Poor People Have the Highest Effective Tax Rates

An argument used to undermine programs that provide tax relief for low-income people—such as Minnesota’s Working Family Credit (WFC) and Child & Dependent Care Credit—is that they provide tax relief to households that are not paying taxes in the first place. However, poor people do pay taxes. In fact, as a percent of income, they pay more state and local taxes than any other income group in the state.

The Minnesota Tax Incidence Study (MTIS), prepared every two years by the Minnesota Department of Revenue, examines state and local taxes paid by households of varying income levels. The MTIS places households into ten equally sized groups known as “deciles,” ranging from the first decile (the lowest income group) to the tenth (the highest). The tenth decile is further broken down into the top 5% (i.e., the top half of the tenth decile) and the top 1%. The most recent MTIS, published in 2017, examines actual data for 2014 and projected data for 2019. The income range for each decile in 2014 is listed below.

The MTIS examines state and local taxes paid by each of these groups as a percentage of income—a measure known as the effective tax rate (ETR). The chart below shows the 2014 ETR for each income group based on MTIS data.

Households in the lowest income decile pay on average 29.9% of their income in state and local taxes—more than double that of any other income group and nearly 2.5 times greater than the statewide average (12.0%). However, first decile ETRs are overstated by an unknown amount due to data anomalies described in the MTIS.* Even the second decile, however, has an ETR that is significantly higher than any other deciles, excluding the first. Per dollar of income, second decile households—with yearly incomes from $11,263 to $18,218—pay 16% more in state and local taxes than the state average and 21% more than the top 1%. Projected 2019 data from the MTIS shows the same general pattern as the 2014 data.

State taxes alone are somewhat progressive—meaning that higher income households tend to have higher ETRs than lower income households.† This is due to  Minnesota’s progressive state income tax, which falls most heavily on higher income households. The income tax liability of some low-income families may even be below zero—thanks to programs like the WFC and Child & Dependent Care Credit. These “refundable” credits can exceed the income taxes paid for some low-income families.

While state income taxes are progressive, most other state and local taxes are regressive, with low- and middle-income households typically paying a higher percentage of their income in these taxes than high-income households. State sales and excise taxes, for example, are steeply regressive. In general, local taxes—which consist primarily of regressive property taxes—fall particularly hard on lower income households. Per dollar of income, second decile households pay 1.6 times more in local taxes than the state average and 3.5 times more than the top 1%.

Throughout the years, the MTIS has repeatedly shown that Minnesota’s state and local tax system is regressive, with low-income families bearing more than their share of the tax load. Key tools in reducing the degree of tax regressivity are refundable credits such as the Working Family Credit and the Child & Dependent Care Credit. The state should not forego enhancing these programs on the false premise that poor people don’t pay taxes.

 

*The MTIS identifies two major reasons why ETRs for the first decile are overstated. First, the first decile “includes households who have temporarily low incomes or have better overall economic well-being than was indicated by their money income in 2014.” This group includes retirees who may be living off savings and households that “reported business losses or large capital losses for income tax purposes in 2014.” Second, income reported within the first decile can be understated due to an inability to identify all sources of income; this problem is particularly common among first decile households, which often do not file income tax return or a property tax refund return. The MTIS notes that “While this study does adjust for negative incomes for a small number of households, no attempt has been made to adjust for possible underreported or unidentified sources of income or for other differences between transitory and long-run measures of income.” However, the MTIS notes that Minnesota’s state and local tax system remains regressive, even if data from the first decile is excluded.

The exception to this rule is the first decile, which has a higher state ETR than any other income group examined in the MTIS. However, for reasons noted above, the ETRs in the first decile may be overstated.