Giving Credit Where Credit is Due: Reducing Inequality with a Progressive State Tax Credit

• Author: Eric Kades
• Position: Thomas Jefferson Professor of Law at William & Mary Law School.
• Pages: 359-423

Giving Credit Where Credit is Due: Reducing

Inequality with a Progressive State Tax Credit

Eric Kades*

TABLE OF CONTENTS

Introduction .................................................................................. 360

I. Income Inequality, Federal Tax Progressivity, and

State Tax Regressivity .................................................................. 363

A. The Inequality Revolution Since 1980 .................................. 363

B. The Normative Case for Progressive Taxation ...................... 368

C. Federal Tax Progressivity ...................................................... 373

D. State Tax Regressivity ............................................................. 377

II. Deductions and Credits, Progressive or Regressive, and

Interactions Between National and State Taxation ....................... 386

III. Modeling a Progressive State Tax Credit (“PSTC”) .................... 389

A. An Overview .......................................................................... 390

B. Computing Aggregate State Tax Payments ........................... 393

C. Constructing the PSTC .......................................................... 395

D. Explaining Key Choices Made in Constructing

the PSTC ................................................................................ 398

1. Choosing the Income Level at Which the

100% Credit Begins to Phase Out ................................... 398

2. Choosing the Rate of the Phase Out ................................ 399

3. Ensuring Revenue Neutrality .......................................... 401

IV. Estimating the Impact of the PSTC Across the 50 States ............. 402

V. The PSTC and the Constitution’s Uniformity Clause .................. 408

Copyright 2016, by ER IC KADES.

* Thomas Jefferson Professor of Law at William & Mary Law School.

Thanks to Eric Chason, Brian Galle, Mark Gergen, Edward Kleinbard, Daniel

Shaviro, Kirk Stark, Bill Richardson, Ted Sims, and Ed Zelinksy for comments

on earlier iterations o f this Article. Thanks also to other participants at meetings

of the American Law & Economics Association, the Canadian Law & Economics

Association, and the National Tax Association; and thanks to the University of

Minnesota Law School workshop participants.

360 LOUISIANA LAW REVIEW [Vol. 77

Conclusion .................................................................................... 414

Appendix A. Credit in Dollar Amount and as Percent

of State Taxes and Income, by State ............................................. 417

Appendix B. Comparing Effective Tax Rates: Current v.

Under the PSTC, by State ............................................................. 420

INTRODUCTION

Anyone not living in a cave knows that since about 1980, income

inequality in America has exploded. Top incomes have soared while

middle and lower class paychecks have stagnated.1 Just as income

inequality has exploded, so too has the scholarly literature surrounding

inequality.2 Commentators have proposed a number of stock policy

measures to deal with inequality, from increasing the minimum wage to

reinvigorating unions to imposing a global tax on capital.3 This Article, by

contrast, takes a new tack. First, it identifies a key driver of today’s income

inequality entirely within the control of governments: unfair, regressive

state taxation. Second, it proposes a novel means of ameliorating that

inequality through the use of a federal income tax credit.

Simply put, the tax regimes of all 50 states4 are unfair. From the

perspective of fairness and equity, tax systems come in three flavors. If the

percent of income paid in taxes—the “average” or “effective” tax rate—

increases with income, the tax is progressive; if this percent is equal across

all incomes, it is a “flat” tax; and if percent tax burdens fall as income

rises, the tax is regressive. The federal income tax is and always has been

1. See infra Figure 1 (charting sharp rise in top incomes since 1980) and

Figure 2 (showing essentially no real incomes gains for middle and lower classes).

2. The literature on income and other for ms of inequality is growing

prodigiously. Perhaps the most pathbreaking work on the current inequality trend

is T homas Piketty & Emmanuel Saez, Income Inequality in the United States,

1913-1998, 118 Q. J. ECON. 1 (2003).

3. Paul Krugman, Liberals and Wages, N.Y. TIMES, July 17, 2015 , at A27

(making the case for raising minimum wage); ROBERT REICH, SAVING

CAPITALISM: FOR THE MANY, NOT THE FEW 183–92 (2015) (arguing for legal

change to reinvigorate unions); THOMAS PIKETTY, CAPITAL IN THE TWENTY-

FIRST CENTURY 447–67 (Arthur Goldhammer trans., 2014) (advocating global tax

on capital).

4. Throughout this Article, “state taxation” is used as a shorthand for “state

and local taxation.”

2016] GIVING CREDIT WHERE CREDIT IS DUE 361

progressive—the percent of total income paid in federal taxes rises with

income.5

Although the flat tax rate structure has advocates,6 it is hard to find

friends of regressive taxation. Yet, despite the almost complete absence of

express support for regressive taxation, it turns out that every single state

in the United States taxes regressively.7 This regression occurs primarily

because widely used, highly regressive sales taxes and potentially

regressive property taxes outweigh slightly progressive state income

taxes—for those states that tax income. States that lack income taxes and

rely almost exclusively on sales and property taxes have the most

regressive overall tax systems.8 One of the most egregious examples is the

state of Washington, where the lowest-income households must devote

16.8% of their income to state taxes while those at the top pay less than

2.8%.9 This is an astounding level of regressivity, and many states have

only modestly less regressive tax systems.10

Regressive state tax schemes gratuitously contribute to inequality.

Some of the market forces driving the divergence between the top 1% and

everyone else are so elemental that governments can do little to counteract

them.11 Taxation, however, is an animal entirely of government creation

and entirely under government control. It is disturbing and perverse that

5. See TAX FOUND., FEDERAL INDIVIDUAL INCOME TAX RATES HISTORY

(2013), http://taxfoundation.org/sites/taxfoundation.org/files/docs/fed_ individual

_rate_hhistory_nominal.pdf [https://perma.cc/Q7BD-FMMR]. Marginal tax rates

that increase with income ensure the progressivity of a tax, and the federal income

tax has always had such a structure. This was true even for precursors of the modern

federal income tax, enacted in 1913, which had relatively high exemptions—that is,

a marginal tax rate of 0% for most taxpayers. Id.

6. The most influential version of a flat tax proposed a flat tax on

consumption—income less savings. ROBERT HALL & ALVIN RABUSHKA, THE

FLAT TAX, at xiv–xvi (1995). Republican presidential candidate Steve Forbes did

much to popularize the flat tax during the 1996 Republican primaries and

continues to advocate for such a tax. Steve Forbes, The Tax Code: Make It Flat,

FORBES (Mar. 7, 2014, 9:00 AM), http://www.forbes.com/sites/steveforbes

/2014/03/07/the-tax-code-make-it-flat/ [https://perma.cc/YW73-4LHR].

7. CARL DAVIS ET AL., INST. ON TAXATION & ECON. POLICY, WHO PAYS? A

DISTRIBUTIONAL ANALYSIS OF THE TAX SYSTEMS IN ALL 50 STATES 1 (5th ed. 2015).

8. Id.

9. Id. at 123.

10. Id. at 4 (Table, “ITEP’s Terrible 10 Most Regressive State and Local Tax

Systems”).

11. See infra text accompanying notes 33–40 (describing skill-biased

technical change and winner-take-all markets).