RALEIGH – Just about everyone in North Carolina agrees that the state’s tax code needs substantial revision. It might surprise you to learn, however, that not only is there broad agreement about the need to reform North Carolina taxes, but there is also fairly broad agreement about what sensible tax reform consists of: eliminating special tax deductions and exclusions, broadening the tax base, and reducing the marginal tax rates.
In the coming months, I’ll be writing a great deal more about these areas of agreement – and how they might point the way to tax reform in 2013 that would enhance North Carolina’s economic competitiveness and create jobs.
But today’s topic is an area of disagreement, one that must be addressed before any broad-based movement for North Carolina tax reform can have any hope of legislative success.
As has become evident over the past few weeks, there are large numbers of North Carolinians (and Americans) who seem to believe that the current tax code is biased in favor of the wealthy. They have heard Warren Buffett proclaim that he has a lower tax burden than his secretary does. They have seen some large corporations get special tax incentives for relocating or expanding their businesses in North Carolina.
And they have been told repeatedly by liberal politicians that by relying too heavily on sales taxes, North Carolina’s tax code is steeply regressive – that the percentage of income paid in taxes to Raleigh and local governments is significantly higher for poor North Carolinians than for affluent ones.
Of course, these same liberal politicians inflicted a series of sales-tax increases on North Carolina consumers over the past decade, but hypocrisy is not my subject today. Mythology is. The truth is that even after accounting for the giveaways and biases of the current tax code, affluent households have a far higher tax burden than poor- or middle-income households do. And as for North Carolina’s state and local tax burden, it is roughly proportional, not steeply regressive.
Let’s examine the second proposition at some length.
The North Carolina Budget & Tax Center (BTC), a project of the left-wing North Carolina Justice Center, has long claimed that the state’s tax system is steeply regressive. As evidence, the BTC points to an analysis by the Washington-based Institute on Taxation and Economic Policy (ITEP). The analysis is a couple of years old, having last been updated in November 2009, but BTC used the same figures for a tax-reform plan it published earlier this year, so it seems that no more recent estimates are available.
Like BTC, ITEP is a left-wing research institution. Just as I previously used data from the Citizens for Tax Justice to show that America’s tax code is highly progressive, I’ll use the ITEP figures to show that North Carolina’s tax code is not steeply regressive as claimed by North Carolina liberals. Obviously, in both cases the researchers in question have every incentive to choose methodologies likely to maximize the apparent tax burdens of poor households and to minimize the apparent tax burdens of wealthy ones. Right-of-center groups might well opt for different methodologies. By citing the tax-distribution estimates of liberal groups, I am being charitable to the Left’s argument.
The ITEP study combined the revenues collected from income taxes, sales taxes, and property taxes. In total, state and local taxes amounted to a little less than 10 percent of personal income in North Carolina. The Left’s claim of steep regressivity comes from ITEP’s estimates of tax burden by income (parenthetical comments are my own):
• Poorest 20% of families – 9.5 percent
• Next 20% (lower-middle) – 9.4 percent
• Next 20% (middle-income) – 9.4 percent
• Next 20% (upper-middle) – 8.9 percent
• Next 15% (upper-income) – 7.9 percent
• Next 4% (evil rich people) – 7.3 percent
• Richest 1% (evil filthy rich) – 6.8 percent.
Look steeply regressive to you? Sure. But there are two problems, one minor and one major.
The minor problem is that when you break out the top 20 percent of taxpaying households into smaller subcategories, in order to heap scorn on those evil filthy rich, you should note that the number of households in the top 1 percent is extremely small – a few thousand at most – and that the identity of those households (earning $400,000 or more according to ITEP) changes quite a bit over time, reflecting one-time events such as the sale of a primary residence. Plus, why break out the top 20 percent into subcategories and not break other quintiles into subcategories, too? For example, the “poorest of the poor” within the bottom 20 percent do not pay 9.5 percent of their incomes in taxes. Many are highly dependent on untaxed government or charitable benefits and services.
In short, it makes more sense just to stick to quintiles.
That’s more of a quibble, really. The other problem is actually a devastating one: The above table is not an accurate representation of state and local taxes paid in North Carolina, by ITEP’s own admission. Instead, these figures reflect an adjustment for federal tax deductions that North Carolina families take on the state income and local property taxes they pay.
The vast majority of those who itemize their deductions, be they in North Carolina or any other state, have above-average incomes. There is no question that the deductibility of state and local taxes is chiefly of value to these relatively affluent taxpayers. However, the deductibility of state and local taxes is obviously not a feature of North Carolina’s tax code. It is a federal tax policy, and taxpayers use it to reduce their federal tax liability. It is highly misleading to report the amount of federal taxes North Carolinians saved through deductions without also reporting the amount of federal taxes these same North Carolinians ended up paying.
In other words, ITEP and BTC are selectively including some federal tax data but not others. In reality, the households who benefit most from the federal tax deduction also have a vastly higher federal tax liability. As with love and marriage, you can’t have one without the other. As previously observed, when you include taxes at all levels, the highly progressive federal income tax more than offsets the regressivity of any other taxes, so that the top quintile bears a total tax burden that is twice as large as the bottom quintile.
Where does that leave us here in North Carolina? If we exclude all federal tax data from the calculation and just look at state and local taxes alone, here’s what the ITEP study shows for the five quintiles (I have combined the data to estimate the tax burden for the top 20 percent):
• Poorest 20% of families – 9.5 percent
• Next 20% (lower-middle) – 9.4 percent
• Next 20% (middle-income) – 9.6 percent
• Next 20% (upper-middle) – 9.7 percent
• Wealthiest 20% of families – 9.1 percent
So the truth is that North Carolina’s tax code stays roughly proportional through 80 percent of the income distribution, and then falls slightly for the wealthiest families. Given that that top group happens to include most of North Carolina’s current and prospective job creators – and that they already shoulder a disproportionate share of the federal tax burden – I think the best response to this slight regressivity at the top end would be to find ways to reduce the tax burdens on the other 80 percent of North Carolina families, rather than raise the tax burden on the top 20 percent.
Now, how might we go about doing this? Well, the incidence of the retail sales tax is steeply regressive, so perhaps what we ought to do first is allow North Carolina’s sales tax rate to drop by a percentage point. Low and middle-income families will derive most of the benefit from such a tax change, which will further flatten the distribution of tax burdens.
Oh wait, the North Carolina General Assembly already did that in 2011. But North Carolina liberals were against it. Never mind – I promised I wouldn’t make today’s column about hypocrisy.
Hood is president of the John Locke Foundation.