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Income Inequality Hurts States, Dampens GDP Growth

Standard & Poor’s says income inequality is becoming a problem for state governments.

In a report released this month, the credit rating agency says the annual growth rate of state tax revenue fell by half in recent years, from nearly 10 percent to just below 5 percent. And S&P says that came as the wealthiest 1 percent doubled their share of total income to 20 percent, helping squeeze the tax receipts.

S&P said that’s because the wealthy tend to take a larger share of their income from investment vehicles that are taxed a lower rate than ordinary wages and can shelter more of their income from taxes.

State governments are more sensitive to such differences because their tax structures tend to depend on current economic activity — personal income and consumption — while local governments depend a great deal on relatively steady property taxes.

“Rising income inequality contributes to weaker tax revenue growth by undermining the rate of overall economic expansion,” the paper concludes. “In addition to slower revenue growth, Standard & Poor’s believes income inequality has tied the states’ revenue performance more closely to that of the financial markets. Reflecting this linkage, state tax revenues have become more volatile, greatly complicating the task of budgeting.”

The paper complements a report S&P released last month that said income inequality was dampening the growth of the nation’s gross domestic product, at the same time an aging population puts new demands on spending.

Higher-income taxpayers are more likely to save than to spend, so growth in their income is less likely to boost state revenue collections.

And the stagnation of wages for low- and middle-income taxpayers has compounded the problem of dwindling revenues, since state officials are loath to cut funding for social services that become more crucial as residents experience economic hardship.

State tax revenues grew at an annual rate of 9.97 percent from 1950 through 1979, S&P found, but the growth rate fell to less than 4 percent between 1999 and 2009.

Another part of that decline may be explained by a growth in online purchases. Congress is currently debating a measure that would allow states to collect sales tax outside their borders from online merchants.

A “move toward more progressive tax rates may help states generate faster tax revenue growth than would flatter tax regimes,” S&P concluded.

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