An economic  issue that is becoming increasingly prominent in national political discourse is the expiration of the “Bush-era tax cuts.”   As a political compromise to meet budget rules, the controversial tax cuts of 2001 and 2003 were legislated to expire at the end of this year.  Congress and the President now face the prospect of allowing the cuts to expire–raising taxes in 2011 relative to taxes in 2010–or extending them.

In the spirit of the Arkansas-centric focus of the Arkansas Economist, we ask the question:  “How does this issue affect families in Arkansas?”

The Tax Foundation just issued a report that provides a state-by-state comparison of the tax implications for a “middle-income” family.   The report compares the  tax change for an average family in the middle 20% of each state’s income distribution.  The comparisons illustrate some interesting features of the tax changes that would result if the tax cuts are allowed to expire.

Table 1 shows the Tax Foundation figures for Arkansas compared to the U.S. as a whole.  For the average middle-income American family, the expiration of the tax cuts would mean a tax increase of $1540.  For a middle-income family in Arkansas the increase would be $1418–a little bit less than the national average.   In percentage terms, however, the difference is remarkable:  the national average represents an increase of 45% while the Arkansas increase is over 100%.

Table 2 shows a 50-state comparison of the Tax Foundation data, along with some additional calculations to show percentage increases and relative state rankings.   Arkansas ranks 43rd in terms of the dollar-value impact of allowing the tax cuts to expire, but it ranks number 2 (2nd only to Mississippi) in terms of the percentage increase in taxes that it would imply.

The state rankings reveal a clear pattern:  Those states in which middle-income families would bear the largest dollar-value increase in tax bills (e.g. Alaska, Connecticut, and New Jersey) are the same states that show the lowest percentage increases.  Those that have the smaller dollar-value changes (e.g. Mississippi, Arkansas, and West Virginia) are the states with the largest percentage changes.

This pattern is related to the structure the Bush-era tax cuts.   The tax cuts were across-the-board, but the largest cuts–in dollar terms–went to the wealthiest Americans.  In percentage terms, however, the largest reductions went to lower and middle-income Americans.   As a state with a relatively low median income, Arkansas has many families that benefited from higher exemptions, the reduction of the lowest tax rate, and larger tax-offsets like the increase in the child tax credit.  As a result, a complete expiration of these modifications to the tax code would result in large percentage increases in the tax burdens of middle-income Arkansans.

The course of legislative action on the issue is uncertain, but President Obama has proposed to extend the tax cuts for all taxpayers except married couples with incomes over $250,000 (or single people with incomes over $200,000).  Table 3 gives an indication of how many households this limited extension might affect:  It reports data from the Census Bureau’s 2008 American Community Survey (ACS) on the number of households in each state with an income greater than $200,000.  In Arkansas, over 20,000 households fall into this category– about 1.8% of the total.  This is the second-lowest percentage among the 50 states.

An Excel file of the data in this post is available here.