The best and worst states for taxes

By Scott McCredie

All 50 states may use similar methods to fund their budgets -- taxes on income, sales, property, fuel, alcohol, tobacco -- but each does so with its own formula.

The differences can be extreme. If you lived in Wyoming, the least-taxed state, you'd pay about $7 out of every $100 to the governor. In New Jersey, on the other end of the scale, you'd fork out $12. On average, state and local governments combine to loosen nearly 10% of your income from your grasp.

A smoker wanting to save some dough might prefer to live in South Carolina, which charges just 7 cents a pack -- as opposed to the state tax average of $1.19. A heavy drinker might want to move from Oregon, where hard liquor is taxed at the rate of nearly $21 a gallon, to Maryland or Washington, D.C., which have the country's lowest liquor taxes, $1.50 a gallon.

Are you a lottery devotee? You'll keep more of your winnings in Rhode Island, which takes a tax of 22 cents on the dollar, and the least in West Virginia, with a 61-cent tax.

Of course, even Ted Taxpayer and Debbie Deduction, two people making the same salary and living in the same neighborhood, pay different amounts in taxes. For example, Ted's house is worth more, so he pays higher property taxes; Debbie buys fewer goods and services, thus saving on sales taxes; Ted drives a gas hog and commutes farther to work, costing him more in gas taxes; Debbie doesn't drink or smoke, so she saves on so-called sin taxes.

That's not to mention the countless other ways they can incur, avoid or defer taxes. Each state also sets its own formula for estate, property and inheritance taxes, as well as taxes on Social Security and pension income.

Higher taxes on the way

If you think you're paying too much in state and local taxes now, just wait. Experts say it's just a matter of time before states start demanding more taxes to make up for huge state budget shortfalls created by the nationwide economic slump.

Even if you live in a state with generally low taxes, such as Alaska or Tennessee, expect legislators to begin burning the midnight oil to figure out ways to balance their budgets. Unlike the federal government, all state governments (except Vermont) are legally bound to balance their budgets without the luxury of simply borrowing more money. They've got to reduce services or increase revenue, or both.

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Many have turned to gambling. Maryland is the latest state to legalize slot machines. It's bordered by three states that already had them, and legislators decided they were losing too much potential income across their state lines.

"There are only six or seven states that don't have lotteries now," says Josh Barro, an economist with the Tax Foundation, a nonpartisan tax research group in Washington, D.C. "The states see it like free money."

They're also increasing taxes on tobacco products. The reasons may not be entirely altruistic, but according to the American Lung Association, higher taxes have proved to reduce tobacco use, especially among youths. The federal cigarette tax rose from 39 cents per pack to more than $1 a pack April 1. Some states are also raising cigarette taxes this year, led by sizable boosts in Massachusetts, New Hampshire and New York, as well as the District of Columbia.

Taxes you'll see next

What other state taxes are in the wings?

Out-of-staters will continue to be tapped via taxes on rental cars and hotel rooms. If you don't live in the state, you can't vote out the politicians who create the taxes, so such taxes are "politically one of the easiest things to do," Barro says.

Online businesses are also being asked to pony up. In New York, for example, the state is collecting sales tax from Amazon.com despite the fact that the company has no physical presence in New York. Although the legality of the state's policy is being challenged in court, several other states are thinking of following suit.

Barro sees an uptick in taxes on cigarettes, alcohol and gambling. He calls these the "low-hanging fruit" that will delay the more difficult choice of implementing broad-based tax increases, which are politically unpopular.

Raising income tax rates on the wealthy, for instance, could backfire by causing those people to move out of the state. Realistically, a recession is the worst possible time to raise taxes because people are the least able to afford them.

"States are trying to buy themselves time right now," Barro observed. "The day of reckoning will come next year."

In the meantime, don't expect tax increases prompted by the economic meltdown to go away anytime soon. As an unknown wag once said, there's nothing more permanent than a temporary tax increase.