Prosperity Watch (Issue 58, No. 3)

February 16, 2016

Low- and middle-income taxpayers in North Carolina pay a larger share of their income in state and local taxes than the wealthiest taxpayers in the state. This inequity in North Carolina’s tax code makes it difficult for working families to make ends meet and further challenges the state’s ability to invest in communities and opportunity across the state.

The elimination of a state Earned Income Tax Credit (EITC) in 2014 further contributed to the tax shift on to low- and middle-income families and away from profitable corporations. Policymakers continue to suggest that raising the standard deduction can help address North Carolina’s upside-down tax code even as they continue to reduce the income tax rate and expand the sales tax to more goods and services. Raising the standard deduction, however, is a poorly targeted and inefficient tax policy for ensuring that working families keep more of what they earn. This approach fails to address the increasing reliance in North Carolina on the sales tax, which asks more from low- and middle-income taxpayers who struggle to make ends meet and spend more of their earnings.

Last week, members of the Revenue Laws Committee proposed an increase to the standard deduction by $2,000. Yet analysis shows that a state EITC is a better tool for allowing low- and middle-income taxpayers to keep more of what they earn.

Just 28 percent of the more than $200 million tax cut from an increase in the standard deduction goes to taxpayers with incomes below $35,000. Sixty percent of taxpayers in the top 20 percent, whose incomes are $95,000 or higher, receive a tax cut with the standard deduction proposal.

In contrast, a refundable state EITC would provide no tax cut to taxpayers in the top 20 percent of taxpayers, while 87 percent of the total tax cut would go to taxpayers in the bottom 40 percent. As such, a refundable state EITC is a much better tool for helping low- and middle-income taxpayers keep more of what they earn as compared to raising the standard deduction.