Every one of us could find some productive use of an extra $20. Those at the lower end of the income scale are most likely to notice whether that money ends up in their wallet or with the N.C. Department of Revenue.
The state House’s proposed increase in North Carolina’s standard income tax deduction would free up another twenty bucks ($19.68) for each single taxpayer and more than $39 for each married couple filing jointly in 2021.
Boosting the standard deduction — otherwise known as raising the zero tax bracket — also would ensure that higher-income earners end up paying an even larger share of their income in taxes than their lower-income neighbors.
To recap: the House budget bill would increase the state’s standard deduction from $10,000 to $10,375 for single filers starting with the 2021 tax year. For married couples filing jointly, double those numbers. Their $20,000 deduction increases to $20,750. Heads of household see the same 3.75% jump in their deduction, from $15,000 to $15,563.
At the current flat state income tax rate of 5.25%, the savings amount to $19.68 for single taxpayers, $39.37 for married couples, and $29.55 for heads of household. It’s interesting to look into how those savings impact taxpayers at different income levels.
Before employing an example involving three distinct households, now is a good time to mention two caveats.
First, the examples assume that each taxpayer involved employs the standard deduction rather than itemizing expenses. The higher the taxpayer’s income, the less likely this scenario is to be true in the real world. Targeted credits and deductions can skew tax advantages toward taxpayers with higher incomes. If so, critics may question the merits of those credits and deductions.
Meanwhile, combining a higher standard deduction with a flat tax rate clearly benefits those at the lower end of the income scale.
The second caveat involves children. Just as some credits and deductions might favor higher-income earners, North Carolina’s child deduction works in the opposite direction. A single parent making up to $20,000 and a married couple making up to $40,000 can deduct $2,500 for each qualified child. As income levels grow, that child deduction decreases. Single parents making more than $60,000 and married couples with incomes above $120,000 enjoy no child deduction. For a head of household, the equivalent thresholds are $30,000 and $90,000.
To simplify comparisons of the increased standard deduction at different income levels, let’s set aside all other credits and deductions. We’ll focus on three childless couples, making $25,000, $120,000, and $1 million. (The first two figures equate roughly to the average salary of a bank teller and bank president in North Carolina.)
At the current tax rate and current standard deduction, the $25,000 household owes $262 in state income taxes. That amounts to an effective tax rate of roughly 1% of household income. The $120,000 household owes $5,250 (4.4%). The $1 million household owes $51,450 (5.1%).
Under the House’s budget plan, the increased standard deduction would drop the tax bill to $223 (0.9%) for the $25,000 household, $5,210 (4.3%) for the $120,000 household, and $51,410 (5.1%) for the $1 million taxpaying couple.
Perhaps most interesting is the impact on the relative tax burdens of the three households. The $120,000 household earns 4.8 times as much income as the $25,000 household. With the current standard deduction, the $120,000 household pays 20 times as much income tax. With the House’s proposed change, the $120,000 household would pay 23 times as much.
Meanwhile, the $1 million household earns 40 times as much income as the $25,000 household. The higher-income household pays 196 times as much income tax under current rules. With the larger standard deduction, that $1 million household would pay 230 times as much.
Those are apples-to-apples comparisons based only on different income levels. An apples-to-oranges comparison might also prove useful. Let’s compare a head of household with three children and $25,000 of income to a childless couple with $120,000 and a single taxpayer making $1 million.
Under current rules, the head of household owes $131 (0.5%). The $120,000 couple owes $5,250 (4.4%). The $1 million single taxpayer owes $51,975 (5.2 percent). With the House’s proposed changes, the respective bills drop to $101 (0.4%), $5,210 (4.3%), and $51,955 (5.2 percent).
The House’s larger standard deduction would increase the higher earners’ relative income tax burden. The $120,000 couple now pays 40 times as much as the $25,000 head of household. With the change, the higher-earning couple would pay 51 times as much. As for the single $1 million earner, he now owes 397 times as much income tax as the lower-earning head of household. With the change, he would owe 514 times as much.
It’s unclear at this point whether the increased standard deduction will end up in the final state budget plan. As House and Senate budget negotiators work during the weeks ahead, one hopes they will keep tax burden impacts in mind.
Mitch Kokai is senior political analyst for the John Locke Foundation.