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How income inequality hurts state and local economies

Adam Samson

Swelling income inequality across the U.S. is cooling economic growth, and could pose a problem for state policymakers, a new report shows.

Standard & Poor's said in a report Monday the earnings gap between top-earning Americans and those on the lower end of the salary bracket "contributes to weaker tax revenue growth by undermining the rate of overall economic expansion."

Indeed, data from the firm known for rating corporate and government bonds indicate between 1980 and 2011, average annual state tax revenue slumped 5%-10%, while the share of total income derived from the top 1% doubled.

S&P said income inequality negatively affects the pace of tax-revenue growth in states reliant on both sales and income taxes. However, the data show sales-tax reliant states tend to take a bigger blow from inequality. Still, S&P analyst Gabriel Petek told Yahoo Finance income-tax reliant states might actually face a tougher situation to manage since incomes are more closely linked to "wild swings" in financial markets. For example, the broad S&P 500 stock-market index plunged 36.6% at the height of the financial crisis in 2008, before posting a 25.9% rebound rally the following year.

Among the states that have faced the most volatility in tax income between 2000 and 2012 were California, Arizona, and New Mexico. Meanwhile, Kentucky, South Dakota and Wisconsin faced the least tumult in revenue due to income inequality.

Income inequality affects state governments more acutely than local governments because they tend to rely on income and personal consumption, as opposed to property taxes. Generally, spending and income are tied tightly to economic cycles.

A move by many state governments toward more progressive tax schemes -- those that put a greater burden on the higher earners -- has helped alleviate the burden of income inequality to some extent, S&P said.

In fact, the New York-based firm noted several of the states with the highest level of inequality, including Connecticut, California, Massachusetts, New Jersey and New York, have applied more progressive policies in recent years. That has helped ease the blow of inequality.

Petek noted, however, that states "face a conundrum" in determining tax policy, since increasing top-level tax rates increases both tax-collection revenue, and volatility. In fact, the S&P report said states likely can't correct for slower tax-income growth on their own via tax policies.

Here's a look at which states are facing the biggest, and smallest, swings in tax collections due to income inequality:

Top 10

New Mexico      
Bottom 10

South Dakota    
West Virginia   


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