It’s wrong to suggest a proposed state constitutional amendment would block North Carolina from adopting a system of graduated tax rates.
What’s worse? Ignoring the fact that the state’s current tax system already forces people with higher incomes to pay higher effective tax rates.
Yes, North Carolina instituted a flat income tax rate in 2014. At the same time, lawmakers started a series of substantial increases in the standard deduction from income taxes. The second change counteracts that flattening effect of the first — to the benefit of low- and middle-income taxpayers.
The current debate surrounds a constitutional amendment scheduled for the November ballot. It would lower an existing cap on state income tax rates from 10 percent to 7 percent. The current personal tax rate is 5.499 percent. It will drop to 5.25 percent next year. So lowering the cap will have no impact on current tax rates.
Nor would the lower cap have any impact on lawmakers restoring a system of graduated or tiered tax rates. Years of peer-reviewed academic research suggest that would be a bad idea. But the state constitution would not stand in the way if lawmakers wanted to make that dubious choice. With or without the amendment.
Facts, then, fly in the face of a key argument the state NAACP has made against the proposed constitutional amendment.
That’s disturbing. More disturbing? Amendment critics refuse to acknowledge that the state’s current income tax system forces people with higher incomes to pay significantly larger tax bills.
An example illustrates the point. Let’s compare three households. Each features a married couple. They file taxes jointly.
A longtime N.C. political columnist has opined that this state’s tax policy ought to ensure that a bank president pays higher rates than a bank teller. So our first household has $25,000 in income, roughly matching a bank teller’s annual salary. The second household has $120,000 in income. This represents a bank president. We throw in a third household with $1 million of income. If our current system offers excessive benefits to the wealthy, the evidence should emerge with this third taxpaying unit.
We’re limiting our example to changes in tax rates and standard deductions. I concede that other exemptions and deductions could change the relative balance in tax burdens for the three households. If so, perhaps lawmakers should reassess those exemptions and deductions. That’s an argument for another day.
The households in our example have no children. The current state tax system skews child tax credits to favor lower-earning taxpayers. Legislators in recent years have made changes shifting even more of the benefits of these credits to those with lower incomes. Adding children to the mix would strengthen my argument. The argument doesn’t need the help.
Groups including the state NAACP advocate a “graduated tax rate on people with higher incomes.” North Carolina had such a system as recently as 2013. Under that system, households paid a 6 percent rate on all income earned after exemptions and deductions. At an income level of just $10,625, the rate jumped to 7 percent. At $50,000, the rate climbed again to 7.75 percent.
Meanwhile, the standard deduction for married couples stood at $6,000. Under our scenario, then, the $25,000 household owed $1,223 in state income tax. The $120,000 household owed $8,353. The $1 million household owed $76,553. (All other exemptions and deductions have been removed to help simplify the comparison between tax systems.)
The $25,000 household paid an effective tax rate of almost 4.9 percent. The $120,000 household paid just under 7 percent. The $1 million household paid an effective rate of more than 7.6 percent. Earning 4.8 times as much income as the bank teller, the bank president’s income tax bill was nearly seven times as large. Earning 40 times as much income as the teller and more than eight times as much as the bank president, the $1 million household paid a tax bill 62 times as large as the teller’s bill and nine times as large as the president’s.
No one could argue against the proposition that the old system forced higher earners to pay a higher tax bill.
Fast forward to today. Each household now faces the same flat tax rate: 5.499 percent. But each also benefits from a higher standard deduction. When the flat tax took effect in 2014, the standard deduction more than doubled. By now, the deduction has nearly tripled to $17,500 for married couples filing jointly.
Applying the current rate and the current standard deduction to our three households, we find that the $25,000 household owes $412 in state income tax. The $120,000 household owes $5,636. The $1 million household owes $54,027.
Each household has seen a drastic reduction in state income taxes. The $25,000 household faces a tax bill today roughly two-thirds lower than the bill from 2013. Its effective tax rate has dropped from 4.9 percent to 1.6 percent. The $120,000 household has seen its state tax bill decrease by about one-third. Its effective tax rate has dropped from 7 percent to 4.7 percent. The $1 million household has seen its tax bill decrease by almost 30 percent. Its effective tax rate has dropped from 7.6 percent to 5.4 percent.
What’s especially interesting is the degree to which the combination of a lower flat tax rate and higher standard deduction has helped the different households.
The “bank president” household earns 4.8 times as much income as the “bank teller” household. Under the old system, the president paid seven times as much tax. Now? More than 13 times as much tax.
The “millionaire” household earns 40 times as much income as the “bank teller” household. Under the old system, the millionaire paid 62 times as much tax. Now? More than 131 times as much.
In other words, the new system forces higher earners to pay an even larger share of the income tax burden. The higher standard deduction offers such a benefit to lower- and middle-income earners that it significantly offsets the single tax rate’s flattening effect.
The gap in tax burdens widens even more next year. The flat tax rate drops to 5.25 percent, while the married couple’s standard deduction jumps to $20,000.
The $25,000 household’s tax bill will drop to $262 (1 percent). The $120,000 household will pay $5,250 (4.4 percent). The $1 million household will pay $51,450 (5.1 percent). The “bank president” household will pay 20 times as much income tax as the “bank teller” household. The “millionaire” household will pay 196 times as much.
Advocates for a graduated income tax system want to ensure higher earners pay a larger tax bill than those with lower incomes. It would be nice for them to recognize that our current system aligns well with that goal.
One could say the alignment is even stronger with the current flat tax than with the old, graduated, three-tiered tax system lawmakers dumped in 2014.
Mitch Kokai is senior political analyst for the John Locke Foundation.