Beware of income tax rate creep

Jun 11, 2021

When a new tax is imposed we’re often told: “Don’t worry; it only hits other people and will never expand to you.” As history demonstrates, however, the natural course of new taxes is to expand. For example, let’s look at income taxes across the country. Once an income tax is implemented, not only do state governments then become increasingly dependent on it for revenue, but the tax brackets also vastly expand to include more payers than what was initially promised. 

Both federal and state income taxes have experienced dramatic transformations over the years. For the federal level, Business Reference Services indicate the Revenue Tax Act in 1916 made the first income tax bracket at 1% for the lowest income and 7% for the highest. This suggests that the federal income tax was originally meant to include all income earners, with the lowest earners paying the least and the high-income earners paying the most. However, ever since this act was established, there have been dramatic changes in the tax bracket. In recent years, the maximum income tax has been sitting at around 37% to 40% for top income earners. 

Over the years, many states have developed their own income tax rates as well. The most well-known states have experienced similar patterns as the federal government in income taxes. The states that have the highest maximum tax rate include California, New York, New Jersey, and Connecticut. In 1980, California’s income tax bracket on average was around 5% to 11% according to the Lowe Institute. RJS Law establishes that the income tax bracket is now 1% to 13.3% and consists of nine different brackets for different income earners. Alongside California, New York has experienced an increase in the top earner’s income tax rates. While the income tax rate in the 1990s for the top earners peaked, the bottom rate was retained at the same 4% tax rate as reported by the New York State Department of Taxation and Finance. Now, the income tax rate bracket is from 4% to 8.82%. 

Furthermore, New Jersey's state income tax was enacted in 1979 and originally began with a simple bracket of 2.0% for low-income holders and 2.5% for higher ones.  However, as the state became more reliant on taxing for government revenue, this gap has greatly increased. Now the income tax bracket is reported to be 1.4% to 10.75% by efile. Connecticut was one of the last states to impose a graduated income tax rate that began at a bracket from 3% to 4.5% according to Illinois Policy. Now Connecticut has seven income tax brackets with the top at 6.9%, a 55% increase from the original rate enacted. All of these states demonstrate a growing dependency on income tax for revenue by increasing the personal tax rates and expanding the tax brackets.

Although Washington State has never experienced a personal income tax, state taxes such as sales and B&O are currently in place. Since the first adoption of a sales tax at 2.0%, the rate has risen to 6.5%. While the B&O tax was first enacted as a temporary funding mechanism in 1933, the tax is still in place. It now ranges from 0.138% to 1.5%, and Washington State collects more from this tax than most states do from the more common corporate income tax. Moreover, the B&O tax is now the second-largest source of tax revenue for the state, after the retail sales tax. If an income tax were to be enacted in Washington State, similar trends of growing reliance and more tax brackets would be expected to emerge. Assuming Americans and firms “vote with their feet” in the United States, the average state tax burden for the gaining states is 7.9% compared to the 9.5% average tax burden for the losing states. This implies that Americans are generally moving away from states with higher tax burdens. Although other factors contribute to inter-state migration trends, tax burdens have been a consistent factor. Washington State should not consider implementing an income tax and needs to look into reducing current taxes considering the mass amount of revenue the state has garnered over the years.