More states are slashing or eliminating taxes, lessening the burden mostly for the wealthy. What does that cost the rest of us?
In 2020, a proposed constitutional amendment in Illinois attempted to turn the state’s flat personal income tax of 4.95 percent into a graduated rate that rises with income. Democratic Gov. J.B. Pritzker, a billionaire himself, posed the amendment as a fight for tax fairness that would ask the state’s wealthiest residents to pay a greater share, but he had a formidable foe: Billionaire hedge fund manager Ken Griffin, who poured $54 million into defeating the measure, framing the amendment as an extra burden on Illinois taxpayers that would enable irresponsible government spending. In fact, it would have kept the tax rate the same or lower for Illinoisans making $250,000 or less. (ProPublica estimated that it would have cost Griffin, who currently is worth around $29 billion, an extra $51 million a year in taxes.)
The measure failed to pass.
Illinois’ flat income tax is one example of a regressive state tax system, in which the tax burden decreases the richer someone is. They are designed for the benefit of the wealthy — and sometimes by the wealthy — at the expense of low- and middle-income taxpayers.
The federal income tax is progressive because the share of income tax someone pays grows bigger the more money they make. But it’s a different story for state taxes. Not only do 14 states already have or plan to implement a flat income tax, the vast majority of them, like Illinois, also have regressive tax systems that serve to widen the wealth gap. What’s more, the past few years have been marked by a flurry of newly passed state tax cuts — in 2022, at least 35 states and DC have voted for some kind of cut. At least 13 have adopted income tax rate cuts, which usually benefit the wealthy more than the poor, and while a minority of states currently have no income tax, a growing number are trying to eliminate it.
Such tax cuts are just one way that state laws and policies can help worsen economic inequality. When the wealthy aren’t taxed, there’s a cost for everyone else. If states take away taxes on wealth — levying no corporate income tax, no progressive income tax, no capital gains tax, no estate tax — what’s left to fund the services society relies on?
A tax system doesn’t just raise money for governments; it can help level the playing field of wealth by taking more from the richest and less from the poorest. That tax revenue can then further address economic inequality through spending on public benefits and services.
Some states, like Massachusetts, have raised taxes on rich residents, but overall, attempts in recent years to tax the wealthy more have been an uphill struggle. States are not just cutting or eliminating income taxes; a growing number are becoming homes to unregulated trust industries that allow the ultrarich to keep their assets hidden.
These states, in other words, are becoming cozy tax havens for the country’s wealthiest people. Low state income and corporate taxes, along with lax oversight of trusts, creates an environment in which the ultrarich keep their wealth mostly out of the reach of taxation, while more of the tax burden is shifted onto low-income Americans. Tax havens have typically been associated with countries like Switzerland, Panama, and Malta, but now they’re flourishing within the US, too.
The policies of tax havens
In September, the Institute for Policy Studies, a left-leaning think tank, published a report detailing the growth of tax haven states in the US, profiling 13 of the worst offenders. The states named in the report have a few key things in common: All but two have no estate or inheritance taxes. Eight have no capital gains tax, five have no corporate income tax, and seven have no state individual income tax. South Dakota, Nevada, and Wyoming have none of these taxes. These taxes are often paid by the wealthy; enacting them would make a state’s tax system more progressive by increasing the tax burden as wealth increases.
Tax havens are “hollowing out state tax bases in a way that results in everyone else paying a higher share of state tax dollars than would otherwise be the case,” Carl Davis, research director at the Institute on Taxation and Economic Policy, told Vox. “If states aren’t able to raise this money from the wealthy, they’re going to raise it from the middle-class and low-income families instead.”
They raise money from middle- and low-income residents by relying heavily on sales taxes. The cost of a good, and the tax on it, after all, is the same for everyone, but takes a greater proportion of your earnings if you’re poor than if you’re a billionaire. In 2021, Texas — which has no individual income tax — raised 61.8 percent of its tax revenue from sales taxes. In contrast, only 16.9 percent of California’s taxes came from sales taxes; its biggest source was the individual income tax, which accounted for 59 percent of tax revenue.
