Soaking the Poor:

Alabama places a heavy burden on low-income families -- but there is a simple solution

By: Rob Collins -- April, Birmingham News

Anna is a full-time child-care worker and a divorced mother of two. Her minimum-wage income places her below the federal poverty line -- but not beneath the notice of the Alabama taxman. On April 15, Anna did not have to pay income tax to Uncle Sam. Yet the state of Alabama charged her $218.

Alabama has a reputation as a “low-tax” state. But for thousands of full-time workers earning poverty wages, the state’s income-tax burden is one of the heaviest in the country. What’s more, the state leans heavily on sales and excise taxes, which hit poor households hardest. These taxes are called “regressive” taxes because they absorb a much larger proportion of a poor family’s income.

State leaders are aware of the problem. Last year, lawmakers and gubernatorial candidate Don Siegelman talked about raising the dependent deduction to $1,500 as a way of easing the income-tax burden. But a new study suggests a more effective alternative.

The study, released this week by Arise Citizens’ Policy Project, shows that an Alabama Earned Income Tax Credit would deliver more tax fairness than an increased dependent deduction, at a similar or lower cost to the state. The EITC would do this by targeting the tax cut to working families with incomes below $31,000.

More than a decade ago, President Ronald Reagan spoke forcefully about the foolishness of taxing poor households deeper into poverty. Congress responded in 1986 by eliminating tax liability for poor families and strengthening the federal tax credit for the working poor: the Earned Income Tax Credit.

In the 1990s, 40 of the 41 states with income taxes have changed their tax codes to eliminate or reduce the tax burden on families with poverty-level incomes. The sole exception is Alabama.

The Arise study evaluates both tax-cut proposals -- the increased deduction and the EITC -- by comparing the benefits to taxpayers, the cost to the state, and the effect of each on low-income families in particular.

Families such as Anna’s would certainly benefit from an increased dependent deduction: Her 1999 tax bill would be reduced by more than half. But she would still have to pay $101 in income tax to the state of Alabama.

Now suppose that Alabama adopted an Earned Income Tax Credit set at a modest 10 percent of the federal EITC. Anna and her children would be much better off: At minimum wage, she would qualify for the maximum benefit of $382. The credit would eliminate her income-tax liability. Moreover, because the credit is greater than her tax liability, she would receive a wage supplement of $164. Instead of being taxed deeper into poverty, Anna would receive an incentive to continue working and increasing her wages.

Because the EITC is only available to working households, it provides an incentive for families with very low incomes to keep working rather than seeking public assistance. The tax credit levels off around the full-time minimum-wage level, and gradually phases out as earnings approach median income. The federal EITC is indexed to inflation, and state EITCs are normally set as a percentage of the federal credit.

Alabama’s reputation for low taxes rests mainly on its extremely low property taxes and generous income-tax deductions, which primarily benefit wealthy households and businesses. State and local taxes on wealthy households are among the country’s lowest; only two states outclassed Alabama in a recent survey of “wealth friendly” states by Bloomberg Personal Finance magazine. The picture is very different for low-income families. According to a 1995 study by the Institute on Taxation and Economic Policy, the poorest 20 percent of married, non-elderly couples earn an average of $12,200 a year and pay $1,415 a year in Alabama state and local taxes. Two-thirds of that tax bill goes to sales and excise taxes.

States have a choice about whether or not to make their EITC refundable. Because of the heavy overall tax burden on low-income families, a strong case can be made for refunding the tax credit in Alabama. A refundable EITC would help close the gap between the tax burdens of the rich and the poor.

But what about the cost to the state? Because the EITC targets benefits to low-income families, it provides more tax relief for a lower cost than the increased dependent deduction. Raising the deduction would cost the state about $76 million per year. An Alabama Earned Income Tax Credit, at 10 percent of the federal level, would cost an estimated $71 million in fiscal year 2000.

It’s time to relieve the income-tax burden on low-income Alabama families. Not only is it fair; it’s essential to the state’s long-term economic health. The state has an interest in “making work pay” rather than taxing families who are striving to escape poverty. An Alabama Earned Income Tax Credit is an efficient, pro-family measure that can make taxes fairer while giving low-income workers an incentive to keep working and earning.