In this module. We're going to talk about the individual income tax, which is one of the big three sources of tax revenue for state and local governments, along with the sales tax and property taxes. But of course, different states rely on the individual income tax to different extents and the makeup of their total state and local tax revenues. So let's take a look at a map from the Tax Foundation, which shows us the extent to which each state relies on the individual income tax and making up their total state and local tax revenues. Now the income tax as we know it today is a fairly modern innovation and tax. But the first income tax of any kind in America actually goes back quite a few years to 1634 in the Massachusetts Bay Colony, that colony imposed something known as a faculty tax, which used a mixed tax base of property and income. More specifically, the income portion of the tax base was defined as returns and gains. Other colonies in America had similar faculty taxes, but overall, this type of tax fell into disuse shortly after the American Revolution. But income taxes were reintroduced by several states as a result of fiscal constraints coming out of the panic of 1837 just a few decades later, during the Civil War, state income taxes would become even more commonplace. In fact, during the Civil War, every single rebel government in the Confederacy enacted a state income tax, and an individual income tax also appeared in several northern union states. The Civil War also marked the first federal income tax in our nation's history. But all these state income taxes were generally inefficient or raising revenue. And a lot of that had to do with how the state tax was a minister, with collections often being done by local officials who oftentimes were elected as opposed to some centralized agency like we know today. And by the turn of the century or 1900 all these state income taxes had died out. But then, in 1911, Wisconsin was the first state to adopt a modern income tax, one that is still in existence today. What made the Wisconsin income tax different from previous state income taxes was that Wisconsin was the first state to have their income tax centrally administered by a state Tax Commission. And while Wisconsin was the first state with a modern income tax, and usually they get all the credit for being first, let me take a moment to acknowledge that Hawaii adopted their modern income tax in 1901 while they were still US territory. Now following up on Wisconsin success and spurred by the new federal income tax enacted in 1913 after the passage of the 16th Amendment, many states adopted their own modern income tax and with state revenue suffering during the Great Depression, another round of individual income tax adoptions by the states occurred. So by the start of World War Two, a majority of states had an individual income tax in place. If we take a look at this great map from the tax foundation, we can see the year each state adopted their own individual income tax. Take a look for your state. When did they adopt their income tax? Currently, only Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming do not have income taxes. The state of New Hampshire has a limited income tax, only taxing certain types of investment income. Now, when it comes to state and local taxation overall is generally thought to operate in a regressive manner once you take all the different tax types into account. In other words, lower income households pay more of their income in state and local taxes than do higher income households. So if we take a look at this chart from the Institute on Taxation and Economic Policy that takes a look at the share of family income paid by non elderly taxpayers, we see that on average, state and local effective tax rates decrease as income increases. This regressivity is in stark contrast to the progressivity of the federal income tax system. On this next slide, we see a chart from the Peter G. Peterson Foundation that shows just how progressive the federal tax system overall is, with effective federal tax rates rising as income rises. However, the one component of state and local tax systems that does provide some progressivity to the overall state and local tax system is the income tax. And that's because most states used, like the federal government a progressive rate structure, which means the statutory rates increase as income increases. Here's a look at another tax foundation map, this one showing how many different tax rate brackets each state uses. As you can see, several states use flat tax rates. But even in those states, exemptions remove some small amount of income from the tax base. But generally speaking, these exemption amounts pale in comparison to the amount exempt from federal taxation. So, for example, for a single taxpayer with no dependence in 2019, the federal standard deduction exempts the 1st $12,200 of income from taxation. You can compare this with a $2275 exemption in Illinois, a $1000 exemption in Indiana and a $4400 exemption of Michigan. So this puts many low income taxpayers in a curious position of not having to file a federal tax return but still owing state income tax. But ultimately, income taxes are important components of the state and local tax mix, because overall, they add progressivity to an otherwise regressive state and local tax system.
