BOSTON - April 12 - States that rely heavily on sales taxes instead of levying a personal income tax are imposing billions of dollars in extra federal income taxes annually on their residents, according to a new report from the Institute on Taxation and Economic Policy (ITEP) and United for a Fair Economy's Tax Fairness Organizing Collaborative (TFOC).

The new report, Leaving Money on the Table, calls attention to the important, but often overlooked, linkage between state and federal tax systems. In particular, the report examines the federal deduction taxpayers may take for state and local taxes they paid, and analyzes the impact of this deduction on the combined federal taxes paid by all state residents.

The report shows that in the seven states that do not levy an income tax but do rely substantially on state sales taxes (Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming), state residents pay considerably more federal income taxes as a result:

• If these seven states enacted even a minimal, flat-rate income tax and used the revenues to reduce sales taxes dollar for dollar, the federal taxes paid by residents of these seven states would drop by a combined $1.7 billion a year.
• If these states enacted a progressive personal income tax similar to what many other states now levy, federal taxes paid by residents of these states would drop by up to a combined $5.5 billion a year.

"How states choose to raise money has a big impact on the amount of federal tax dollars that can be returned to their residents each year," said Karen Kraut, Director of the TFOC. "Substituting an income tax for a sales tax would keep the total revenue raised by the states the same, but would substantially reduce the federal tax bills of the residents of these states. That's because the sales tax deduction offers a small benefit and the low- and middle-income people for whom sales taxes are most burdensome generally do not itemize their federal tax returns, while the income tax deduction offers a much larger tax benefit and the beneficiaries - mostly upper-income taxpayers - are very likely to itemize."

"The federal tax system provides a clear incentive for states to adequately fund public services," noted ITEP Executive Director Matthew Gardner. "It also provides a clear incentive for states to rely on progressive personal income taxes to fund those services. And the few states that have not yet taken advantage of this incentive are basically leaving federal money on the table."

The report also shows that such a tax swap would substantially reduce state taxes on low- and middle-income families, resulting in significant improvements in the tax fairness climate of each state.

The added benefits to the economy of such a progressive tax swap are highlighted in a recent TFOC report, Solutions that Work for Main Street: Progressive Guidelines for Closing Recessionary State Budget Gaps. As the report explains, switching to a more progressive tax structure puts money in the hands of low- and middle-income people who tend to immediately spend it in the local economy. Such increased economic activity leads to job retention and creation, and enhances economic recovery during a recession.

Leaving Money on the Table is available for download at faireconomy.org/news/Leaving_Money.