New S&P Report Helps Make the Case for Progressive State Taxes

The latest report from Standard & Poor’s Rating Services reminds us that progressive tax reform can help mitigate income inequality and ensure states have enough revenue to fund their basic needs.

As has been documented by everyone from the Federal Reserve Board to Thomas Piketty, the share of income and wealth accruing to the very best-off Americans has grown substantially over the past century. The problem worsened in the years immediately following the financial crisis. This trend raises important philosophical questions about whether low-income Americans really have the same opportunities to share in the American dream that the wealthiest have been granted.

But Standard & Poor’s new report finds that there’s also a more mundane, practical reason to be concerned about inequality: it can make it harder and harder for state tax systems to pay for needed services over time. The more income that goes to the wealthy, the slower a state’s revenue grows. Digging deeper, S&P also found that not all states have been affected in the same way by rising inequality. States relying heavily on sales taxes tend to be hardest hit by growing income inequality, while states relying heavily on personal income don’t see the same negative impact.

This finding shouldn’t be surprising. As we have argued before, it doesn’t make sense to balance state tax systems on the backs of those with the least income.  When the top 20 percent of the income distribution has as much income as the poorest 80 percent put together, relying disproportionately on the poorest Americans to fund state services is not the path to a sustainable, growing revenue stream. The vast majority of states allow their very best-off residents to pay much lower effective tax rates than their middle- and low-income families must pay—so when the richest taxpayers grow even richer, these exploding incomes hardly make a ripple in state tax collections. And when the same states see incomes stagnate or even decline at the bottom of the income distribution it has a palpable, devastating effect on state revenue.

Conversely, when states like California enact progressive personal income tax changes that require the best-off taxpayers to pay something close to the same tax rates applicable to middle-income families, growth in income inequality doesn’t appear to damage state revenue growth significantly.

But the clear trend at the state level has been exactly the opposite: regressive tax systems relying more heavily on sales tax and less on the progressive personal income tax. Far more typical of the most salient tax “reform” ideas afoot at the state level these days is Kansas Gov. Sam Brownback’s hatchet job on the state income tax. And, as a front-page New York Times article reminds us today, states considering a shift from income to sales taxes are likely to regret it. S&P and Moody’s have recently downgraded Kansas’s bond rating precisely because reckless income tax cuts have endangered the state’s ability to pay for needed public investments.

Income inequality and declining state tax revenues are both serious issues that go to the heart of our ability to provide economic opportunity for individuals and businesses. Because of growing income inequality, it is more important than ever for states to move toward a more progressive tax system. Regressive tax systems hitch their wagons to those with shrinking or stagnant incomes.  Progressive tax reform is needed to make our tax code more fair and ensure that income inequality does not do damage to states’ ability to collect adequate revenue over the long-term.