State Income Tax Reform

Say what you will about the Democrats, at least they tax and spend. The Republicans, well, they just seem to spend. But more importantly, neither is doing anything meaningful about the growing gap between the rich and the poor.

What we need in Pennsylvania is a progressive income tax structure that would provide a source of revenue while simultaneously adjusting an individual's gross income towards the state mean. This is also referred to as an averaging tax. The beautiful thing about the averaging tax is that it has the appeal of a progressive income tax while at the same time serving as a mechanism for redistributing the wealth of society. Yet it could replace our current income tax without initially changing how much you owe the Commonwealth on April 15th. Sound intriguing?

There are only four things you need to calculate how much you owe. The first is your gross income for the previous year, which you would get from your W2s. The second is the average income for that year, which would come with your PA-40 form. The third is the mean adjustment percentage, which defines how much your gross income is adjusted towards the state mean. The last is the base tax rate, which would be a flat rate like we have now.

Here’s how the averaging tax works. Your gross income is going to differ from the state mean by some amount. The mean adjustment percentage adjusts your income towards the average income a percentage of that amount, raising it if you are below and lowering it if you are above. (If you are above the average income then this is taken out in addition. If you are below the average income then you can deduct this later on.)

You then apply the base tax rate to your adjusted income. If you were below the average income then you subtract your adjustment from this amount. If you were above the average income then you add this amount to your adjustment. The result is what you either pay or get back. It’s that simple.

As you can see the averaging tax is a progressive income tax that doesn’t use arbitrary income brackets. This eliminates the phenomenon known as bracket creep where peoples’ rate jumps when they get pushed into a higher tax bracket. Under the averaging tax, the same rate is applied equally to all people yet those with more income who can afford to pay more taxes do so.

Also notice that the averaging tax itself does not limit how much anyone can make. All it does is ensure that those at the top pay their fair share while those at the bottom do not have to shoulder a disproportionate burden. Those in the middle would be largely unaffected. The combination of the base tax rate and the mean adjustment percentage allow us to fund much needed state programs while ensuring the difference between the richest and poorest does not become too excessive, both of which are in society's best interest.

The averaging tax is easy to understand since you don’t need a booklet with pages upon pages of instructions. And it is quick and painless to figure out how much you owe since the formula isn’t that complicated. The worksheet just isn't straightforward, its literally only three lines:

Your Adjustment Amount = (Your Gross Income - State Mean Income) * Mean Adjustment Percentage

Your Adjusted Income = Your Gross Income - Your Adjustment Amount

Taxed Owed = Your Adjusted Income * Base Tax Rate + Your Adjusted Amount

Let’s look at a couple of examples. In 2004 the per capita income in Pennsylvania was $33,348. To make the math easier we’ll round that to $35,000.

Say Jane Smith’s gross income was $25,000. She is $10,000 under the mean income. If the mean adjustment percentage were 2%, her income would be adjusted up $200 (2% of the gap) to $25,200. She would then pay 3.07% of $25,200, or $932.40. So her total tax owed would be $932.40 minus $200, or $732.40. Compare this to the $925.00 she would pay under our current tax system.

John Smith’s gross income was $45,000. He is $10,000 over the mean income. If the mean adjustment percentage were again 2%, his income would be adjusted down $200 (2% of the gap) to $44,800. He would then pay 3.07% of $44,800, or $1657.60. So his total tax owed would be $1657.60 plus $200, or $1857.60. Compare this to the $1,665.00 he would pay under our current tax system.

The key to the averaging tax is the mean adjustment percentage. The larger the mean adjustment percentage is made, the more progressive the tax structure becomes. Initially, if the base tax rate were kept at the current 3.07 and the mean adjustment percentage started out at 0%, taxpayers wouldn’t notice the change at all. No tax reform has been easier on the pocket book to implement!

Slowly, over time, the mean adjustment percentage could then be increased to narrow the gap between the rich and the poor. I like to think of it as knob that can be turned to socialize society. The averaging tax is but one example of a social democratic reform measure that can bring us one step closer to a better society.