State Income Taxes and Credits
Forty-two states have a personal income tax, and the impact of these taxes on low-income families varies significantly. In many states, families with children whose income is below the official poverty level (about $22,000 per year for a family of four in 2009) are exempt from state income taxes—although they continue to pay other state taxes, such as sales tax, as well as federal payroll taxes. In other states, the income burden on families with poverty-level earnings is hundreds of dollars per year.
The nine states without income taxes tend to rely more heavily on other types of taxes, such as sales taxes, that generally fall harder on low-income families than income taxes. This is because income taxes are typically progressive—so that people with higher incomes pay higher tax rates—unlike other types of taxes.
Among states with income taxes, a growing number offer earned income tax credits, typically based on the federal Earned Income Tax Credit (EITC). These credits reduce the state income tax burden of low-income working families, and, if they are refundable, also provide a cash payment to some families. Like the federal credit, state earned income tax credits are designed to offset low-wage workers' tax burden and to increase work incentives.
As of tax year 2009, 21 states (including the District of Columbia) offer refundable earned income tax credits based on the federal EITC, typically structured as a percentage of the federal benefit. Most of these states have set their credits at a minimum level of 5 percent of the federal EITC, and some are considerably higher. There are also three states that offer credits that are based on the federal EITC, but are nonrefundable. Nonrefundable credits offset the state income tax burden for some families but provide no benefits to families whose incomes are so low that they do not owe state income taxes.
Just over half the state offer a child and dependent care tax credit (or tax deduction) that reduces the state income tax burden on working families with child care expenses. Most states' credits are structured as a percentage of the federal child and dependent care credit or as a percentage of the care expenses eligible for the federal credit. The federal credit had a maximum value of $2,100 (for a family with two or more children) for tax year 2008, but it is nonrefundable, limiting its value for low-income families. Thirteen of the 28 state child and dependent care tax provisions, however, are refundable credits.