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How Do States Manage Without Individual Income Taxes?

Indiana has an individual income tax to help pay for state services. Indiana raises about $8 billion a year from its state income tax, which is 36% of total general fund revenues. Most states have income taxes, but eight states do not. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington (state) and Wyoming do not collect individual income taxes to fund their state governments. How do they get by? What do they do instead?

Let’s compare the state revenues and expenditures of those eight income-tax-free states to Indiana’s numbers. The U.S. Census Bureau provides the data. Its Annual Survey of State and Local Government Finances collects budget information from all the states and sorts the numbers into categories so comparisons can be made. The most recent published numbers are for fiscal 2021.

We’ll use combined state and local totals, instead of just state budgets. That’s because states without state income taxes might provide more services through local governments, funded with local government revenues. And let’s limit the comparison to the general fund, since Indiana’s state income tax is used that way.

We’ll use per capita numbers, not total dollars. That’s because Texas’ and Florida’s populations are way bigger than Indiana’s, while South Dakota’s and Wyoming’s are way smaller. Comparing total revenue and spending won’t tell us much. It makes more sense to divide revenue and spending totals by state population to get dollars per person. Indiana’s population is 6.8 million, which means the state income tax raises about $1,200 per person.

Start with spending. Indiana’s direct general expenditure is just under $10,000 per person, according to census data. Florida, Nevada and Tennessee spend at least a thousand dollars less than that. One way to get by without an income tax is to spend less. Perhaps these states provide fewer government services, or possibly they’ve found economies and efficiencies to deliver the same services at lower cost. You can’t tell from budget numbers.

Alaska and Wyoming spend more than Indiana does, nearly double per person. The data only hint at the reasons. There are big numbers in the “other tax” and “other miscellaneous revenue” categories. Property taxes per person are much higher too. It’s got to be taxes on oil. Alaska and Wyoming raise big money from severance taxes. Draw your state’s boundaries around the oil fields, tax it as it comes out of the ground, and you won’t need income taxes.

That leaves South Dakota, Texas and Washington. The first two spend a little less per person than Indiana, while Washington spends about 20 percent more.

Texas property taxes per person are over a thousand dollars more than in Indiana. Another census source, the American Community Survey, shows 2022 median real estate taxes for homeowners in Indiana at $1,467. In Texas it’s $4,050. Property taxes fund local governments, and in Texas 55% of total general spending is done by locals, compared to 47% in Indiana. Texas largely uses local property taxes instead of state income taxes to fund their governments.

South Dakota has higher property taxes too, but uses sales taxes even more. That state raises $500 per person more than Indiana in general sales taxes, even though the combined state and local sales tax rate averages 6.4 percent, which is less than Indiana’s 7 percent. But South Dakota is famous for making lots of goods and services taxable, including groceries, prescription drugs and many business and personal services. According to the Tax Foundation, the state has the third broadest tax base in the country. Indiana ranks 18th. According to the Urban Institute’s Tax Policy Center, South Dakota taxes 61 percent of overall household spending, while Indiana taxes 37 percent.

That leaves Washington state. Washington also uses more property taxes, but again, sales taxes stand out. General sales taxes per person are two-and-a-half times as high in Washington as in Indiana. Washington’s state rate is 6.5 percent, but their local rates tack on 2.8 percent, on average, for a combined 9.3% sales tax rate. That’s the fourth highest in the country. Washington’s local governments account for 54% of total spending, because of all that local sales tax revenue.

And that’s how eight states get away without using income taxes. Could Indiana be number nine?

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