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How progressive can state taxes be?

November 19, 2009

The Iowa Fiscal Partnership has generated some headlines by passing around their take on a new study by The Institute on Taxation and Economic Policy:

Study says Iowa tax system unfair to poor

Report: Iowa tax code favors wealthiest residents

Report: Iowa tax system hurts low and moderate income families

The report covers all 50 states. It ranks the 10 most-regressive systems (Iowa isn't one of them) and, interestingly, holds Delaware, D.C., New York, and Vermont as models of progressivity. Delaware is a special case because of its status as a state of choice for out-of-state businesses. The other three "progressive" states are ones that have horribly complex, anti-business tax systems that hurt the poor by driving their employers away.

The study begs the question of how "progressive" (and to ITEP, "progressive" = "fair") state tax codes can be. The rich are mobile. If Iowa beats up on the rich, they can relocate to Florida or South Dakota. If California clobbers the rich, Texas and Nevada beckon. It hardly seems "fair" to the poor when a state drives out their "rich" employers with high taxes.

As California has learned painfully in the current recession, tax systems that lean too hard on the highest earners are also very volatile. By spreading the tax burden over a broader population, a state makes its revenues more stable, but it loses "fairness" points with ITEP.

No, states shouldn't clobber the poor. But state tax policy based on "fairness" as defined by ITEP creates problems that are worse for a state than those they try to cure.