Weekly Briefing

The latest budget breakdown provides one more chance to craft a progressive tax package that cuts taxes for most households

Quick take: Though frustrating to all, the latest breakdown in state budget negotiations provides state leaders with another opportunity to "get things right." Lawmakers should seize the moment and revisit a progressive revenue proposal developed during the spring that would have raised more than a billion dollars in critical revenue while actually cutting taxes for most North Carolinians.  

The latest breakdown in state budget negotiations is obviously a source of great frustration to all involved. There is, however, a potential silver lining: the opportunity that the breakdown provides to craft a tax package that raises the agreed upon revenue target in a truly progressive and sustainable fashion. This edition of the Weekly Briefing provides one more reminder of why such a result is important and how it can be done.

Progressive is better

With a progressive tax system, of course, those with the greatest income, pay higher tax rates. This doesn't, however, mean the well-off will feel any truly disproportionate pain. A millionaire, for instance, who paid even two, three or five times the tax rate of a poor person, would still be exponentially better off. Such a system also provides a host of benefits - in terms of equity, fairness, and assuring that government has the resources it needs to provide essential services. This is especially true in an era like the present in which incomes at the top have more than tripled in recent decades, while incomes in the middle and at the bottom have been stagnant.

Overall however, North Carolina's current tax system is actually quite regressive, that is, the wealthy actually pay a significantly lower percentage of their incomes than do individuals in the middle and at the bottom. Even though the income tax is slightly progressive, the combined impact of all other state and local taxes (sales, excise, property, etc…) assures that the poor and middle class pay more. Right now in North Carolina, after federal tax deductions, the richest 1% of households pay on the order of 7% of their annual incomes in state and local taxes, while those in the middle and at the bottom pay around 10%.

Though commonly thought of by many as "the fairest tax" because "everyone pays it," the sales tax is actually one of the most unfair taxes. This is because people of modest income spend a much higher percentage of their incomes on the purchase of goods.

Thus if a person with $30,000 in take-home income spends, say, $20,000 on essentials, he or she will face an effective tax rate of nearly 5% even before any other taxes are even computed. A person with $500,000 in income, however, who spends only a fifth of his or her income on essentials, will face an overall rate of less than 1.5% before other taxes are computed.

The current situation

Right now, North Carolina lawmakers are in a renewed stalemate after Governor Perdue shot down a proposed budget and tax deal last week. That agreement would have generated nearly a billion dollars in new revenue by raising the state sales tax a full percentage point, imposing a 2% surcharge on all income tax bills and bumping up the excise taxes on tobacco and alcohol. Under the plan, the vast majority of dollars would come from the sales tax hike.

Interestingly however, it was the income tax surcharge that attracted the Governor's ire. In attacking the plan, she cited her desire not to balance the budget "on the backs of working families." But as Elaine Mejia of the N.C. Budget and Tax Center reported over the weekend, if it's working families she's concerned about, the Governor is worrying about the wrong tax:

"The fact is that the sales and excise tax increases in the plan would have a far greater impact on working families than the proposed income tax surcharge. In fact the proposal to increase the sales tax by 1% would have cost the middle 20% of income earners ($37,000 annual income) nearly six times more than the proposed income tax surcharge. The sales tax would cost them an estimated $130 in FY 1009-10 compared to a $23 increase in income taxes because of the surcharge.

Since her press conference announcing her budget proposal earlier this year the Governor has continued to imply that somehow taxes on consumption have less impact on taxpayers, insinuating that they are somehow voluntary. Tell that to the "working family" whose washing machine breaks down. The sales tax on that one purchase alone (roughly $39 on a $500 purchase) would eclipse the additional burden from the 2% income tax surcharge (roughly $23) on middle-income families."

Finding a better way

As Mejia makes clear, the biggest problem with the failed House-Senate deal was its over-reliance on the sales tax. Though better hidden on a daily basis to the average taxpayer, the general sales tax is extremely regressive. This is particularly true in North Carolina - a state in which most goods are taxed and most service purchases are not. (This was one of the laudable goals of the original Senate plan: to broaden the base and lower the rate of the sales tax in order to make it fairer).

Fortunately, there are better ways to raise the necessary dollars. This past spring, the BTC released a proposed revenue plan that would have raised over a billion dollars in new revenue while, at the same time, providing most North Carolinians with a tax cut. It would have accomplished this impressive feat by:

• Broadening the personal income tax base by using a different starting point for calculating state income taxes, adding three new tax brackets, increasing the personal exemption to $4,000, increasing the state earned income tax credit from 5% to 10%, adding a refundable credit for charitable contributions, and adding a temporary top bracket for households earning more than $350,000.
• Broadening the sales tax base by taxing the services most commonly taxes in other states and moving to cut the overall rate by 2010-11.
• Closing some large tax loopholes for profitable corporations and eliminating some obsolete business tax credits.

The differences between such a plan and the discarded agreement from last week are striking. Under the BTC plan, taxpayers in the bottom 60% of income categories would see their total tax bills fall by as much as 0.5%, while the top 40% would see their bill rise by no more than the same amount. Under last week's regressive plan, in contrast, taxes would rise 0.7% on the poorest North Carolinians and rise only 0.2% on the richest.

Going forward

From a fairness and sustainability perspective, the BTC plan is clearly far superior to the failed agreement of last week. The only problem with it is political: can lawmakers and the Governor muster the courage to take on powerful vested interests and move the state's tax system in a truly progressive direction? Let's hope lawmakers use the latest break to seriously examine such a new and progressive approach.

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This entry was posted on Tuesday, July 28th, 2009 at 9:48 am and is filed under Weekly Briefing. You can follow any responses to this entry through the RSS 2.0 feed.