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
 
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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 3340 (describing skill-biased
technical change and winner-take-all markets).

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