These 5 states don’t tax your income — but there’s a catch
It’s no secret that taxes differ immensely from state to state. But in a recent GOBankingRates ranking that determined the most tax-friendly states for the middle class by using data from the Institute on Taxation and Economic Policy, an important theme emerged: Residents who live in some states that don’t impose a personal income tax are dealing with tax inequality.
The research found that just because a state doesn’t have an income tax, that doesn’t necessarily mean you’ll pay lower or fewer taxes. States ultimately need to find ways to fill the gap of no income tax, and they do it through other forms of taxation, such as sales and property taxes. And depending on whether the state has a progressive or regressive taxation system, lower- and middle-income residents could experience a blow to their wallets.
RELATED: Take a look at the average tax refund in every U.S. state:
See the Study: Most Tax-Friendly States for the Middle Class
Regressive Taxation vs. Progressive Taxation: Why Does This Matter?
First things first, what’s the difference between progressive and regressive taxes? In a progressive taxation system, upper-income families pay a larger share of their incomes in taxes compared to those with lower incomes, according to the ITEP. On the other hand, in a regressive tax system, poor and middle-income families pay a larger share of their incomes than the wealthiest families.
According to ITEP’s data, these are the five states with the most regressive state and local tax systems:
- South Dakota
One of the most obvious shared features among these five states is that they do not levy an income tax. Another is the heavy reliance on sales and excise taxes. And in the case of Florida and Texas, these states rely heavily on higher-than-average property taxes.
The worst offender among the five is Washington, where the poorest families contribute nearly 18 percent of their income to taxes. Washington, with its booming tech hub in Seattle and lack of income tax, is drawing more people to it. However, the reality of Washington’s sales, excise and property taxes on everyone but the richest is quite burdensome.
Find Your City: The Average American’s Tax Bill in the 50 Biggest U.S. Cities
5 Worst States for Tax Inequality
Let’s take a closer at the five most unequally taxed states in the U.S.
In Nevada, sales and excise taxes consume 7.1 percent of the lowest 20 percent of families’ incomes. Compare that to 4.5 percent paid by the middle 20 percent, and just 0.7 percent paid by the top 1 percent of families.
Taken all together, the lowest 2 percent of families pay 10.2 percent of their income in taxes. And the top 1 percent pay out a mere 1.9 percent.
4. South Dakota
State and local taxes in South Dakota consume 11.2 percent of the poorest 20 percent’s income and only 2.5 percent of the top 1 percent’s income. That means the poorest families are paying around 4.5 times the share of taxes that the top 1 percent is paying.
Florida relies heavily on property taxes to fill the void from not charging a state income tax. But its property taxes are particularly punishing on the lowest income earners. The lowest 20 percent of families spend 3.9 percent of their income on property taxes, which is three times what the top 1 percent pay from their income (1.3 percent). Sales and excise taxes take away another 8.7 percent of the poorest 20 percent’s income.
In total, the poorest 20 percent of families have to dish out 12.7 percent of their income in state and local taxes. The top 1 percent only have to pay 2.3 percent.
Everything’s bigger in Texas, including the share of taxes the lower- and middle-class pay from their income compared to the richest. State and local taxes consume 9.7 percent of the middle 20 percent’s income. And the lowest 20 percent lose 13 percent of their family income to state and local taxes.
Meanwhile, the richest 1 percent contribute only 3.1 percent. Based on these percentages, that means the middle 20 percent are paying more than three times their share of taxes — and the poorest 20 percent pay over four times.
Texas State Taxes: Here’s Everything You Need to Know
In Washington, the top 1 percent of families contribute 3 percent of their income to state and local taxes. By contrast, the middle 20 percent — families earning $44,000 to $70,100 — lose 11 percent of their income to taxes. Lastly, the lowest 20 percent are paying a harsh 17.8 percent of their income toward state and local taxes.
Property taxes in Washington are particularly rough on the poorest 20 percent of families. The middle 20 percent of earners contribute 2.9 percent of their family incomes to property taxes, which is more than double the top 1 percent’s share (1.3 percent). But the lowest 20 percent contribute 4.5 percent, which is about 3.5 times what the top 1 percent contribute.
What to Do If You Live in a State With a Regressive Tax System
It might sound obvious, but one way to survive in a regressive tax system is to increase your income and find ways to protect your paycheck from taxes.
For example, talk to a tax expert about saving money in a tax-deferred retirement account to reduce your taxable income. Or, if you’re thinking about buying a home soon, consider the tax benefits of homeownership. You can reduce your taxable income, for example, by taking advantage of the mortgage interest deduction.
Lastly, because these states exact much of their tax revenue from state and local sales and excise taxes, the key to saving money could be to live in local jurisdictions with lower sales tax rates. A county with a lower local sales tax rate can bring down the combined state and sales tax rate.
Keep reading to see the average American’s tax bill in every state.
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This article originally appeared on GOBankingRates.com: These 5 States Don’t Tax Your Income — but There’s a Catch