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Good or Bad Idea: Living in States With No Income Tax?

In 2018, more Americans moved to Oregon and Idaho than any other state (except for Vermont). Meanwhile, the State of Washington ranked sixth nationwide in terms of incoming domestic migrants. Perhaps most noteworthy is that Washington is amongst the states with no income tax, but Idaho and Oregon aren’t. Why, then, did more people move to the latter two than to their neighbor?

Many consumers believe that they would pay less by living in one of the states with no income tax. However, this isn’t always the case. It is important to keep in mind that there are sales, business, and property taxes. Their figures vary from one state to another and largely depend on the local county or municipal rules.

Ignoring other forms of taxation can be a costly mistake, especially because they add up. In fact, on many occasions, it can be cheaper to live in a state that has an income tax than in one that doesn’t.

Taxes and Moving

Washington is one of only seven states with no income tax. Yet, the cost of living there is higher than it is in nearby Idaho, Montana, and Utah, whose residents have to pay taxes on their income. This is the case because the Evergreen State’s levies on sales, business operations, and properties add up.

In fact, property taxes are amongst the biggest expenses that consumers are facing nationwide. It is one of the reasons why the demand for cheap renters insurance has been going up. The US average property tax, which is set by state governments, is about one percent.

Meanwhile, the median home value is just over $230,000. This means that the average homeowner in the US pays $2,300 per year (or about $200 per month) in property taxes. This number, in itself, is almost just as large as (if not larger than) what many people pay in federal and state income taxes.

Adding Things Up

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When we also add sales duties to the mix, it might as well be irrelevant whether or not consumers live in states with no income tax. After all, keep in mind that it is difficult to add up all the sales taxes from shopping receipts and compare the difference between one state and the other.

Just as importantly, these tolls and burdens have an indirect impact on the cost of living. In Washington State, for example, companies have to pay a Business and Operations (B&O) tax each quarter. The levies are calculated as a percentage of their revenues. The state government also taxes the value of the machines and equipment that a business uses in its daily operations.

Another duty that firms in Washington have to pay is the payroll tax, which applies to all salaries that their employees receive. Because of the hefty costs of doing business, many companies raise their prices. In turn, they pass them on to consumers who have to deal with a higher cost of living.

Idaho has income tax brackets that range between 1.13% and 6.93%. Yet their sales and business taxes are either minimal or nonexistent. The larger picture, of course, is cost of living, especially when we compare the two neighboring states in the Pacific Northwest.

In 2018, groceries in Idaho were 17% cheaper than they were in Washington, while housing costs are a whopping 35% lower in the Gem State. This underlines how, even in states with no income tax, these different government tolls have a direct and an indirect impact on the quality of life.

Different Directions

When consumers pay state taxes, whether on their income or consumption, they can deduct them from what they owe the federal government. For example, someone who made $100,000 and paid $10,000 to the state can deduct that number from their federal taxes. Therefore, it doesn’t matter where they live because they still have to pay the same amount.

This viewpoint is only accurate to a certain extent. First, recent changes to federal tax laws put a limit on how much in local duties an individual or household can deduct. Moreover, in states with no income tax, you still have to add up all the miscellaneous payments when filing with the IRS.

This process takes a lot of time. For example, an employee who makes $25 per hour and spends five hours collecting receipts, filling out forms, and rounding up tax payments will spend an equivalent of $125 worth of their time on this process.

Many people prefer to send these documents to a firm that would take care of filing for them. However, these services also come with a fee.

Meanwhile, calculating a fixed state income tax (such as five percent) is much easier and less time consuming.

Flight of Capital

A common argument in support of states with no income tax is that their approach incentivizes wealthier Americans to move in. Doing so leads to more in-state investments and economic growth.

After all, someone who makes a million dollars per year will prefer paying taxes on groceries, for example, than have a portion of their income taken away. However, that is also not always the case.

Washington, for example, is considering introducing a capital gains duty. In fact, many states with no income tax already have this. Capital gains are earnings from growing investments, such as stocks. Wealthier people, in most cases, hold a large amount of capital in financial instruments that would be subject to this form of taxation.

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Just as importantly, rich residents have to incur the infamous property tax. As mentioned earlier, these can be very hefty. A home worth $2 million comes with a $20,000 per year (or almost $1,700 per month) tax bill. This does not include all the B&O and payroll taxes, nor does it take into account the higher cost of living that is associated with all these fees.

Are States With No Income Tax Truly Better?

At the end of the day, the answer to that question largely depends on several factors. These include how much someone consumes, their employment (business owner vs. W2 worker), housing (rent vs. own), and earnings bracket.

Getting rid of your income tax is easy. Yet, adding up the different forms of alternative levies is difficult, even more so when trying to account for their indirect impact (such as cost of living). Property taxes are another nightmare that homeowners, especially wealthier ones, have to deal with.

Before deciding to move, ask yourself this: How much will I truly be saving, after all? If you need to spend some time on adding up the numbers, then you already started incurring these costs.

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