Taxes

States with the Lowest Rate of Income Tax

We often think of income tax as a simple fact of life. It is something that is almost universally resented, and it is enforced in almost every country in the world. How much tax we need to pay depends on many factors, like income and marital status, but did you know that there are actually several states where income tax is not collected at all? This article goes over these states, as well as some of the benefits and drawbacks of living in a state that does not tax people on their income.

State and Federal Income Tax

One important distinction to make is that between federal and state income tax. As the US is a collection of states with a fairly high degree of independence, these states have a lot of say in their own laws and how much tax they charge people, as well as what they tax people for. In some cases, people are also required to pay tax to their local governments as well. States also vary quite widely in terms of what is taxable within those states and the rates that people are taxed at. There is also a lot of variety with regards to tax credits and deductions.

Generally, federal tax systems are progressive. This means that the more that a person earns, the more they are taxed, relative to their income. However, there is a cap, and there are also many potential deductions that a person can have from their taxable income. As far as the different states go, some states impose a flat rate of tax, while others also have progressive systems. For example, in Michigan, all people pay a flat rate of 4.5%.

States with Low Rates of Income Tax

Compared to many parts of the world, like Europe for example, almost all of the US has incredibly low rates of income tax. California is often cited as an example of high taxes in the US, with one of the highest rates of income tax at a flat rate of 12.7%. This changes progressively depending on your income, but usually caps out at around 37%. Compare this to Sweden, however. The Scandinavian nation is generally thought of as a peaceful utopia with a robust welfare system, and while this may be true, this is largely the product of their taxation system. In Sweden, income tax averages at around 57% per individual. So while income tax in California may be high relative to the other states, it is certainly not in a global context.

There are also other ways of effectively taxing income, which are not necessarily noticed in tax returns or pay-slips, but that can be felt in prices and purchases made instead. For example, there are property taxes, inheritance taxes, and gas taxes in many states around the US, and these also vary from place to place. Here is an overview of the states with the lowest rate of income tax, or which do not tax income, as well as some related information regarding the other types of taxation they have:

Nevada

This dry and hot state is famed for being home to Las Vegas, one of the world’s most famous cities. It is apt that such a place is within Nevada, as the state is home to many wealthy Americans, and it does not have an income tax. Its taxes are generally below average, and it also has below-average property taxes. The hotel industry and the casino industry in Nevada are both hugely lucrative for the state, and the state uses them to support much of the industry and infrastructure in other areas. Gas taxes in Nevada are slightly higher than average, but not substantially, at around 31.7 cents per gallon.

Wyoming

Known by many as the state of freedom, Wyoming is generally renowned for its somewhat lax culture, and this is reflected in the local politics of the state. Not only is there no income tax in Wyoming, but gas taxes in the state also fall below the national average. Combine this with both the local and state sales taxes, which are also both much lower than average, and it isn’t difficult to see why this state is so favored by those looking to preserve as much of their wealth as possible. Property taxes in Wyoming are also very low, roughly the ninth lowest in the whole US, which makes it easy to purchase and retain large tracts of land in this expansive and quiet part of the country.

Tennessee

It has a state income tax rate of only 2% on dividends and interest, but the effective income tax rate in Tennessee is 0%. It is also intended that, as of 2021, the state of Tennessee is no longer charging any income tax whatsoever, making it another of the entirely income-tax-free states on this list. Property taxes also are comfortably below the national average, as well as gas taxes. Gas taxes are actually substantially lower than average, being only 21.4 cents per gallon. However, there are some other systems of taxation in the state that make up for it. Both beer and sales taxes in Tennessee are actually the highest in the US, so it probably isn’t the best place to go for a shopping trip.

Alaska

Many refer to it as the Last Frontier. Alaska is a breathtaking and wild place, and for the most part, very sparsely populated. Income is not taxed in Alaska, and the average sales tax is only 1.76%. Anchorage is the largest city in Alaska, and it does not charge any sales tax at all. Property tax in the state is above average, but not substantially. There is also another perk for living in Alaska: each resident who lives in the state for a full year receives a dividend from the state. The amount changes every year, but in 2019 it was $1,606, and it 2015 it was $2,072.

Florida

This sunny state has no income tax, though there are several other tax systems in Florida which charge people at substantially higher rates than the national average. There are also county taxes which may be applied to certain purchases, like vehicles which cost over $5,000. Property and sales taxes in Florida are fairly average. The gas tax in Florida is quite high, though. As of 2019, it was around 41.99 cents per gallon, which makes it higher than most states in the US.

Washington

Washington has no income tax, though some of its other taxes are higher than the national average. For example, the combined state and local sales taxes in Washington are actually the third-highest rate in the whole country. It is also one of only a few states in the US that charge an estate tax. This means if you have an estate worth over $2,193,000, you are required to pay some level of tax on it. The rate of estate taxes in the US vary from 10-20%.

North Dakota

North Dakota is a state that is grounded heavily on agriculture, and the system of taxation reflects this to some extent. Sales taxes are low, and they are lowest when it comes to buying machinery that is used for agriculture or related ventures in some way. Property taxes in North Dakota are also somewhat lower than the national average, and like the other states on this list, it does not charge income tax. As of 2019, the gas tax was at 23 cents per gallon, which is considerably lower than the national average. The state is large and fairly sparsely populated, so having a low gas tax is something of a boon for residents who rely on their cars to get around.

South Dakota

The state that is famed for Mount Rushmore does not charge any income tax. There are also sales tax exemptions for many vital goods, like prescription medication, for example. However, there are a considerable amount of services that are actually taxed in South Dakota, and property taxes are roughly the same as the rest of the country.

Arizona

Arizona does actually charge income tax, but it is much lower than many other states in the country. It is also only charged for the highest earners in the state, so many residents do not actually have to worry about paying income tax, as it simply doesn’t apply to them in their case. As of 2019, the gas tax was also a lot lower than the average, at only 19 cents per gallon. The tax system in Arizona is actually quite complicated beyond this, however, as many counties charge sales tax for different types of items or goods, and it varies somewhat from place to place.

The average combined sales rate tax in Arizona is quite high overall, being around 11th in the US. The gas tax itself is low, but owners of vehicles in Arizona have to pay a license tax, which is unusual and something of a disadvantage in terms of the tax system in the state when compared to other states.   

New Hampshire

The last state on our list has a cooler climate than many of the others here, but it is a similar environment when it comes to taxation. Its system is fairly similar to Tennessee, in that income tax is quite limited and applies only to interest and dividends. There is actually no sales tax in New Hampshire, which takes off much of the financial pressure of shopping in the state, and the day-to-day expenses that add up are not as high as they might be otherwise. The gas tax is also considerably below the national average – in 2019, it was only 23.83 cents per gallon in New Hampshire. However, the property tax in New Hampshire is quite a lot higher than the national average.

As can be seen above, there are many states in the US which do not charge income tax, and this makes them fairly unique in a global context. It does not, however, mean that living in them is overall cheaper than other states, as they tend to be more expensive or have higher tax rates in other respects. As such, it is best to assess them in their entirety when it comes to taxation, instead of focusing exclusively on income tax.  

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