Prosperity Watch Issue 21

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 Reform of the state’s tax system is a welcome opportunity because the system is out-of-date, inadequate, and unaccountable.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.

Prosperity Watch Issue 21, No.2: Proposals to abolish corporate, personal income tax would eliminate 60% of North Carolina’s revenue base

In recent weeks, lawmakers in North Carolina have proposed a number of tax reform plans that would abolish the corporate and personal income taxes and shift the state’s revenue base to a consumption tax.  In doing so, these proposals would immediately eliminate 60% of the state’s annual revenue, almost certainly requiring significant increases in the sales tax or deep spending cuts in order to be “revenue-neutral”—that is, raise the same amount of revenue as under the current system.  

North Carolina’s budget essentially relies on three separate “pillars,” which together account for 90% of the total tax revenue generated for state government.  The first pillar is the Sales Tax—as its name suggests, this tax is levied on most goods (except food) at the point of sale and comprises 32% of the state’s revenue.  The personal income tax is the second and largest pillar financing the state budget, the source of 53% of the state’s total revenue. This tax is levied on the wage, investment, and business income earned by the state’s households.  Accounting for 6% of the state’s revenue base, the final pillar is the corporate income tax, which is levied on C-Corps, S-Corps, and other incorporated for-profit entities that conduct business activities within North Carolina.

As the  graph indicates, removing these two pillars of the state’s tax system would eliminate 60 percent of the revenue that currently funds state government. In turn, this would increase reliance on the sales tax contribution to state revenue, an approach that both generates significant concerns over regressivity (since low-income families spend a disproportionate share of their earnings on necessities subject to the sales tax) and would likely fail to raise sufficient revenue to adequately finance key public investments (like workforce training and infrastructure) critical in promoting economic growth. In fact, previous research has demonstrated the importance of the income tax in meeting the needs of state government. Without this pillar holding up North Carolina’s tax system, state government would likely generate inadequate revenues, resulting in deep spending cuts to these core growth-enhancing investments. 

The personal and corporate income taxes play an important role in ensuring that state government revenues are adequate to meet the public investment needs of the 21st century economy.

Prosperity Watch Issue 21, No. 3: North Carolina's unemployment rate remains stubbornly high, while unemployed workers outnumber available job openings by 3-to-1

As policymakers consider reforms to the state’s unemployment insurance system, it is critical to address the ongoing sluggishness in North Carolina’s labor market, sluggishness driven largely by the fact that workers outnumber available job openings by almost 3-to-1. As a result, one of the central challenges facing North Carolina’s employment growth and economic recovery is the fundamental lack of open, available jobs.

Although the long-term trend of the state’s unemployment picture is moving in the right direction—the state’s unemployment rate dropped from 10.4% December 2011 to 9.2 percent in December 2012—the rate of job growth in the state still remains stubbornly listless. In fact, the state’s jobs deficit—the number of jobs that need to be created in order to replace the employment lost in the Great Recession and to keep up with the state’s 8.3 percent population growth—has continued to remain high, now standing in excess of 520,000 jobs.

Some policy makers have argued that these trends are due solely to the absence of qualified workers unable to take advantage of available openings because they lack the requisite skills.

The reality, however, is very different.

The real problem facing North Carolina’s labor market’s recovery is the fact that there are too many unemployed workers chasing too few job openings. In fact—making the safe assumption that North Carolina mirrors the rest of the South—there are almost 3 unemployed workers for every one available job opening in the state. In essence, there are just not enough open jobs to meet the needs of our unemployed workforce. While promoting a skilled workforce training certainly matters for ensuring the long-term competitiveness of North Carolina’s employment base, the immediate problem is the lack of available job openings—a challenge which no amount of training can fully address.