Though better than some, North Carolina’s tax system still socks it to the poor and the middle class. The results are bad for everyone.

All taxes are not the same. Most North Carolinians “get” this simple premise. Even the most mathematically challenged among us understands that there is a difference between a sales tax applied to a bill at Target and the income tax deducted from one’s paycheck every two weeks. Many also understand the fact that the lottery is a tax and perhaps even that property taxes are a big component of the rent that many pay each month for their apartments or houses. Fewer could probably explain the deductibility of state taxes on one’s federal income tax return or the ways in which businesses shelter income in certain states by creating paper subsidiaries that are really run by and for the exact same individuals.

And probably just about no one can tell you, without a lot of help, how this all fits together to produce a coherent and comprehensive system that provides both the necessary funding for society to meet its shared challenges and spreads the responsibility as fairly as possible amongst the citizenry.

There are two primary reasons for this latter reality: 1) The subject is complex as heck, and 2) It doesn’t! That is to say, this may be how some of us would like the system to work, but in reality, few tax systems live fully up to such ambitious objectives. Most – at least in the United States – raise inadequate revenue and do so in a way that favors the rich and powerful, i.e. the people who have the most to say about how the system is put together.

Who pays in North Carolina?

A recent study by the N.C. Budget and Tax Center (BTC) entitled “Who Pays Taxes in North Carolina?” documents this hard reality. Despite the state’s longstanding progressive tradition and increasingly rapid growth in modern times, North Carolina’s tax system remains both unfair and inadequate. Though not as regressive as some (perhaps many) states, North Carolina’s system continues to ask for disproportionate sacrifices from those in the middle and at the bottom at the same time that its public services struggle to tread water.      

Here’s how the report’s author, Meg Gray, summarized the findings about the how the responsibility for funding government is distributed (you can see an interactive graph of these numbers by clicking here):

“Every North Carolina household pays taxes; however, low-income households pay the greatest share of their incomes in state and local taxes. In 2007, the bottom 20% of North Carolina households, with an average income of $10,000, paid 10.7% of their incomes in state and local taxes. That same year, the top 1%, with an average income of $970,000, paid only 7.1%. This means the responsibility of paying local and state taxes falls hardest on those with the least ability to pay.

In other words, North Carolina’s state and local tax system on the whole is regressive. North Carolina relies primarily on income, property and sales taxes to fund state and local services. The fairest of these options, the income tax, is the largest of North Carolina’s combined state and local revenue sources. This helps to lessen the overall regressivity of the state’s tax system; however, it is not enough to offset the impact that the sales, excise and property taxes have on the poorest households. A fair tax system should be structured such that the combined impact of all tax sources results in households with higher incomes paying the greatest share of income in state and local taxes.”

And here’s how the report summarizes the implications of such a system for funding essential services:

“A tax system that relies on raising money from the people who have the least of it has direct implications on North Carolina’s ability to raise adequate revenues. The simple reason is that the top 20% of North Carolina households earned close to 60% of the state’s income in 2006, compared to just 3.5% earned by the bottom 20%. Over time, this trend will worsen because the incomes of the top 1% are growing at a much faster rate than any other income category. Between 1979 and 2005, incomes of the top 1% increased on average by 228% compared to only a 6% increase for the bottom 20%.”

In other words, the current system is helping to perpetuate a vicious cycle that features ever widening income gaps and debilitating budget shortfalls. Especially in this era of flat or falling middle class wages brought on by globalization, the tax system is slowly but surely helping to build a very different North Carolina; a harsher, more starkly divided and less hopeful North Carolina.

What is to be done?

In spite of the powerful global economic trends that North Carolina has little capacity to resist or alter, there is still much that state policymakers can do. The new BTC report identifies at least seven specific improvements to the North Carolina tax system that could, if lawmakers found the courage, be implemented immediately. These include:

For income taxes

• Increase the number of income tax brackets. There are currently just three.
• Index income tax brackets and deductions for inflation.
• Expand the earned income tax credit for lower income workers.

For sales taxes

• Expand the sales tax base to include more personal services (and use new revenues to lower the overall sales tax rate).

For property taxes

• Create a refundable “circuit-breaker” credit for low-income homeowners and renters that would allow them to claim a refundable credit against their state income tax, thus offsetting their property taxes.

For all taxes

• Require all tax policy changes to be thoroughly analyzed in terms of their impact on all income groups.

Each of these seven ideas is in place today in other states around the country and could, if implemented here, dramatically improve the fairness and quality of life for all North Carolinians. According to the Washington, DC-based Institute on Taxation and Economic Policy, if North Carolina lawmakers changed the state and local tax system to require the wealthiest 1% of households to pay as much of their income as the poorest 20% do, the revenue yield would have been $589 million in 2006. Extending that same condition on the top 20% would have yielded $1.6 billion.

Such revenues would be enough to enable the state to make enormous inroads in areas of glaring need like the current crisis in mental health, developmental disabilities and substance abuse, the huge shortage of affordable housing, as well as public transportation and education, childcare and juvenile justice. And note, this is not even a call for a progressive tax system; such a dramatic change would only produce what amounts to a flat state tax system.

Going forward

Recently, state lawmakers sent some clear signals that they have little appetite of tackling the kinds of fundamental tax reforms called for in the “Who Pays?” report during a major election years that also coincides with the final year of the Easley administration. While perhaps understandable from a purely political standpoint, delay will only exacerbate many of the structural dilemmas confronting the state. Let’s hope that between now and the start of the 2008 session in May, some of the state’s top political figures – particularly some of the candidates for statewide office – have a change of heart. The road to a fair and adequate tax system may be long and uphill, but at least we now have an excellent map.