Report

The DC Tax System Is Regressive and Tax Burdens on Near-Poor Families Have Increased Since 1989

by Ed Lazere and Angie Rodgers
PDF of this analysis

One way to evaluate tax systems is to consider whether the system is progressive or regressive.  In progressive tax systems, the percent of income devoted to taxes increases as income rises.  In regressive systems, tax burdens decrease as incomes increase; higher income residents pay a smaller portion of their incomes in taxes than poorer residents.  An analysis of the District of Columbia’s tax system finds that while it has both regressive and progressive elements, the overall tax system is regressive.  Policy changes over the past few years have reduced tax burdens somewhat on the District’s residents, but the tax burden on near-poor families has increased since 1989.

  • The highest income one percent of District families faces a lower tax burden than other residents.  These families pay 6.3 percent of their income in District taxes, while the greatest tax burden ‘ nearly 12 percent of income ‘ is levied on the second poorest fifth and middle fifth of families.
  • Since 1989, the tax burden on the second poorest fifth of DC families rose from 10.8 percent to 11.7 percent of income, while tax burdens remained stable or fell for all other groups of DC families.
  • The poorest fifth of DC families experienced the greatest tax reduction since 1989 ‘ from 9.8 percent of income to 8.7 percent.  This occurred primarily as a result of the District’s adoption of a refundable Earned Income Tax Credit (EITC) for low- and moderate-income workers.

 

The District’s Tax System is Regressive

This analysis considers the full range of taxes paid directly by non-elderly DC families in 2002 ‘ including income, sales, and property taxes ‘ as well as taxes passed on to consumers by businesses.  District residents are divided by income into fifth, or quintiles.  The top quintile is further divided into the next 15 percent, the next four percent, and the top one percent.  It is based on research conducted by the Institute on Taxation and Economic Policy. [1]

The analysis takes into account the reduction in the federal income taxes households receive based on the state and local income and property taxes they pay.  Households that itemize deductions on their federal taxes are allowed to deduct the state and local income and property taxes from their federal taxable income.  This has the effect of reducing the net effect of the state and local taxes.  Because high income residents are more likely to itemize deductions on their federal returns and because they face the highest marginal tax rates, the deduction pays off the most for them.[2]  Most low income families, by contrast, receive no benefit from this deduction because they do not itemize deductions.

These findings indicate that the District’s tax system is regressive.

  • The highest income one percent of District residents, with incomes of $422,000 or more, paid 6.3 percent of their income in DC taxes in 2002.  This tax burden was lower than for any other income group.  The tax burden on the families with incomes between $166,000 and $422,000, the next highest four percent, is 8.1 percent.  This is lower than for any group in the bottom 95 percent of DC’s income distribution.
  • The second and middle fifth of DC families, with incomes between $15,000 and $42,000, face the highest tax burdens.  These families pay 11.7 percent and 11.6 percent of their income on DC taxes, respectively, which is almost double the tax burden on the highest income one percent.
  • The tax burden on the poorest fifth of families is 8.7 percent of income, which is lower than the burden of all income groups except the top one percent and next four percent.

 

The District’s Tax System Has Undergone Both Regressive and Progressive Changes Since 1989

Overall tax burdens have fallen in the District since 1989, but the benefits of the reductions have not been uniform.  Near-poor District residents have faced an increase in their tax burden during this period, while targeted tax relief for the lowest income residents resulted in a substantial cut in their tax liability.  The following chart details the changes in District taxes since 1989.

The tax burden on DC families with incomes between $15,000 and $28,000 ‘ the second fifth of DC’s income distribution ‘ rose from 10.8 percent to 11.7 percent between 1989 and 2002.  This was the only group of District residents to face an increase in tax burden in the 1990s and primarily reflects an increase in income tax burdens.  While tax rates have been reduced since 1989, the personal exemption and standard deduction have not been changed, which means their value has lost ground to inflation.  In addition, the size of DC’s lowest income tax bracket  ‘  the first $10,000 of taxable income  ‘  has not been changed, which  means that some families could have moved into higher tax brackets even if their incomes rose only at the same rate as inflation.

The largest relative reduction in tax burdens was experienced by the lowest fifth of families, whose tax burden fell from 9.8 percent to 8.7 percent of their incomes.  This appears to be largely a result of the establishment of the refundable DC EITC, a tax credit for low- and moderate-income workers, particularly those without children.

