Living in States Without State Income Tax: The Economic Benefits and Drawbacks

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States without state income tax are those that do not charge income tax on individual and business income earned from state sources. Although residents and businesses housed in these seven states must still pay income taxes at the federal level, they are free from state income tax, which may represent significant savings.

Two additional states tax only income from dividends and other investments. Although avoiding state income tax may seem appealing, it’s important to weigh all the factors, since these states often make up income tax revenue by charging higher taxes in other areas.

Living in States Without State Income Tax: The Economic Benefits and Drawbacks

States Without State Income Tax

  • Not only have Alaska residents and businesses been free of state income tax since 1980, but the state also does not charge sales tax. Instead, these funds are made up through severance, gift, excise, estate, and other types of taxes, most of which affect the prevalent gas and oil industries. In addition, extra funds are distributed to residents every year through the Alaska Permanent Fund Corporation. Although a proposed bill to reintroduce state income tax was proposed in 2017, it was eventually defeated in the Senate.
  • The Sunshine State abolished state income tax in 1855, and it’s been that way ever since. However, property taxes in Florida are higher than in most other states, and residents are subject to sales tax while businesses must pay corporate income tax.
  • Because Nevada makes so much money from tourism along with billions from gambling taxes and fees, it’s one of the few states that does not charge its residents income tax. However, it does have high sales tax — up to 8% in some jurisdictions — to make up the deficit.
  • New Hampshire taxes investment income of more than $2,400 per person at 5% but otherwise does not have personal income tax. However, this state also has the nation’s third-highest property taxes as well as high alcohol and excise taxes, according to Smart Asset. In addition, New Hampshire has some of the highest college costs in the nation and dedicates few funds to higher education.
  • South Dakota’s status as one of the nation’s most tax-friendly makes it a haven for retirees. South Dakota hasn’t had state income tax since 1943, making up the difference with additional taxes on alcohol, cigarettes, and laundromat license fees. It also has one of the lowest sales tax rates in the U.S. and has property tax rates comparable to the national average. South Dakota residents are subject to local property and personal taxes that fund schools and other city and county improvement projects.
  • Tennessee taxes only dividend and interest income, but not personal wages. In addition, the tax rate on investment income will be decreased by 1% every year beginning in 2016 and ending in 2022, when it is completely eliminated. The state makes up the difference with high excise taxes, beer taxes, and sales taxes.
  • Personal income tax is not allowed under the Texas constitution. However, the state makes up the difference with higher use and sales taxes as well as property taxes, which are the fourth highest in the nation.
  • No personal income tax has ever been levied on Washington state residents. However, the average sales tax rate is nearly 9%. Businesses are also not subject to income tax but must pay other fees such as the business and occupation tax. Washington also has higher than average fuel costs.
  • Wyoming residents are free not only from personal income taxes but also from taxes on retirement income. Corporations are also not charged income tax. Property tax rates average just 0.62% and sales tax is under 5.5% on average. Businesses producing coal and other natural resources are taxed; the state also makes money through property taxes.

Benefits and Disadvantages of Living in an Income-Tax-Free State

Proponents of eliminating state income tax say that doing away with this tax promotes growth, retains educated young workers, and creates jobs. Data from the American Legislative Exchange Council reported by Bankrate indicates that the nine states described above consistently outrank the nine states with the highest income taxes when it comes to these measures.

The lack of income tax is also an effective tool to redistribute wealth, which means low-income individuals are most likely to benefit from living in states that do not charge this tax. On the flip side, however, higher sales tax has a much bigger economic impact on poor residents than it does on those who are well-off.

According to data from the Institute of Taxation and Economic Policy reported in the Bankrate article, although non-income-tax states have higher population growth rates than states with high income tax, they struggle to add jobs at a rate that can accommodate these new residents. This is a particular problem in Wyoming, which has the most substantial gap between population growth and job growth.

Keep in mind that states earn revenue in three main areas: sales tax, income tax, and property tax. This income is essential to fund roads, public works projects, law enforcement, and other services. When income tax is not part of the equation, the other costs will be higher. In fact, several of the states listed above, including Alaska, Florida, New Hampshire, Washington, and South Dakota, have a cost of living well above the national average.

How New Tax Laws Will Affect State Income Tax

One section of the newly passed tax law caps itemized deductions for state and local taxes at $10,000. This will be detrimental to individuals who live in states like New York and California with high personal income tax rates. Previously, taxpayers could deduct the full amount of their property taxes and sales tax if they were not taking the standard deduction ($6,350 for individuals and $12,700 for married couples filing jointly).

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Andrea Miller
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Andrea Miller

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