Prosperity Watch Issue 45, No. 3: North Carolina's upside-down tax system asks the most from those with the least

Low- and middle-income North Carolinians pay a larger share of their income in state and local taxes compared to wealthy taxpayers, according to a new report by the Institute on Taxation and Economic Policy (ITEP). The lowest 20 percent of North Carolinians – with an average income of $10,700 – pay 9.2 percent of their income in taxes compared to 5.3 percent for the top 1 percent of income earners in the state. Middle-income North Carolinians pay 70 percent more in state and local taxes as a share of their income compared to the top 1 percent of income earners.

The way North Carolina taxes its residents is important in ensuring that economic opportunity and prosperity is broadly shared. The ITEP report highlights many of the regressive features of the state’s tax code, including a flat personal income tax rate, comparatively high state and local sales tax rates, local sales tax bases that include grocery, a Child Tax Credit that is non-refundable, and the elimination (in 2013) of a refundable state Earned Income Tax Credit (EITC). Such regressive features not only contribute to widening income inequality, but also leave the state challenged with raising adequate revenue to fund schools, healthcare services for the elderly and poor, and other public investments that promote economic growth.

North Carolina ranks 31st amongst states for the most unfair state and local tax system according to ITEP’s Tax Inequality Index, which assesses whether incomes are more or less equal after taxes than before taxes. Among neighboring states, Tennessee and Georgia score worse on the Tax Inequality Index compared to North Carolina while Virginia and South Carolina fare better.

The tax plan passed by state lawmakers in 2013 made the state’s tax system even more upside-down. Key aspects of the tax plan included replacing a graduated personal income tax rate structure with a flat rate of 5.75 percent, expanding the state sales tax while allowing the state EITC to expire, and cutting the corporate income tax rate to 5 percent from 6.9 percent and possibly to as low as 3 percent. These changes not only created a state tax system that further favors the wealthy over average people, but also led to a significant reduction in revenue, with North Carolina now challenged with raising adequate revenue for public investments.

Opportunities exist for lawmakers to address the state’s upside-down tax system. Returning to a graduated income tax rate structure, reestablishing a state EITC, providing a property tax “circuit breaker” credit for low-income taxpayers, and stopping further tax cuts that largely benefit the wealthy and profitable corporations would help create a fairer state tax code that works for all North Carolinians.

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