Federal Tax Burdens and Expenditures by State

Special Report - Tax Foundation, Mar 2006 by Dubay, Curtis S

Which States Gain Most from Federal Fiscal Operations?

Introduction

The Tax Foundation's annual federal tax burden and expenditure study clarifies the geographical patterns of income redistribution that federal tax and spending policies cause each year. The results of the study have been controversial for years because they show that the nation is not only redistributing income from the prosperous to the poor, but from the middle-income residents of high-cost states to the middle-income residents of low-cost states.

Thanks to a steeply progressive federal income tax, states with higher incomes pay vastly higher federal taxes, payments that are unlikely ever to be matched by federal spending directed to those states. Ironically, most of these high-paying states are the so-called blue states that have generally elected politicians who support a more steeply progressive tax system even though their own constituents bear a greater share of the burden as the code gets more progressive.

All categories of federal taxes, including income taxes on individuals and businesses, social insurance taxes, excise taxes, estate and gift taxes, customs duties and all other taxes, are tabulated and the total tax burden of each state is determined. This figure is compared to the flow of federal funds back to each state, bringing the two sides of federal fiscal operations together.

In fiscal year 2004, New Mexico, Alaska, West Virginia, Mississippi and North Dakota received substantially more from the federal government than they paid in taxes, while New Jersey, Connecticut, New Hampshire, Minnesota and Illinois paid much more in taxes than they received in spending.

Tax burdens for fiscal year (FY) 2004, which starts October 1, 2003 and ends September 30, 2004, are used in this study because the most recent state-level federal expenditure data released by the Census Bureau, to which the tax burdens are compared, is for FY 2004.

Federal Spending Per Dollar of Tax Collected

By comparing each state's share of federal spending to its share of federal taxes, we can see what states might call "the bang for their buck." Of course, this is not a very civic-minded view of federal government. Presumably citizens pay federal taxes to provide for the common defense and to support other national programs that benefit the nation as a whole. The data presented in Figure 1 and Table 1 show which states are the biggest beneficiaries of federal fiscal operations and which are the so-called donor states.

New Mexico is the biggest beneficiary, with a federal spending-to-tax ratio of 2.00. That's another way of saying that for every tax dollar the federal government takes from the people of New Mexico, $2.00 in federal spending goes back into the state. This high ratio is the result of the state's relatively low FY 2004 per capita federal tax burden, 77 percent of the national average, and its large share of federal spending, 155 percent of the average per capita. A few states have lower per-capita taxes than New Mexico, and a few received more federal funds per capita, but when both flows are included in the calculation, New Mexico ranks highest. Other states with high federal spending-to-tax ratios are Alaska (1.87) and West Virginia (1.83).

The donor states are those where so much is collected in federal taxes that the federal dollars they receive are overwhelmed. With a high FY 2004 federal tax burden per capita (141 percent of the national average) and a below-average amount of incoming federal funds (78 percent of the national average), New Jersey has the lowest federal spending-to-tax ratio (0.55) and is therefore the nation's biggest net donor to federal fiscal operations. The 0.55 ratio means that New Jersey receives 55 cents in federal spending for every dollar its taxpayers send to Washington. New Jersey received almost four times less what New Mexico receives for its tax contributions. Other states that had low federal spending-to-tax ratios in FY 2004 are Connecticut (0.66) and New Hampshire (0.67).

Table 1 also shows which states' ratios rose or fell between FY 1994 and FY 2004. The state that improved its ratio the most over that ten-year period is Alaska where the ratio rose from 1.30 to 1.87. Other states that got a much better deal from Uncle Sam in 2004 than they did a decade earlier are Alabama and West Virginia. States that have not fared so well include Colorado, Massachusetts and California. Colorado has seen the largest change with its federal spending-to-tax ratio falling from 1.00 in FY 1994 to 0.79 in FY 2004.

Comparing Each State s Share of Federal Taxes and Spending to the National Average

The two components of these spending-to-tax ratios can be examined separately. Table 2 presents data on federal taxation and expenditures per capita in each state compared to the national average, with snapshots of FY 1994 and FY 2004.

States that saw their federal tax burdens increase the most relative to the national average during this period include Massachusetts, Connecticut and Wyoming. Residents of Massachusetts went from paying 122 percent of the national average in federal taxes to 140 percent. Similarly, the residents of Connecticut were paying 148 percent of the national average in federal taxes in FY 1994, but ten years later they were paying 166 percent.