2022 has been a banner year for state tax cuts, says Richard Auxier, a senior policy associate at the Urban-Brookings Tax Policy Center. Many were one-time rebates, similar to the stimulus checks the federal government sent in 2020 and 2021, that won’t have long-term effects on a state’s ability to raise revenue.
But several states, said Davis, are “taking this moment as an opportunity to cut taxes on a permanent basis — pursuing, in many cases, top-heavy tax cuts that they would have pursued anyway.”
These cuts are coming at a time when states are enjoying a budget surplus, thanks to the unprecedented federal aid that states received throughout the Covid-19 pandemic.
“If you narrowly look at this moment, states are great. Revenues are up, spending is good,” said Auxier. “If you pull back a little bit, you look at the challenges that we’re dealing with and the uncertainty going forward.”
In other words, what happens when the federal aid runs dry and states have lowered tax rates while staring down a recession?
“We’re in an incredibly uncertain moment right now,” Davis said, pointing out that inflation has affected state and local budgets. “We know that the expenses that state and local governments are facing are rising quite significantly. Infrastructure costs a lot more than it used to.”
How trusts allow the ultrarich to reduce their taxes further
Wealth-friendly tax cuts alone don’t produce tax havens. The lack of regulation around trusts — a financial arrangement that is simply meant to hold someone’s assets until they are passed on to another person — works in tandem with low taxes to create the perfect conditions for the very wealthy to avoid taxes.
One of the revelations of the Pandora Papers leaked in 2021 was the proliferation of tax havens inside the US. They’re used not just by wealthy Americans but by foreign politicians, business leaders, and criminals as well. South Dakota in particular has become a destination for the wealthy to stash their riches, and it currently hosts more than $512 billion in trusts, according to the IPS report. The ultrarich have parked trillions of dollars in secretive trusts within US tax haven states.
“It’s not just South Dakota, it’s not just Delaware,” said Chuck Collins, director of the Program on Inequality and the Common Good at the Institute for Policy Studies and one of the authors of the tax haven report. “A bunch of states are in the chase.”
The benefit for states is attracting businesses and jobs, but there’s little evidence that becoming a trust-friendly tax haven boosts job growth for states. Populous states like Texas and Florida are getting in on the game, too. It could accelerate what Collins calls a “race to the bottom,” in which more states change laws to attract the trust industry.
A trust is a contract that stipulates what assets one person wants to pass on to another. When assets are put into a trust, the original wealth-holder technically no longer owns them. A third-party entity, known as a trustee, manages the assets for a named beneficiary until the terms of the trust are fulfilled — for example, a parent establishes a trust for their child that will transfer assets to them when they turn 25 or upon the parent’s death. A trust is supposed to end at some point, and ownership of assets is supposed to pass to the beneficiary; it’s a way station for wealth, not the final destination.
Except that a growing number of trusts don’t end. None of the 13 tax haven states has a strict life span limit on trusts. Several states have abolished a rule limiting the life span of trusts altogether. Others set the limit somewhere between 300 and 1,000 years. By carefully setting up a dynasty trust that lasts generations, a wealthy family can avoid paying inheritance or estate taxes for millennia. These trusts often obfuscate who really owns the assets, so they can continue using them — assets like real estate or yachts — or take out “loans” from the trust without triggering gift taxes. The secrecy and confusing ownership structures of trusts are big problems. The government can’t tax something that legally doesn’t belong to a person anymore, and it certainly can’t tax assets that it doesn’t even know exist.
What tax havens mean for public spending
Whether and how states tax residents matters not only because it can worsen inequality, but also because it’s states, not the federal government, that make many of the decisions that affect people’s day-to-day lives. States decide how much money to collect, and then how to divvy it up. How much should they spend on education? How much on public assistance programs?
