Prosperity Watch Issue 21, No. 1: Raising Equity Concerns, Tax Shift Would Have Outsized Impact on Lower-Income North Carolinians

Income inequality is a growing problem in North Carolina. Census data show that a wide income gap exists in North Carolina, with the top fifth of households holding more income than the bottom 80 percent (lowest 4-fifths) of households combined. Since 2007, each fifth of the income tier has experienced shrinking household incomes, but none more so than the households in the bottom fifth.

Unfortunately, policies aimed at reforming our state’s tax system could well make the growing income gap worse. 

North Carolina legislators are poised to reform the state’s revenue system in the upcoming 2013 legislative session. Reform of the state’s tax system is a welcome opportunity because the system is out-of-date, inadequate, and unaccountable. Some lawmakers, however, are seriously considering proposals that would result in a great tax shift that results in greater overall tax contributions from low- and moderate-income households and less from higher income households. This tax shift would actually worsen income inequality across the state by exacerbating the existing equity problems in the current system.

For instance, North Carolina’s tax system is currently upside-down—it asks more from those with the least ability to pay. One policy change that may be part of the revenue reform package is a shift away from the personal income tax—which, unlike other taxes, is based on one’s ability to pay—and toward a revenue system that primarily relies on the regressive sales tax. Elimination of the personal income tax  as part of a plan that raised the same amount of revenue as the current system would require significantly raising the state sales tax rate—all the way to 13.88 percent.

This tax shift would hit lower-income North Carolinians harder because they tend to spend nearly all (three-quarters) of their earnings on sales-taxable items in order to meet their basic needs. This experience is in great contrast to that of the highest earners who spend a much smaller share (roughly one-sixth) of their earnings on sales-taxable items.

The graph below shows the outsized effect of this tax shift on all residents by income group. This tax shift would result in tax increases for North Carolinians in the bottom 80 percent of the income distribution, and tax cuts for those at the top. Specifically, earners in the bottom 20 percent would experience a tax increase of 5.6 percent—the highest tax increase of all the groups—whereas taxes would be cut for the richest 20 percent. In fact, the richest 1 percent of earners in North Carolina would benefit the most from this tax shift; their tax burden would shrink by 4 percent.

Increasing taxes on lower- and middle-income people to finance further tax cuts for wealthy people would not only fail to keep widespread income inequality in check but it would also fail to contribute to economic growth. If the goal of revenue reform is to reform a broken system and to make the overall system more equitable, it is evident that the proposal to rely more on the sales tax in lieu of the personal income tax has no merit.



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