Income inequality is no higher in states without an income tax and incomes of the poor are higher

By John Phelan. John Phelan is an Economist at the Center of the American Experiment.

"This week I’ve looked at how the seven states without state income taxes – Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming – were responsible for a disproportionate share of GDP and employment growth in the decade before COVID-19 hit and attracted a disproportionate share of domestic migrants. Clearly there is something about these states that is working.

Inequality

But the income tax is progressive. Others sources of revenue which state governments rely on – such as Sales and gross receipts taxes and Charges and miscellaneous general revenue – are not. So maybe Minnesotans are willing to sacrifice the dynamism associated with eliminating their income tax for the greater redistribution and resulting economic equality that comes with having one.

Of course, that argument depends on states with income taxes having greater income or wealth equality than those that don’t. The data show that this isn’t the case.

Figure 1 uses data from the Census Bureau’s 2019 American Community Survey to show the Gini coefficient for each state and the District of Columbia. The Gini coefficient measures the inequality of income distribution. It ranges from zero, which indicates perfect income equality, with every household earning exactly the same, to one, which implies absolute inequality, with a single household earning all of a jurisdiction’s income. The higher the number, the more income unequal a place is.

Figure 1: Gini coefficients, 2019

Source: Census Bureau and Center of the American Experiment

No very clear pattern emerges. New York and California, which both had relatively high top rates of state income tax in 2019, had more income inequality than the most unequal state without an income tax, Florida, and the most equal five states included three without an income tax. Indeed, for the seven states without state income taxes the average Gini coefficient is 0.46 which is exactly the same as it for the 43 states and District of Columbia with an income tax and for the United States generally. Not having an income tax, then, does not seem to make a jurisdiction more unequal.

Poverty

But, as Margaret Thatcher pointed out so long ago, the attempt to make incomes more equal should not distract us from the much more important goal of making incomes higher. Someone with an income of $30,000 in a state with a Gini coefficient of 0.6 is better off than someone with an income of $20,000 in a state with a Gini coefficient of 0.5.

Figure 2, again using data from the Census Bureau’s 2019 American Community Survey, shows the average income of the lowest earning 20% of households in each of the 50 states and District of Columbia.

Figure 2: Average income of lowest earning 20% of households, 2019

Source: Census Bureau and Center of the American Experiment

We see that there are 18 states – including New York – where the lowest earning 20% of households earn less than in the state with no income tax where they earn least – Florida. Indeed, across the seven states with no income tax, the average income of the lowest earning fifth of households is $15,863 compared to $14,722 for the jurisdictions which do have income taxes. Again, it seems that not having an income tax is not associated with a jurisdiction having lower incomes for the poor.

Again, none of this is to understate what an arduous journey it would be for Minnesota to become a no income tax state. But we should be clear about what the destination would be like and that requires looking at the reality of life in those seven states with no income tax."