Income inequality slowing tax revenue for U.S. states

Income inequality is leading to a slowdown in tax revenue for U.S. state governments, according to a report being released Monday by Standard & Poor's.

While the wealthy have become more affluent in the last five years, they manage to shield much of their income from taxes. And the sales tax revenue from their spending cant match the spending of millions of middle-income people.

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Middle-income people, who traditionally pay the bulk of taxes, have barely kept pace with inflation or are fallingbehind. They no longer have the spending power to contribute to sales tax revenue.

The poor remain poor and contribute little to tax revenue. And the rise of online retailing has created a class of retailers who pay lower state taxes.

It all adds up to a slowdown in sales and income tax revenue for U.S. states.State tax revenue grew an average of 3.62 per cent annually between 2000 and 2009, compared to 9.97 per cent a year from 1950 to 1979.

"Rising income inequality is not just a social issue," said Gabriel Petek, the S&P credit analyst who wrote the report. "It presents a very significant set of challenges for the policymakers."

States are facing tough decisions over whether to raise taxes or cut spending to balance their budgets.

Investments in education, highways and other infrastructure are necessary to spur economic growth, yet without a rising flow of tax revenue, it gets more difficult for states to afford these investments. And taxes are a dirty word, with politicians of all stripes eager to keep them low to attract business and manufacturing.

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"If you've got political pressure to spend more money and pressure against raising taxes, then you're in a pickle," said David Brunori, a public policy professor at George Washington University.

Earlier this year S&P found the widening gap between the wealthiest Americans and everyone else has slowed the U.S. economy's recovery from the Great Recession.

Throughout the U.S., weak pay growth has cut into consumer spending, a key driver of U.S. growth.

Adjusted for inflation, government data show that median household income rose by just over $3,000 since 1979 to$51,017 in 2012 and remains below its level before the recessionbegan in late 2007.

By contrast, the top 1 per cent has thrived.Their incomes averaged $1.26 million in 2012, up from $466,302 in1979, according IRS data.

The wealthy make more because investment returns have outpaced the growth of wages. A larger share also goes to businesses and their shareholders from the productivity gains that resulted from technology. But taxes on capital gains are uneven from year to year, making taxation income more unpredictable.

The S&P study also looked at how the structure of taxation in the U.S. states affects revenue growth. It found both states that mainly tax income and states that rely on sales tax are suffering, but those that rely on sales taxes are hardest hit.