Higher income groups also gained reductions in District tax burdens in the 1990s.  The tax burden on the top one percent of families fell from 6.8 percent to 6.3 percent of their incomes.  Families with incomes between $70,000 and $155,000 ‘ the next 15 percent after the fourth quintile ‘ experienced the second largest reduction in tax burden, from 9.4 percent to 8.6 percent of income.

The tax burden for the middle remained essentially unchanged ‘ moving from 11.7 percent to 11.6 percent of income.

 

The District’s Tax System has Regressive and Progressive Elements

Like most states, the District relies on a mix of both regressive and progressive taxes ‘ the sales and excise tax, property tax, and income tax.

  • Sales and excise taxes, from which the District derives 25 percent of its revenue, generally are heavily regressive, with the tax burden decreasing sharply as income increases.  It is the most regressive among major tax sources because low income residents spend a greater portion of their income on goods and services than higher income residents.  The poorest District residents spend 8.6 percent of their income on sales and excise taxes ‘ more than any other group.[3]  The District’s sales and excise tax burden declines sharply as income increases, dropping to one percent of income for the highest income one percent of District residents.  The sales and excise tax makes up the largest portion of the total tax burden for the poorest three-fifths of District residents.

  • The property tax, from which the District gets 17 percent of its revenue, is mildly regressive.  The poorest fifth of residents ‘ with a property tax burden of 1.5 percent ‘ have a burden that is equal to or higher than almost all other income groups.  Additionally, the top one percent pay the least in property taxes ‘ with a burden of 0.8 percent of income.  The second and middle fifth, however, ‘ who pay 1.0 and 1.1 percent of income in property taxes, respectively ‘ face lower burdens than all income groups with the exception of the top one percent.

  • The income tax, from which the District gets 34 percent of its revenue, is solidly progressive.  The District’s income tax is structured in a progressive way by using graduated rates ‘ that is, by applying a series of tax rates that increase as income rises.  The District’s tax system is also made progressive by inclusion of a refundable Earned Income Tax Credit, modeled on the federal EITC.  The EITC is a tax break targeted on low and moderate-income workers, particularly those with children.  As a result, the poorest fifth of the District’s families on average get more back than they owe in taxes, receiving refunds that on average equal 1.4 percent of their income.  Income tax burdens then rise as income rises, with the top one percent paying the most ‘ 7.6 percent of income.

 

The District Could Move Towards a More Progressive Tax System

This report finds that the tax system is largely regressive and has become more so since 1989.  It also highlights the importance of targeted tax relief such as the EITC, which has substantially reduced tax burdens on the District’s poorest families.

This analysis also suggests that future tax changes’including both cuts and increases ‘ should be analyzed to determine whether they make the overall tax system more or less progressive.  In general, taxes that make the system more regressive could be avoided or combined with other tax changes that offset the regressive effects.

In particular, future tax relief efforts could focus on reducing taxes on the second-poorest fifth of DC families ‘ those with incomes between $15,000 and $28,000 ‘ since these families experienced an increase in tax burdens since 1989 and now pay more of their income in taxes than any other group of DC residents.  The middle-fifth of DC families ‘ with incomes between $28,000 and $42,000 ‘ also face higher tax burdens than other DC families and thus could be targeted in future tax relief proposals.

 

Appendix — Charts


End Notes:

[1] The data presented in this analysis are from a special analysis conducted by the Institute on Taxation and Economic Policy.  They reflect tax burdens based on tax rates and policies in effect in the District in 2002.  These figures differ somewhat from data in a 2003 report by The Institute on Taxation and Economic Policy ‘ Who Pays? ‘ which calculated state and local tax burdens in all states and the District of Columbia because the 2003 report assumed that all enacted taxes were fully phased in while this analysis looks at the law in effect in 2002.

[2] While many middle- and upper-income households benefit from the deduction for state and local income and property taxes, the value of these deductions is limited for some families by the Alternative Minimum Tax and the limit on itemized deductions for high-income households.

[3] These sales tax figures show that the sales tax burden on many DC residents is higher than the District’s basic sales tax rate of 5.75 percent.  This stems from several factors.  First, the figures reflect the combined effect of the general sales tax and a number of selective sales and excise taxes, including taxes on utilities, gasoline, alcohol, and cigarettes.  The rates for some of these taxes are higher than 5.75 percent, such as the 11 percent tax on utilities.  Second, the figures include the impact of sales and excise taxes on businesses that are passed through to consumers.  Finally, some low-income households spend more than their income in order to meet their needs.  This includes elderly households that draw on savings and families that fail to pay all of their bills or rely on credit to meet their needs.  Because these families spend more than their income, sales taxes can be high as a percent of income.