At both the federal and state levels, debates about tax reform often devolve quickly into wildly conflicting claims about winners and losers. The 2013 tax bill state lawmakers and Gov. Pat McCrory are about to put into effect has followed the same pattern.
Supporters of the bill, pointing to income-tax scenarios from the legislature’s nonpartisan fiscal staff, are claiming that most North Carolina households will receive a net tax cut from the tax-reform legislation. Opponents of the bill, pointing to tax-incidence estimates from the left-wing N.C. Justice Center, are claiming that most North Carolina households will receive a net tax increase.
These claims are obviously in direct conflict. As I observed about a previous version of the tax-reform bill, the Justice Center’s contractor has constructed a model that yields highly unrealistic estimates. It may be due to inaccurate reporting of the actual change in sales-tax liability for electricity and natural gas. It may be due to inconsistent assumptions within the model itself about who bears the incidence of taxes on business — assuming, say, that taxes placed on business inputs get passed along to consumers but that taxes placed on corporate income affect only shareholders, not employees.
Other claims about the effects of the tax bill, however, are not as much in conflict as the political rhetoric might suggest. In response to Republican claims that most households will receive a net tax cut, Democratic legislators cited their own data from Fiscal Research showing that some households, such as retirees and large families at particular income levels, will pay higher taxes when all tax changes are taken into consideration.
Both sides are right here, as far as I can tell. There are, indeed, some married couples who will pay somewhat-higher state taxes after the 2013 tax changes, particularly if they have three or more children or derive a high share of their total annual income from self-employment or pensions. But most households don’t fit these parameters.
Nearly 40 percent of North Carolina’s taxpaying households are classified as singles. Another 18 percent file as heads of households, meaning singles with children. Of the remaining married couples filing jointly, about half — 20 percent of the total — have minor children living at home, according to extrapolations from Census data. Most of those families have one or two children. So married couples of modest means with three or more children simply don’t make up a sizable fraction of North Carolina households.
As for self-employment income, Census data reveal that only 3.5 percent of North Carolinians over the age of 18 are classified as self-employed in non-incorporated businesses. Even if you include some additional workers who receive a combination of wage and self-employment income, you won’t come up with a large share of North Carolina households who will lose more from the phase-out of the 2011 self-employment income exclusion than they will gain from the 2013 cuts in personal and corporate income taxes.
It is true that the latest round of tax-distribution scenarios from Fiscal Research staffers did not include estimates of the sales-tax liability, unlike the work they did on previous tax-reform proposals. Why? Fiscal analysts explained that because the final tax-reform bill didn’t expand the sales tax base as much as prior versions — most of the apparent increase in sales-tax collections is just a swap-out with preexisting franchise taxes on energy purchases — the magnitude of any increases in sales-tax liability was too small to affect the analysis. The net change in electricity and natural gas taxes, for example, worked out to an annual average of $3 per residential household.
To say that most households get a net tax cut under the 2013 tax reform, however, is not to suggest that we shouldn’t care about the adverse consequences for some taxpayers. One reason why the John Locke Foundation’s original tax reform model used personal exemptions rather than standard deductions is that the number of exemptions — and thus the amount of household income shielded from income tax — rises with family size. But both the Senate and House chose to employ standard deductions instead.
The final bill did compensate for this effect a bit by retaining the per-child tax credit of $100 and even increasing it to $125 for households with incomes below $40,000. In future sessions, legislators should consider dramatically increasing that credit to $250 per child or more. As JLF has long argued, pro-growth tax reform should take into consideration that family expenditures for children is a form of human-capital investment. It ought to be treated much as the tax code treats deposits into individual retirement accounts or other forms of investment.
In short, while Democrats are correct to point out that some households will experience a net tax hike, Republicans are correct to point out that most households will experience tax relief and that the resulting economic growth will further boost job creation and personal incomes across the board.
By the way, I’d also take the Democrats’ objections about adverse tax consequences for families more seriously if they hadn’t as recently as 2011 tried to keep North Carolina’s state sales tax at 5.5 percent, or more than $800 million a year higher than the current rate of 4.75 percent. Even with a state Earned Income Tax Credit in place as a partial offset, such higher sales taxes would have placed a far greater burden on families of low to moderate incomes than will any tax change happening this year.
Because Republican legislators opposed that Democratic plan two years ago, the sales tax burden fell by more than $800 million, disproportionately benefiting families of modest means. I think all the time and effort Democrats have spent attacking the 2013 tax bill on regressivity grounds might have been better employed washing the windows of their glass houses.