How do state taxes work?

Most people would consider a tax system to be unfair if those who earned less paid a higher percentage of their income in taxes than those who earned more. But that’s exactly how regressive taxes work.

As we’ve seen, Alabamians contribute to the funding of public services by paying taxes on their income, purchases, property and business operations. The next sections of this handbook will explain the basic principles of tax policy and examine the nuts and bolts of Alabama taxes.

Most people probably would agree that taxes should be “fair.” But what does tax fairness look like? From the vantage point of our own individual budgets, fairness may seem to be “lower taxes for me.” From the vantage point of the common good, however, economists have developed some basic tools for measuring tax fairness.

The charts on above illustrate three ways that any given tax can affect the total pool of taxpayers:

A regressive tax requires people who make less money to pay a bigger share of their income than people who make more.
A proportional tax (or flat tax) requires the same percentage of income from everyone, regardless of how much they earn.
A progressive tax requires people who make more money to pay a bigger share of their income than those who make less.

Most people would consider a tax system to be unfair if those who earned less paid a higher percentage of their income in taxes than those who earned more. But that’s exactly how regressive taxes work. They reduce the standard of living of families with low and middle incomes, while affluent families are not similarly affected. The sales tax is a regressive tax, because people with low incomes spend most of their income on goods that are taxed. Property taxes also are often regressive, especially in areas where home values are increasing more rapidly than incomes for the lowest-paid workers. Alabama’s regressive tax system taxes families with low incomes deeper into poverty, while demanding less of wealthy people, who have enjoyed the vast majority of the state’s income growth in recent decades.

Proportional taxes also are inequitable in practice. Requiring families who are working hard to make ends meet to pay the same share of their income in taxes as a wealthy family results in vastly different consequences for each. For those who must spend most or all of their monthly income for basic necessities, even a relatively low tax rate can have a large impact on daily life. For wealthier taxpayers with more discretionary income, however, a tax at the same percentage will not have the same impact. Alabama’s income tax is close to proportional.

Progressive taxes are the fairest taxes. Families with low incomes can be exempted entirely by providing all taxpayers with an exemption large enough to cover the basic cost of living. Tax rates also can be graduated – meaning they rise along with income – so that families at middle and high incomes pay taxes fairly related to what they can afford. At both the state and federal levels, personal income taxes can be, and typically are, designed to be progressive taxes.

All state tax systems are different. But government leaders, economists and advocacy groups have identified several principles that mark a healthy tax system:

Fairness – Does the tax system require people to contribute to the cost of public services on the basis of their ability to pay?
Adequacy – Does the tax system raise enough money, in the short term and the long term, to finance needed public services? Does earmarking prevent revenues from being spent as needed?
Simplicity – Does the tax system have confusing tax loopholes? Is it easy to understand how our state’s taxes work and to file a basic income tax return?
Transparency – Is information about the tax system readily available to the public? Can taxpayers see that all businesses and individuals pay a fair share?

By these measures, what kind of health rating does Alabama’s tax system deserve? Read on to find out how our tax system compares to those of other states and how each tax affects the whole system. Spoiler alert: We have a lot of work to do.

How does Alabama’s tax system measure up?

Alabama’s tax structure is among the nation’s most unfair, according to the 2024 edition of ITEP’s Who Pays? report, an analysis of the tax systems in all 50 states. (See whopays.org for the full report.) ITEP’s calculation includes both state and local taxes and excludes households where the primary tax filer or their spouse is aged 65 or older, because older adults often benefit from tax provisions unavailable to most other people. If you compare Alabama’s chart above with other states’ charts in Who Pays?, two things stand out:

We rely heavily on regressive sales taxes. Alabama has high state and local sales tax rates. We continue to tax groceries (though at a lower rate than other consumer goods), which account for a large share of spending for households with low incomes. And we tax relatively few services, which people with higher incomes tend to buy more often.
Our income tax is only moderately progressive compared to other states. Alabama’s income tax is almost flat for all but the lowest-paid 20% of families, so it doesn’t offset our steeply regressive sales tax. We’re better off on this measure than states without an income tax, like Florida and Tennessee, but not by much. And our income tax is even less fair than flat taxes used in some states, largely because of some generous tax breaks for the highest earners.

The result for Alabama is an upside-down tax system in which the less you make, the more you pay. The lowest-paid fifth of Alabamians pay nearly 12% of their incomes in state and local taxes, while the wealthiest 1% pay just 5.4%. Adding to the upside-down nature of this structure, Alabama is the only state to allow a full federal income tax (FIT) deduction on state individual income taxes. This tax break’s benefits flow disproportionately to wealthy households.

Alabama has an upside-down tax system in which the less you make, the more you pay.

All four legs of our state tax system need repair. Alabama made its income tax slightly less regressive in 2006 and 2022, but it remains mostly flat. While Alabama took historic steps to reduce the state grocery tax in 2023 and 2025, our sales taxes still remain high, taxing low-paid workers deeper into poverty. Our property taxes have changed little since the end of segregation and provide large tax breaks to wealthy owners of timber and agricultural land. And our corporate income taxes have numerous loopholes that allow many of the wealthiest corporations operating in Alabama to pay nothing.

Sections 4-7 look at each of these taxes – how they work, how they measure up and how we could improve them.