The Tax Foundation

November 13, 2003

Federal Income Tax Burden Falls Ever Harder on Taxpayers in Areas with High Cost of Living

NEWS RELEASE

WASHINGTON—A new report from the Tax Foundation quantifies how much higher federal income tax payments are for taxpayers who live where the cost of living is high, even when they have the same standard of living as similarly situated taxpayers who live where the cost of living is low.

The report is No. 125 in the Foundation’s Special Report series, "Federal Income Taxes and the Cost of Living," by J. Scott Moody and David K. Hoffman. It was released at the Tax Foundation’s 66th National Conference, where Treasury Secretary Snow and a host of policymakers and tax scholars discussed the nation’s tax and job creation climate. Tax Foundation President Scott Hodge gave an example from the study of three dual-income couples with no children, enjoying the same median standard of living despite having significantly different incomes.

"An income of $132,143 in San Francisco buys the same standard of living as $84,111 in Portland or $70,772 in Phoenix. But the San Francisco family pays 17.3 percent of its income in federal income taxes. That’s $22,812, almost triple the national median. The Portland family pays $10,748, less than half as much as in San Francisco but still more than the national median. Meanwhile, the Phoenix family pays $7,576, about $400 less than the median.

"The income difference is illusory because it does not result in a higher standard of living," Hodge commented, "but the tax burden on that illusory income is real."

The culprit is progressively higher federal income tax brackets, indexed for inflation but not for cost of living. They force taxpayers from high-cost, high-salary areas up into higher tax brackets. Similarly, exemptions and credits are specified as dollar amounts that apply nationwide but are worth comparatively more to people in low-cost, low-salary areas.

Every state has comparatively low- and high-cost areas, but there is a significant variation among state averages. Income tax liabilities by state range from a high of 16.5 percent of income in Connecticut to a low of 9.5 percent in Utah.

Preliminary evidence from the first year of the Bush tax cut in 2001 shows a slight increase in progressivity, so recent tax policy changes at the federal level have not changed the geographic pattern of income tax burdens.

"Some lawmakers from states with high average costs of living are avid supporters of our tax code’s progressive structure and wish to make it more progressive," continued Hodge, "but they may not be aware of how much their constituents are already shouldering the lion’s share of the income tax burden."

Some locations with the highest costs of living, and therefore the highest tax burdens for comparable standards of living are famous for their high cost: Manhattan, San Francisco, Honolulu, San Diego, Chicago. All of these rank in the top ten costs of living, and consequently the top taxpaying locations. But not every high-cost location is so obvious: Oakland, CA; Stamford, Connecticut; and two New Jersey locations, Bergen-Passaic and Jersey City, are also in the top ten.

Measuring the Cost of Living
The report relies on the ACCRA Cost of Living Index for survey data from hundreds of Metropolitan Statistical Areas. (See www.accra.org for details.) The survey focuses on what ACCRA calls "professional households," which implies the purchase of name brand products but nothing that would qualify in common parlance as a luxury.

Moody and Hoffman use this data and Census Bureau data on median incomes for dual-income couples to calculate the specific income in each surveyed jurisdiction that is necessary to purchase the national median standard of living and the federal income tax liability on that income.

This income level — an amount necessary to buy comparable consumer goods, including housing and transportation — varies from a little over $60,000 (in many locations) to almost $160,000 (in Manhattan). Of course, Manhattan is an outlier because of housing costs. Nationwide, the income necessary to purchase the median standard of living for a couple with no dependents is $72,886. The federal income tax due on this income in 2003 is $7,942, or 10.9 percent of income.

Unfortunately, most cost of living measurements, including the ACCRA survey this report relies on, do not factor in the differential impact of taxes, even though federal, state and local taxes combined are by far the biggest item in any American family’s budget. When included, the variations in cost of living are much greater.

Implications for Tax Policy
The study of varying costs of living and tax burdens poses a dilemma for practitioners of tax distribution analysis—the science of determining who’s earning what in America and how much they pay in taxes.

A typical tax distribution table shows that the top-earning five percent of all U.S. taxpayers account for about a third of the individual income earned. This same group pays more than one half of all the income taxes collected, a distribution that results from a progressive income tax structure designed to redistribute income.

At the upper end of the income scale, such tax distribution charts are generally used to suggest that everyone above a certain level of income lives so well that they do not need tax relief. At the lower end of the income scale, the charts are usually used to demonstrate that people are living so poorly that they need assistance or a tax cut. At both ends of the income scale, cost of living is ignored.

A Milwaukee couple with no dependents earns a median income of $73,105, pays $7,996 and is classified in the top quintile (the top 20 percent). If the couple lived in Jacksonville, their comparable income — that is, what they would need to buy the exact same standard of living — would be $66,253, and they would no longer be in the top 20 percent.

If the couple lived in Orange County, California, a comparable income would be $97,959 and the couple would be described as one of the "wealthy" people in the top 10 percent of the nation’s earners. In San Francisco their adjusted income would be $132,143 and they move into the top 5 percent. In Manhattan their adjusted income is $159,621 and they move into the top 3 percent.

The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.

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Media Contact: Bill Ahern (202) 464-6200

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