The past few decades of American life have been, in broad strokes, marked by fiscal austerity. After the Great Recession, state and local governments made deep budget cuts to boost economic recovery.
“The Great Recession was really, really hard on states,” said Auxier. “The federal government didn’t exactly step in and do all it needed to do, and so even as the economy was slowly growing in the 2010s, state revenue, state spending, state employment — those things didn’t really recover until 2019 or 2020.”
The strategy of making deep budget cuts after an economic crisis like the Great Recession doesn’t necessarily have immediately obvious consequences. They can add up over time until one day you find yourself driving on a highway in disrepair to drop your child off at a school with a teacher shortage. Other times, the effect lights up like a neon sign: The pandemic was a flashpoint where states’ public health systems, which have faced steep declines in spending since 2010, buckled under strain.
States vary widely not only on what kinds of taxes they collect but also on how much they choose to spend. Washington, for example, doesn’t levy an income tax, but it still has a “fairly expansive state and local provision of services and goods — things that it values and thinks its residents should get from its government,” said Auxier.
That’s very different from a state like South Dakota, which also doesn’t tax income. Per capita, Auxier said, “it spends less on schools, it spends less on what they call public welfare.” A huge part of public welfare spending for most states is Medicaid, the public health insurance program that most states have now expanded to cover more low-income residents (South Dakota only voted to expand their Medicaid program in the 2022 midterms). Currently, 11 states have chosen not to expand the program; five are tax haven states, including Texas and Florida. Medicaid expansion is more a reflection of state leaders’ politics than it is about balancing a budget, Auxier explained, because the federal government gives states most of the money they need to expand Medicaid. Even if the initial expansion has costs, studies have shown that, in the long run, states save on overall health care costs.
While states do many things for their residents, the biggest services they provide are schools and health care. “If you keep taxes low, it means you don’t spend that much on schools and health care,” Auxier said.
In 2019, before Covid-19, according to data from the Urban Institute, the biggest portions of state and local expenditure went to public welfare, elementary and secondary education, and health and hospitals. On average, state and local governments spent $10,139 per capita that year.
Nine out of the 13 tax haven states named in the IPS report had lower per capita expenditures than that in 2019. South Dakota spent only $8,200 per capita. Florida spent $8,083, and Texas spent $8,746. There are cost of living and demographic differences between states that impact how much a state needs to spend on various categories, but these numbers give an impression of the approach a state takes to taxation — and to public investment.
An alternative to tax havens
There are states that are trying to rein in wealth concentration. Twenty-one states plus Washington, DC, have an estate or inheritance tax (though it should be noted that until 2001, every state had some such tax), and the federal government levies an estate tax, too. Some states levy an extra tax on especially expensive real estate. Earlier this year, California lawmakers proposed a 1 percent wealth tax on residents with a net worth over $50 million, but the constitutional amendment required for the tax didn’t win at the polls. Massachusetts voters, on the other hand, passed an additional 4 percent tax on incomes over $1 million this past November. The estimated $1.3 billion in extra revenue is earmarked for public education and transportation. Such taxes won’t completely shake up the distribution of wealth in the country, but the potential for extra revenue — and the potential for what that money could do for Americans — is nothing to scoff at.
Tax policy is the subject of plenty of debate. Conservative think tanks and lawmakers argue for a flat percentage for everyone. Progressives want a higher percentage the more people make. Business leaders often claim that taxes on corporations and investors stifle innovation and economic growth, hurting everyone, rich or poor. Billionaires like Warren Buffett, when asked why he pays such a low tax rate, point to their philanthropic contributions — Buffett has pledged to give away 99 percent of his fortune. But these considerations are separate from the question of what makes a tax system fair: Who would bear the heaviest tax burden in a just world?
“We find very few people who explicitly defend regressive taxation, where you’re asking more of the poor and the middle class than you are of the wealthy,” said Davis of the ITEP. “And yet, here we are.”
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