Chart of the Week: Initiative 1098 effective tax rates are lower than most

Initiative 1098 will lower property taxes on residential and commercial property owners, exempt 81% of Washington small businesses from B&O taxes, and reduce the B&O rate for another 12% of businesses. It will offset the revenue reductions with a tax on high incomes (5% on income above $200K/individual or $400K/joint, and 9% on income above $500K/individual or $1 million/joint).

Because the tax will only apply to income over the threshold, we must calculate the effective tax rate in order to understand what percentage of income is actually paid in tax. The effective tax rate is found by subtracting the exempt amount from total income, and multiplying the remainder by its corresponding marginal tax rate.

Of course, the effective tax rate on an individual earning exactly $200,000 will be 0% — and it will be the same for couples earning $400,000. So what about for those who earn enough to pay income tax? For an individual earning $500,000 or a couple earning $1 million, the effective tax rate is 3%. For individuals earning $1 million and couples earning $2 million, the effective tax rate will be 6%.

Now, let’s take a closer look at how I-1098’s effective tax rates stack up against those in other states. These graphs below show how Washington’s effective income tax rates on individuals earning $500,000 and $1 million per year, respectively, would compare to other states under I-1098.

Click to enlarge

Data from the Federation of Tax Administrators; based on standard deductions. Some states allow itemized deductions, and personal exemptions vary by state.

Example 1: Chris is an individual filer, earning $500,000 in adjusted gross income. Under I-1098:

  • The first $200,000 of Chris’ $500K income would be exempt from any tax, leaving $300,000 taxable.
  • That $300,000 is taxed at 5%, resulting in $15,000 in total tax revenue.

So Chris will pay $15,000 in state income tax on a $500,000 income — a effective tax rate of 3%,  nearly the lowest in the nation.

Click to enlarge

Data from the Federation of Tax Administrators; based on standard deductions. Some states allow itemized deductions, and personal exemptions vary by state.

Example 2: Andy is an individual filer, earning $1,000,000 in adjusted gross income. Under I-1098:

  • The first $200,000 of Andy’s $1 million income would be exempt from any tax, leaving $800,000 taxable.
  • Of that $800,000, the first $300,000 is taxed at 5% (remember, that is the amount from $200K – $500K), resulting in $15,000 in tax revenue.
  • The remaining income of $500,000 is taxed at 9%, resulting in $45,000 in tax revenue.

Combined, Andy pays $60,000 in state income tax on a $1 million income — an effective tax rate of 6%, a rate that would put Washington right at the midpoint among all states that have an income tax.

Looking for more information about Initiative 1098? Visit the Economic Opportunity Institute website.

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