2013 North Carolina State Legislature Tax Reform: Flat Tax Impacts
The 2013 North Carolina State legislature passed tax reforms that were the largest tax cuts in the past decade. These tax reforms included reducing corporate and personal income tax rates, eliminating tax exemptions, raising standard deductions, and expanding the state sales tax to include service contracts and entertainment. The prior three-bracket income tax rate was eliminated for individuals and a modified flat tax of 5.8 percent for all levels of income was implemented. As a result of the flat rate income tax, broadened sales taxes, and elimination of personal exemptions, the lower class will be negatively affected by the tax reform. Therefore, a higher graduated income tax and lower sales tax rate will benefit more of North Carolina’s population, while still providing the needed revenue to operate the state government, and taxing individuals as fairly as possible. The main beneficiary of this tax break is the highest income bracket, while the lowest income bracket is stuck in the same position as they were prior to the changes, or are even worse off. As a person’s income rises, the more he or she will benefit from the new flat rate income tax. Henceforth, I recommend that readers, especially college students, pay closer attention to political debates concerning taxes and educate themselves about policies that impact them either positively or negatively.
High Point, North Carolina used to be known as the “Furniture Capital of the World,” with a prospering furniture production industry and an internationally renowned furniture market. Unfortunately, the furniture industry began to feel the effects of increased foreign competition, and companies were forced to consolidate or even go out of business. With fewer people traveling to High Point for the bi-annual furniture market, the economy was heavily impacted. According to NC in the Global Economy, a study from Duke University showed that in 2004 the furniture industry contributed $2.8 billion while in more recent years it has only contributed $1.2 billion to the economy yearly.
The economy of North Carolina during the 1900s was heavily based on the manufacturing industry, which influenced the tax laws of the time; however, that economy does not exist anymore. In an effort to revive economic prosperity after the recession, North Carolina’s 2013 legislature passed tax reforms that were the largest tax cuts in the past decade. Tax modifications were made in hopes of replacing “rapidly vanishing jobs in declining manufacturing industries with jobs in growing industries that pay enough to allow workers and their families to make ends meet” (Freyer, 2013).
The example of High Point shows how the manufacturing industry has disappeared over time, shutting down businesses and leaving many people out of work. Although this is just one example, it illustrates the reason for a part of the tax reform, which involves lowering the corporate income tax rate. While the reduction of corporate income taxes is ideally supposed to be a positive aspect of the tax reform which will create jobs for the working class, it does not necessarily benefit these individuals because corporations are not required to open new positions. Consequently, this paper will argue that the new tax code will negatively affect the lower class by lowering corporate income taxes, implementing a flat rate personal income tax, broadening the sales tax base, and eliminating credits and personal exemptions.
To summarize the reform, “corporate income and personal income tax rates were reduced…and the coverage of the State sales tax was expanded to include service contracts and entertainment” (Turlington, 2013). The corporate income tax rate was lowered from 6.9 percent to 6 percent and it is expected to drop to 3 percent by 2017. By reducing corporate taxes to be competitive with neighboring states, the state legislators believe it will draw in more businesses and factories to North Carolina instead of Virginia and South Carolina. Governor Pat McCrory approved of these lower tax rates, and said that “they will encourage new businesses and provide more jobs for North Carolina residents” by taking less in taxes from the business and allowing more money to be spent on workers. There is a discrepancy with this assumption, though; businesses being taxed less does not necessarily result in their spending more money on hiring new workers. If companies choose not to hire more people or pay current workers higher wages, then the state government will lose millions of tax dollars from businesses each year.
Another aspect of the tax reform consists of eliminating the prior three-bracket income tax rates for individuals and implementing a modified flat tax of 5.8 percent for all levels of income. It is thought that changing from the progressive income tax system to a flat tax system is more equitable because it taxes everyone at the same rate no matter how much income an individual makes. However, the lowest tax bracket will not benefit from this change since the old income tax rate for families making less than $40,000 was 6 percent. Therefore, these families only gain 0.2 percent. On the other hand, the upper class, which had an income tax rate of 7.75 percent, receives a 2.95 percent reduction, and will reap significantly larger benefits from the modified income taxes. One may think that since there was a reduction for the lowest tax bracket, these households will be paying less. However, this is not the case. When comparing the modifications, the highest tax bracket received a 2.95 percent reduction while the lowest tax bracket only received a miniscule 0.2 percent income tax break. Although this is a decline, “the bottom 80 percent of the income distribution will see their taxes rise. This means that four out of five taxpayers in the state are going to pay more in income taxes next year” (Pyke, 2014). Families making more than $100,000 are receiving the largest tax breaks from the new tax laws even though they are making the most money. As seen below in Figure 1, the low income households will be paying a greater share of their income towards taxes than any other income bracket. In addition, Figure 1 depicts the difference between the old tax law and the new 2013 tax law on different ranges of income. The only decrease in taxes paid between the two laws is in the two highest income ranges.
Figure 1. The final tax plan makes upside down tax system worse.
