Imagine this: your state has the option of reducing its residents’ combined federal tax bills by hundreds of millions of dollars a year and, at the same time, substantially reducing state taxes for almost 80 percent of its residents ... but then chooses not to do so.
Remarkably, that’s exactly what Wyoming and six other states are doing. Wyoming, Florida, Nevada, South Dakota, Tennessee, Texas, and Washington are opting out of a state tax reform that would make those significant benefits to taxpayers possible.
Like the other six states, Wyoming raises revenue by relying heavily on sales taxes instead of levying a personal state income tax. Those two revenue approaches combined create a lose-lose situation for most Wyomingites.
Low- and middle-income residents lose because they end up paying significantly more of their income in total state taxes than do high-income taxpayers. And residents who itemize their federal tax returns lose the "bang for the buck" on the deduction for state tax payments (the "federal offset"), thereby missing an opportunity to export a more substantial part of their state tax load to the federal government.
It doesn’t have to be this way in Wyoming.
According to a new report, "Leaving Money on the Table," from the Institute on Taxation and Economic Policy and United for a Fair Economy, if Wyoming and the other six states swapped a portion of their sales tax for an income tax, they could return to their taxpayers billions of dollars of federal income taxes each year.
Specifically, if Wyoming enacted even a minimal 3 percent flat income tax and used the revenue to reduce sales taxes dollar for dollar (a revenue-neutral change), the federal taxes paid by residents collectively would drop by a combined $14 million a year thanks to the federal offset. If Wyoming enacted a progressive personal income tax similar to what many other states now levy, the federal taxes collectively paid by residents could drop by a combined $57 million a year ... hardly chump change.
While the federal offset benefits only those taxpayers who itemize their federal tax returns -- overwhelmingly upper-income people -- low- and middle-income taxpayers would also enjoy significant benefits because an income-for-sales tax swap would substantially reduce their total state taxes. Each of the seven state’s overall tax structure -- currently steeply tilted in favor of the very wealthy -- would become more fair.
In Wyoming right now the tax structure is "upside down" with the lowest income 20 percent of people paying 8.3 percent of their income in state and local taxes, and the top 1 percent paying only 1.5 percent. Under the progressive income tax swap, the lowest income 20 percent would pay 2.6 percent of their income in state and local taxes, while the top 1 percent would pay 5.7 percent.
While the income-for-sales tax swap would require a constitutional amendment in Wyoming, it’s well worth it. Forty-one states have figured this out and take advantage of the strong federal incentive to raise revenue through a broad-based state income tax. Now it’s time for Wyoming and the remaining states that don’t to do right by their citizens and stop leaving money on the table.