Measuring tax and transfer progressivity, state by state

To what extent does the collective web of government taxes and spending programs redistribute resources among richer and poorer households? In a 2017 article in the Quarterly Journal of Economics, Minneapolis Fed Monetary Advisor Jonathan Heathcote, Kjetil Storesletten of the University of Minnesota, and Giovanni Violante of Princeton established a method to assess the overall “progressivity” of federal taxes and transfers (that is, to what extent the net burden of taxes becomes heavier—or lighter—as households get richer). In new research, they update their federal calculations and extend their analysis to the 50 states and Washington, D.C. (Minneapolis Fed Staff Report 663, “Fiscal Progressivity of the U.S. Federal and State Governments,” with Johannes Fleck of the Federal Reserve Board of Governors).

The economists funnel an extensive array of data into a straightforward function, yielding a single number to capture progressivity and its opposite, regressivity.¹ Importantly, their analysis is limited to working-age households with a minimal level of earned income. The bottom lines, in their baseline model: The federal government is progressive—considerably more progressive than any single state. The states, collectively, are roughly proportional (neither progressive nor regressive). But the states vary widely along the spectrum (see figure).

Roughly two-thirds of states are regressive—taxing poorer households at higher rates than richer ones, even after transfers. Illinois is the most regressive state, given its flat income tax and steep property taxes, followed by other states that lack income taxes, rely heavily on property and sales taxes, or spend less on social programs. Alaska is by far the most progressive state, thanks to annual cash dividends all Alaskans receive from natural resource revenues. Minnesota is No. 2 for a more balanced set of reasons, including a progressive income tax and higher social spending.

These baseline calculations include federal and state income and excise taxes, state and local sales and property taxes, and a full array of transfer programs at all levels. These programs include federal transfers like Social Security, Medicare, food assistance, and housing assistance; state programs like unemployment insurance and workers’ compensation; and jointly funded transfers like Medicaid. With this scope, the staff report offers the most comprehensive view of American policy progressivity to date.

The economists rely primarily on the Annual Social and Economic Supplement of the Current Population Survey. But they supplement that survey with alternate data and modeling to estimate the full range of taxes and transfers at the household level. These efforts include imputing the incomes of the highest-income Americans (which are top-coded in surveys); estimating the incidence of sales and excise taxes on consumers of different income levels; isolating the state and federal components of joint transfer programs; and imputing the property taxes paid by each surveyed household, including the pass-through of property taxes to renters (which will vary across housing markets).

In extensions of the model, the economists make additional assumptions to explore the progressivity of indirect taxes and transfers. Corporate and business taxes are progressive at the federal level and mildly regressive at the state level, with little effect on the ranking of states. Transfers in the form of public goods and services—a broad spectrum of government spending including public education and public safety—are heavily progressive, with significant effects on the state rankings.

Breaking down the progressivity rankings into their various components yields many observations:

• States that rely primarily on income taxes tend to have higher overall tax rates and to be more progressive. (In most states that have them, income taxes have progressive schedules where the marginal rate increases with income.) Of the 10 most regressive states, five have no income tax.
• States that rely on sales and property taxes tend to be more regressive. The economists diagnose how property taxes are especially regressive for owners and renters, rising much less than proportionately with household income.
• The pattern of regressivity across states in the South is attributable in part to less generous social insurance benefits.
• State progressivity increased somewhat in 2011–2012 compared with earlier (2005–2006) and later (2015–2016) snapshots, as states extended unemployment benefits in the aftermath of the Great Recession. Another major policy change—the larger share of Americans covered by Medicaid after the Affordable Care Act expansion in 2010—had not appreciably improved overall progressivity by 2016.
• Americans of all incomes are more likely to migrate to more regressive states. Households in the top 1 percent are especially likely to do so. This is significant, the economists note, given that the top 1 percent of households account for 30 percent of state and local income taxes paid, hitting the tax base of the (generally more progressive) states they leave behind.

State and local tax revenues average almost 9 percent of U.S. GDP, more than federal income taxes (8 percent) and payroll taxes (6 percent). Understanding who pays them—and how they are ultimately redistributed by state governments—is essential to policymakers seeking to understand the complex flows of money from the private sector to government and back again. The new research by Heathcote and co-authors represents the most comprehensive data available to them so far.

Read the staff report: Fiscal Progressivity of the U.S. Federal and State Governments

Endnote

1 Specifically, their function measures how the relationship between household pre-government income (y) and after-tax-and-transfer income (T(y)) varies with the size of a household’s pre-government income: log(y − T(y)) = λ + (1 − 𝜏) log(y), where 𝜏 is the progressivity parameter.