Chart of the Week: Initiative 1098 effective tax rates are lower than most

Initiative 1098 will lower property taxes on residential and commercial property owners, exempt 81% of Washington small businesses from B&O taxes, and reduce the B&O rate for another 12% of businesses. It will offset the revenue reductions with a tax on high incomes (5% on income above $200K/individual or $400K/joint, and 9% on income above $500K/individual or $1 million/joint).

Because the tax will only apply to income over the threshold, we must calculate the effective tax rate in order to understand what percentage of income is actually paid in tax. The effective tax rate is found by subtracting the exempt amount from total income, and multiplying the remainder by its corresponding marginal tax rate.

Of course, the effective tax rate on an individual earning exactly $200,000 will be 0% — and it will be the same for couples earning $400,000. So what about for those who earn enough to pay income tax? For an individual earning $500,000 or a couple earning $1 million, the effective tax rate is 3%. For individuals earning $1 million and couples earning $2 million, the effective tax rate will be 6%.

Now, let’s take a closer look at how I-1098’s effective tax rates stack up against those in other states. These graphs below show how Washington’s effective income tax rates on individuals earning $500,000 and $1 million per year, respectively, would compare to other states under I-1098.

Click to enlarge

Data from the Federation of Tax Administrators; based on standard deductions. Some states allow itemized deductions, and personal exemptions vary by state.

Example 1: Chris is an individual filer, earning $500,000 in adjusted gross income. Under I-1098:

  • The first $200,000 of Chris’ $500K income would be exempt from any tax, leaving $300,000 taxable.
  • That $300,000 is taxed at 5%, resulting in $15,000 in total tax revenue.

So Chris will pay $15,000 in state income tax on a $500,000 income — a effective tax rate of 3%,  nearly the lowest in the nation.

Click to enlarge

Data from the Federation of Tax Administrators; based on standard deductions. Some states allow itemized deductions, and personal exemptions vary by state.

Example 2: Andy is an individual filer, earning $1,000,000 in adjusted gross income. Under I-1098:

  • The first $200,000 of Andy’s $1 million income would be exempt from any tax, leaving $800,000 taxable.
  • Of that $800,000, the first $300,000 is taxed at 5% (remember, that is the amount from $200K – $500K), resulting in $15,000 in tax revenue.
  • The remaining income of $500,000 is taxed at 9%, resulting in $45,000 in tax revenue.

Combined, Andy pays $60,000 in state income tax on a $1 million income — an effective tax rate of 6%, a rate that would put Washington right at the midpoint among all states that have an income tax.

Looking for more information about Initiative 1098? Visit the Economic Opportunity Institute website.

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Posted in An Inclusive Economy, Progressive Tax Reform

Comments

  1. Steve Roth says:

    can you provide the data tables for those graphs? would like to run some correlations, like against growth in real gdp/cap.

    • You’ll find a dataset on state income tax rates for your research at: http://www.taxfoundation.org/taxdata/show/228.html. Note that some of the 43 states that have an income tax use federal Adjusted Gross Income as a basis for tax assessment (as I-1098 proposes), while others do not.

      If you search around (as I’m sure you have), you’ll see that you won’t be the first person to try to assess whether there’s a correlation between tax rates and economic growth — and if so, in which direction. Turns out, it’s a more difficult task that it looks at first blush. For one thing, as Eliot Spitzer wrote in recent article for Slate.com: “Simultaneity does not equal causation. Annual growth rates are a consequence of many factors, macro and micro, and the isolated impact of marginal tax rates on growth is hard, if not impossible, to discern from these numbers alone.”

      Spitzer cites an article in the Yale Law Journal (Why Tax the Rich? Efficiency, Equity, and Progressive Taxation) which, he writes, “concludes that there is scant, if any, legitimate academic support for the proposition that moderate, as opposed to dramatic, increases in marginal rates have any impact on the willingness of the wealthy to participate in the economy.”

      On a broader note, there are also limitations to using GDP as a proxy for assessing overall economic health. The economist Simon Kuznets (who helped the U.S. Department of Commerce standardize the measurement of GNP) wrote in his report to the US Congress in 1934: “…the welfare of a nation can, therefore, scarcely be inferred from a measure of national income…”.

      In a 1962 article in The New Republic, Kuznets stated: “Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.”

      Food for thought. Good luck with your research!

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