The Best Way to Measure the Cost of Living Differences among States is not the CPI

How can you make a true comparison of the cost of living across states? What states have the lowest cost of living? The government publishes the Consumer Price Index (CPI), which is used to measure inflation, and the Personal Consumption Expenditure index (PCE), which is also primarily an inflation measure, as well as a tool to compare the cost of living differentials across states and regions. They both capture your biggest expenses, such as housing, utilities, food, fuel, insurance, clothing, and sales taxes. These indices have their uses, but they are mainly used as composite measures made up of many components to gauge how prices change over time. Changes in their individual cost drivers are not well publicized and are hard to observe.

You Cannot Control Taxation

The biggest shortcoming of these indices is that they do not easily capture how your own out of pocket expenses are likely to be impacted if you move from one state to another. The cost of house, or rent, is a big expense item, yet it is under your control to a large extent. You may want to downsize or upsize. You can choose your house, as you can choose whether to go out to eat or what clothes to buy. What you cannot choose or control, is your taxation. And it is one of your biggest expenditures. Both the CPI and CPE indices are constructed from representative samples of baskets of goods, so you cannot really get a true picture of how your own cost of living is or would be impacted by state-level taxation. In fact, it is state-level taxes and fees which effectively are the biggest drivers of cost of living differences across states, and yet, these are hard to observe.

Taxation Lacks Transparency

Cost transparency for both state and local taxation is lacking, in contrast to on-line purchases or house prices. For most people, housing is perfectly understandable—you own a house and pay a mortgage, or you are shopping for a house and know the price. If you rent, you know how much you pay, and if you are looking to move, rental prices are discoverable. Many of your purchases come from global markets, where prices—pre shipping and pre-tax, are generally equalized. Therefore, price differentials of the goods that people buy do not have wide variation across the continental US.

The biggest driver of how the cost of living varies by state is state-level taxation.

Is the cost of living in Florida less than New York? Many people have already made the move to what they hope are lower-cost states, such as from New York to Florida, Connecticut to South Carolina, or Illinois to Tennessee. Did their taxes and fees really go down? If you are thinking about moving, understanding your true exposure to state taxation and how that impacts your cost of living is important information to have.

Why an Income Tax Rate or Sales Tax Rate is Not Enough Information

As most people know, not all states tax income and not all states tax sales. But those are broad statements. States that have “no income tax” may tax passively earned income. States with “no sales taxes” may tax many high-value items that you purchase, such as fuel, insurance, or alcohol. And states levy taxes on a variety of assets and activities in addition to income and sales taxes, such as estate taxes, vehicles, utilities, fuel, insurance, property transfers, even property itself. Yes, New Hampshire is a low-tax state with no tax on earned income and no taxes on most sales. But New Hampshire has to get revenue from somewhere, for example property taxes (state-levied), excise taxes, fees, sales taxes on certain items, and running businesses. Florida is a low tax-state, but it too must collect revenue from somewhere.

Therefore, it’s not enough to compare sales tax rates across states because of exemptions, tax holidays, special categories, and other carve-outs for items such as food purchased from the grocery store and clothing up to a certain dollar amount. The same challenges hold for state income taxes. Income tax rates vary across states, rates can be graduated, and normally do not kick in until an income threshold is surpassed. And certain types of income may still be taxed in “no income tax states,” such as passive income.

And then there are fees paid to states for car registrations, property transfers, probate, road usage, and more. These fees need to be factored into each state’s cost of living.

Taxes and fees should be compared both on a total dollar basis and as a percent of the income of residents. Ohio and Pennsylvania may have similar costs in dollar terms, but residents’ incomes in Pennsylvania are higher than in Ohio, which makes Pennsylvania more affordable on a relative basis.

Our approach is to capture all taxes and fees collected by a state and its state agencies from a state’s residents. This approach is the most comprehensive way to understand what the true burden is of living in a particular state. Consider a state’s budget process, which generally has the following pattern: First, the state government forecasts its expenditure needs. Second, it forecasts the revenue it expects to collect. Third, it measures if there is a funding gap. Fourth, if there is a gap, decisions are made as to how the gap should be filled, whether with higher taxes or fees, new taxes or fees, spending cuts, borrowing, or some combination of these options. If a new tax is created to fill the gap, for example, an excise tax on a new category, this does not show up in a sales tax “rate.”

We measure and compare state-levied taxes and fees across states, with all taxes and fees thrown into the “tax and fee bucket.” We rank states, measured as a percent of the fully-loaded state taxes and fees paid by households relative to household income, and as an absolute dollar cost per household. In the ranking, a “1” is the best, meaning lowest burden or lowest absolute dollar cost, and “50^” is the worst. The state with the lowest state-levied tax and fee burden on households is Missouri, and the state with the highest state-levied tax and fee burden on households is New Mexico. Note that we exclude Washington, D.C., because it combines features of both a state and municipality, and for all other states, we are capturing taxes and fees levied only by states and state agencies.

State Rankings based on Taxation

The table below confirms that you will save significantly in taxes by moving from, for example, California to Idaho, Connecticut to Florida, or Illinois to Tennessee. From a state-tax perspective, yes, Florida is better than both Connecticut and New York, as is Tennessee. And Florida is still better than Tennessee, and Tennessee is still better than Idaho. But what about moving from Massachusetts to North Carolina? Here, the benefit of moving south is not so clear. For comparisons of selected states, in terms of total state-levied taxes and fees as well as how much you’d save by moving, see our Insights Post What States have the Lowest Taxes? – TownScoreReport.

In summary, having easy access to information about one of the biggest expenditure items of your life which you cannot control, is vital. More information on the cost of living across states, on state-taxation, and which states offer the best value for residents can be found in a State Score Report, available at www.TownScoreReport.com. Note that the State Score Reports are updated periodically, so for the most recent information, check www.TownScoreReport.com.

State and State Agency Taxes and Fees are the Biggest Drivers of Cost of Living differences in States.

Cost of Living Rankings, by State and State Agency Taxes and Fees. “1” is Best/Lowest.  

Source: Pality.

Copyright Pality 2024.

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