Opinion: CJ Opinion

Child tax changes in N.C. Senate plan would benefit low-income earners most

Families at the lower end of the income scale could end up among the biggest winners if lawmakers adopt the N.C. Senate’s latest tax package.

The plan boosts the state’s existing sliding-scale child tax deduction. Plus the deduction would help more people, reaching married couples earning up to $140,000 a year.

Before examining the potential impact, let’s review some basics.

North Carolina uses a flat tax. Every dollar of income subject to taxation faces the same tax rate. But that doesn’t mean every taxpayer pays the same percentage of income in taxes.

For one thing, a standard deduction removes a not-insignificant chunk of income from taxation. Under current law, a single taxpayer pays no tax on his first $10,750 of income. A married couple eliminates $21,500 from the tax man’s consideration.

That standard deduction helps lower-income taxpayers most. A childless couple earning $25,000 owes taxes on just $3,500. With the current flat tax rate of 5.25%, the tax bill amounts to $184. That leads to an effective tax rate of 0.7%.

With the same standard deduction, a childless couple with $50,000 owes $1,496. The effective tax rate is just under 3%. With twice as much income, the $50,000 couple owes eight times as much tax.

Repeat the calculations for a childless couple earning $100,000. The tax bill totals $4,121, and the effective tax rate tops 4.1%. With four times as much income, the $100,000 couple owes 22 times as much income tax as the $25,000 couple.

Senate Bill 337 would allow all of these groups to save even more money. The flat tax rate would drop to 4.99%, while the standard deduction would climb to $12,750 for single taxpayers and $25,500 for married couples.

The impact for the childless couples above? The couple earning $25,000 would see its income tax liability drop to zero. That’s a 100% cut. The $50,000 couple would save $273 as its bill dropped to $1,223 (an 18% cut). The $100,000 couple would save $403 and face a new tax obligation of $3,718 (a nearly 10% cut).

Now, add children into the mix. The benefit for lower-income earners grows.

Under existing state law, married couples making up to $40,000 can claim a $2,500 deduction for each child. The deduction drops to $2,000 for couples earning more than $40,000 but less than $60,000. The deduction phases out as income levels grow, with a $500 per-child deduction available to married couples earning up to $120,000. (Single parents earning up to $60,000 and heads of household with $90,000 also can take advantage of the deduction.)

Returning to the three couples from our earlier example, add two children to each household. Under existing state law, the $25,000 couple owes no income tax. In fact, married couples with two children earning up to $26,500 have zero state income tax liability. The $50,000 couple owes $1,286. That’s $210 less than a childless couple with the same income. The $100,000 couple owes $4,016. That’s $95 less than the childless couple.

Under S.B. 337, the child tax deduction would grow. Couples earning up to $40,000 would be able to deduct $3,000 per child. The deduction would grow by $500 per child at each stage of the current sliding scale. Couples making between $120,000 and $140,000 would be added to the upper end of the scale. They could deduct $500 per child.

Married couples with two children would have as much as $31,500 removed from the state Revenue Department’s consideration. Two-child couples making $40,000 would pay taxes on just $8,500. The resulting tax bill of $424 would lead to an effective tax rate of 1%. Combining the lower tax rate, higher standard deduction, and enhanced child deduction, the $40,000 couple saves $285 (40%) from its current $709 bill. About $50 (7%) in savings results directly from the higher child tax deduction.

A married couple with two kids and $60,000 of income would see the tax bill drop from $1,811 to $1,472, a 19% savings. Once again, about $50 of savings results directly from the increased child tax deduction.

A married couple with two children and $140,000 of income takes no child deduction now. The family’s current income tax bill stands at $6,221 (an effective tax rate of 4.4%). With S.B. 337’s proposed tax rate and standard deduction changes alone, the bill would drop to $5,714. That’s a $507 savings (about 8%). Add in the newly expanded child tax deduction, and the couple would save another $50 (about 0.9%) and pay $5,664.

Everyone can use an extra $50. But the money makes more difference to the bottom line in a family with less income.

Thus the proposed increase in the per-child income tax deduction offers another reason for fans of progressive tax policy to support Senate Republicans’ current tax plan.

Mitch Kokai is senior political analyst for the John Locke Foundation.