Tuesday, November 17, 2009

State Tax Policies

Tax rates vary significantly by state. The states with the lowest income tax rates, and most importantly the lowest "marginal" rates (the tax rate on your last dollar of income) tend to attract the wealthy and entrepreneurs and have higher rates of growth. Florida, Texas and Nevada in particular benefit from this type of tax regime. As an Illinois resident, virtually the only positive element of the tax situation in Illinois is that we have a "flat", non-graduated state income tax rate at 3%. In all other areas (property taxes & sales taxes in particular) our rates our onerous and damaging to the business community. To see the income tax rate on a state-by-state basis, check out this site here and put in your state to see the tax brackets and the marginal tax at the highest income rates.

As states get into financial trouble, the situation is getting even worse. California has very high marginal rates, and continuous attempts to raise taxes (although the fact that tax increases must be approved by 2/3 of the legislature gives Republicans some say in that state), at a top rate of 10.3%! Admittedly this is a bit of a simplification, because states with progressive tax brackets like California typically allow for more deductions, while Illinois at 3% pretty much just takes your Federal taxable income and applies the rate with few distinctions. Changing Illinois to a graduated rate requires changing the state constitution, which is a big barrier to never ending schemes to move to this type of arrangement. Another factor on state taxes is that they are deductible against Federal taxes, although in fact the amount of the deduction is lower than it may appear because you have to cross the standard deduction before you can deduct the taxes, and there may be other income limits on deductions.

For wealthy individuals, the problem is acute. If you live in California, you may be taxed at up to 10.3% on your last dollar of income, while across the state border in Nevada you face ZERO state income taxes. This can be a big difference.

A recent Wall Street Journal article was titled "Wealthy Eye Rising State Tax Rates" and describes the impact of these policies:
The topic of high state-tax rates come up most often when a client is selling a business. Though a hasty move to low- or no-state-tax states such as Florida, Texas, Washington or Wyoming can be tempting, advisers say states have grown more aggressive about tracking down and collecting from former residents.

If you KNOW that you are going to have a high-tax event, such as selling a profitable business for a lot of money that has a low tax basis, then the wealthy are considering moving out of state at the time the taxable event occurs. This makes a lot of sense depending on the size of the gain and how the deal is constructed. Rather than being more competitive, this article points out that states are just getting more aggressive at counting the days in-state for people claiming out of state status and trying to shake them down for additional taxes.

The Tax Foundation is a great site that is highly recommended and has many excellent articles about tax policy. I am going to send them a donation tonight, since we are coming up on year end anyways and it is time to start getting my tax records and donations in order. If you are interested in this topic check it out and recommend that your elected representative do the same.

Cross posted at Chicago Boyz

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