Living in a state without income tax might sound like a dream come true, but there’s more to the story than meets the eye. While it’s true that avoiding this tax can lead to significant savings, there are potential downsides that residents of nine US states that don’t have income tax often face. Let’s explore the hidden costs of this seemingly attractive tax break.
Higher Property Taxes
States that have no income tax aren’t benevolent. They have a different structure for raising revenue. With no income tax coming in, these states have to get their revenue from other sources. Typically, this translates to higher property taxes. For example, homeowners in New Hampshire and Texas pay some of the highest property taxes in the country, at 1.86% and 1.81%. While they may not have to pay income tax, their tax bill actually might be higher, depending on your lifestyle. Owning some expensive real estate could make your tax bill significant.
Higher Sales Tax
Many states without an income tax impose higher sales taxes to compensate for lost income tax revenue. This means you’ll end up paying more for everyday purchases. Tennessee is a prime example of a state with no income tax that compensates with a hefty sales tax. With a combined state and local sales tax rate that can reach 9.55%, Tennessee residents often find themselves paying significantly more for purchases compared to residents of states with income taxes.
Influx Of New Residents
While states without income tax are attracting new residents at a rapid pace, this influx is creating challenges. The increased competition for housing and jobs is driving up prices and making it harder for newcomers to establish themselves. For example, popular destinations like Texas and Florida are experiencing rapid population growth, leading to soaring housing costs and traffic congestion, making it increasingly difficult for new residents to find affordable living and navigate daily life.
Higher Gas Prices
Living in a state without income tax often means paying more at the pump. Many states impose significantly higher gasoline taxes to compensate for lost revenue. For example, Washington state has one of the highest gas taxes in the nation (49.5 cents per gallon), which can add up quickly for frequent drivers, offsetting some of the perceived savings from no income tax.
SALT Deduction Limitations
Residents of states without income tax may face challenges in maximizing their federal tax deductions. The SALT deduction, which allows you to deduct state and local taxes from your federal taxable income, is capped at $10,000. Since most people rely on income tax deductions to reach this cap, those living in states with no income tax may find it harder to fully utilize this deduction, leading to a higher tax burden overall.
Bigger Burden on the Poor
States without income tax often rely on sales taxes to generate revenue. Unlike income taxes, which typically target higher earners at a higher rate, sales taxes are flat, meaning everyone pays the same percentage of tax regardless of income. This can disproportionately impact lower-income individuals who spend a larger chunk of their income on essential goods and services subject to sales tax.
Infrastructure Challenges
A lack of income tax revenue can hinder states’ ability to fund crucial infrastructure projects. With a smaller revenue base, these states may struggle to allocate sufficient funds for roads, bridges, public transportation, and other critical infrastructure. This can lead to deteriorating conditions, increased maintenance costs, and a lower overall quality of life for residents. For example, Texas and Florida have faced criticism for congested roads and aging infrastructure.
Poor Job Growth
Rapid population growth in states without income tax may not always translate into a corresponding increase in job opportunities. This imbalance can increase competition for jobs, especially among prime working-age adults. As a result, finding employment opportunities in these states can be more challenging than in areas with more robust job growth. A West Virginia Center on Budget and Policy study using ITEP data found that states with the highest income taxes experienced faster job growth among adults aged 24 to 55 than those without income tax over the past decade.
Less Education Spending
States without an income tax often rank lower in education spending. This could be due to a lack of tax revenue. For example, Nevada, Florida, Tennessee, and South Dakota are among the states with the lowest education spending per student. Notably, these states don’t have income taxes.
Higher Healthcare Costs
While states with no income tax might seem attractive, they often have lower government spending on public services like healthcare. For instance, Texas, a no-income-tax state, has notably low government healthcare spending. This can mean higher healthcare costs for residents. So, while you save on income tax, you could pay more for essential services.
Higher Insurance Costs
Surprisingly, some states without income taxes also have exceptionally high insurance costs. Florida, for example, boasts no state income tax but holds the unfortunate title of having the nation’s most expensive homeowners insurance, with average annual premiums reaching $10,996 in 2023. Texas, another popular no-income-tax destination, follows closely behind with the fourth-highest average homeowners insurance cost at $4,436 annually.
Higher Cost of Living
The influx of residents attracted by the lack of income tax can drive up the overall cost of living, offsetting potential tax savings. Beyond income tax, residents might face higher property and sales taxes, as well as potential taxes on capital gains, dividends, and Social Security benefits. Additionally, recurring expenses like utility bills can be significantly higher in some tax-free states.