Statement from Elaine Mejia, Director of the North Carolina Budget & Tax Center regarding the latest tax package negotiations (recommendations in bold)
The latest, and possibly near-final, revenue package being considered by the legislature would reportedly raise approximately $1 billion, an amount that will allow lawmakers to avoid very deep cuts to state services that would otherwise have to be made. Unfortunately, the revenue package currently under consideration will disproportionately impact low- and moderate-income taxpayers and will do nothing to close the state’s long-term structural budget gaps. State lawmakers should consider making a few minor changes to the plan that would make it fairer and improve long-term stability.
Published media reports from the past few days indicate that the final revenue package under consideration by the General Assembly relies primarily on a substantial increase in the state sales tax, moderate increases in sales and excise taxes on purchases of cigarettes and alcohol, and a temporary surcharge on state income tax payments.
Earlier this year, the NC Budget & Tax Center (BTC) put forth a General Fund revenue plan  that would have raised $1 billion and would have improved the fairness, stability and long-term adequacy of the state’s revenue system. Unfortunately, the latest version of the tax package under consideration by the General Assembly does not include any of the reforms recommended by the BTC. At this point it is understandably too late in the process to reach agreement on sweeping reforms; however, the plan under consideration could be improved considerably by making a few modest changes.
The vast majority of the revenue generated from the plan under consideration would be from the proposed sales tax increase. A hypothetical 1% increase in the state sales tax rate would mean that the lowest income taxpayers (bottom 20% of income-earners whose average annual income is $10,000) would pay an additional 0.65% of their incomes in additional sales tax over the course of one year. In contrast, the state’s top 1% of income-earners whose average annual income is $1.015 million would pay only 0.13% of their income in additional taxes from this change. In other words, the proposed sales tax increase will hit the lowest-income taxpayers six times harder than the state’s highest-income taxpayers. To blunt the impact of this regressive change, lawmakers should consider increasing the state Earned Income Tax credit to at least 15% of the federal credit which would completely offset the impact of these changes on the bottom 20% of income-earners.
In addition to the highly regressive nature of the primary component of the plan – the sales tax – , it is also unfortunate that the final plan abandons many of the reform-minded elements that had been previously part of the negotiations. These include changes such as broadening the sales to base to include more services, broadening the income tax base to to Adjusted Gross Income rather than the more narrowly-defined Federal Taxable Income, and closing corporate tax loopholes by requiring Combined Reporting for all corporations. At the very least, lawmakers should revisit including the reform-minded elements that were included in both of the legislative plans. These include applying the Franchise Tax to businesses that are structured as LLC’s, a small expansion of the sales tax base by broadening the tax to include warranties, installations and repairs, and digital downloads and converting the privilege tax on movies to a sales tax on entertainment purchases.
Finally, the proposed temporary 2% across-the-board surcharge on income tax payments is likely to be moderately progressive because the state income tax is moderately progressive. However, to more fairly distribute the additional tax responsibility of the plan overall, lawmakers should consider restructuring the surcharge such that the rate applied to the income tax payments of higher-income taxpayers is greater than it is on low- and moderate-income taxpayers.
By raising $1 billion in additional tax revenues state leaders will avoid having to take steps such as laying off thousands of teachers and other state workers or making deep reductions to critical state services, both of which would further compromise the economic prospects of families already struggling to make ends meet during the recession. Moreover, making modest improvements to the final tax plan would also lessen the impact of the current recession on these families by lowering their additional tax responsibility and improving the stability of the General Fund’s revenues for the next few years.