a fairly proportional levy for the great mass of taxpayers in the lower and middle income brackets (Table 19).

The "second generation" diminishing sales tax credits are more sophisticated instruments for pulling the regressive stinger from the general sales tax (Table 19). Hawaii pioneered this approach in 1965 with its credits for consumertype taxes ranging from $18 per qualified exemption for taxpayers having a modified adjusted gross income of less than $1,100 to $.45 per exemption for those with adjusted income of $6,300 or more. In 1967, Iowa came up with a vanishing sales tax credit against its State income tax liability. In this case the credit ranges from $12 for taxpayers having taxable income under $1,000 to no credit in those cases where taxable income exceeds $7,000 (Table 20).

This vanishing type credit scores high from the standpoint of maximizing tax yield. It also converts a regressive levy into a tax with some of the characteristics of a progressive revenue instrument (Table 19).

Residential Property Tax Relief

Although the value of the family residence served as a fairly good proxy of the ability to pay taxes in a rural society, total household income is a more precise measure of taxable capacity in our modern urban society.

This is illustrated by the hardship that the payment of residential property taxes imposes on low income households in general and on elderly householders in particular. With retirement, the flow of income drops sharply and a yearly property tax bill of, say, $500 that once could be taken in stride becomes a disproportionate claim on the income of an elderly couple living on a pension of $1,500 a year. By the same token, if the flow of income falls sharply as a result of the death or physical disability of the breadwinner, or unemployment, then again payment of the residential property tax can become an extraordinary tax burden.

The need for property tax relief for the elderly in particular is dramatically understood by the finding of the Wisconsin Tax Department that in 1965 over 5,000 elderly households were forced to turn over more than 20 percent of their total money income to the residential property tax collector.

This Wisconsin study also revealed that there were 841 households headed by elderly persons that were paying out on the average 55 percent of all of their total money income to the local property tax collector. These householders were obliged to draw on their savings to pay this tax on shelter. Compared to the average family's property tax burden--3 to 4 percent of household income, this situation not only violates the ability to pay principle, it produces a catastrophic family expense situation (Table 21).

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