Due to the tax reform, North Carolina will see a loss of over $700 million each year (Citizens for Tax Justice, 2013). The state needed to recover the lost revenue that came from income taxes of businesses and individuals. For this reason, the new tax laws created higher standard deductions, eliminated personal exemptions and credits, and broadened the sales tax base. Prior to the changes, one was able to receive tax exemptions on certain things such as charitable contributions, childcare, and even some taxpayers with disabilities. Now all personal exemptions have been eliminated, taking away money that used to be written off as tax refunds. With the broadened sales tax base, things that were never taxed before, such as services and entertainment, are now being taxed at the full sales tax rate. Some examples of newly taxed items or services include natural gas and electricity, lawn care and haircuts, concerts, and movie tickets. According to North Carolina Justice Center, “The primary reason that tax contributions rise as ability to pay falls in North Carolina is that state and local sales and excise taxes consume a much larger share of the budgets of low- and middle-income families than of the budgets of high income families” (Sirota, 2013).
“Taking account of all state and local taxes, low- and middle-income North Carolinians currently pay a greater share of their incomes in taxes than high-income households do” (Sirota, 2013). The problem with relying heavily on sales tax to provide revenue instead of income taxes is that the lower and middle-income families could end up paying a greater portion of their income each year on sales tax alone. In a recent study from the North Carolina Budget and Tax Center, it was found that “in replacing half the revenue from the income tax with additional sales tax, the top one percent of North Carolinians would see a net reduction in their contributions of 4.6 percent.”
As a result of the flat rate income tax, elimination of personal exemptions, and broadened sales taxes, the lower class will be negatively affected by the tax reform. Therefore, a higher graduated income tax and lower sales tax rate will benefit more of North Carolina’s population. A way to fix the issues with the tax reform of the 2013 North Carolina legislature is to create a system that stimulates greater economic growth and wealth creation, therefore bridging the margin between the top 1 percent and the lowest tax bracket: “A tax system that allows citizens to keep more of what they earn spurs increased work, saving and investment. Low tax rates significantly boost the value of all income-producing assets and help citizens maximize their fullest economic potential, thereby broadening the tax base” (Guiding Principles of Taxation, 2013).
The viable solution for fixing the effects of the tax reform entails reinstating the graduated income tax brackets so that each demographic can be taxed based on the income he or she makes. Since income taxes collect revenue based upon what an individual gains in wages, salaries, capital gains and other income sources, the graduated rates increase as income increases. In a progressive system with graduated income taxes, a taxpayer’s income best reflects their ability to pay taxes. A progressive personal income tax also aligns with historical growth in incomes in North Carolina, which have not been evenly distributed for households at all income levels. “In fact, since 1979, the top five percent have seen 35 percent growth in their earnings while those with earnings in the bottom 20 percent have seen growth of 12 percent” (Sirota, 2013). Graduated taxes “help to partially offset the disproportionate impact of regressive state and local sales and excise taxes on low- and middle-income families’ budgets” (Sirota, 2013).
Figure 2. North Carolina state and local taxes.
In a graduated tax system, each of the three tax brackets should be taxed proportionality to the income of each bracket. These income tax rates would need to be balanced so that it can provide the needed revenue to operate the state government while taxing the individual as fairly as possible. An example of how this progressive policy could work might involve tax rates of 5.8 percent for the lowest income bracket, 7 percent for the middle-income bracket, and 8 percent for the highest income bracket. The theory behind these particular rates is that the lowest imposition of taxes during the past century in North Carolina’s government is the 5.8 percent rate of the new tax reform; therefore, this rate would be applied to the lowest bracket. The middle bracket should be taxed at a median rate between the highest and lowest income tax rates in which the previous 7 percent would meet this criterion, thus not affecting these households by the income tax changes. Lastly, the highest tax bracket should be taxed at 8 percent or 0.25 percent higher than the old tax law based upon the ability to pay principle. In addition, lowering the sales tax rate for the whole state will positively affect the entire population instead of a particular demographic. Keeping the new tax law modifications which broadened the sales tax base, but lowering the percent which sales tax is charged will give the government the needed revenue to operate while allowing consumers to purchase more goods, further stimulating the economy.
Another measure the government should reconsider in the tax reform is the elimination of certain tax credits. For example, one of the credits the reform eliminated is the Earned Income Tax Credit (or EITC) that was “established in 2007… during a period when North Carolina families faced job loss, spikes in poverty, and a boom in low-wage work” (NC Policy Watch). The credit was only available to people who work and earn an income from wages, salaries, or self-employment. According to Thinkprogress Writer Alan Pike (2014) “The goal of the credit was to buoy the incomes of working people whose employers pay them too little to provide the economic stability that having a job is supposed to ensure.” It was an alternative way to keep working people out of poverty without interfering with how private businesses operate. “The federal EITC lifted approximately 298,000 North Carolinians—half of whom were children—above the federal poverty line ” (NC Policy Watch, 2014). Now over one million North Carolinians will receive the credit for the last time this 2013 tax season. “The refundable state Earned Income Tax Credit, representing 5 percent of the federal credit, offsets to some extent the greater total tax contributions for low-income families” (Sirota, 2013). The EITC helped increase the equity within the state’s tax system, and eliminating it only hinders those who received the tax credit. In order to minimize the margin between the highest and lowest tax bracket, the EITC also needs to be reinstated because it gave working class families extra money, which is then put back into the economy since the working class is what drives the economy as consumers.
Considering these issues, there are many reasons why North Carolina’s tax reform needs to be revised. The lowest income bracket will be negatively affected by tax reform of the 2013 North Carolina state legislature. The flat rate income tax of 5.8 percent and broadened sales taxes with no tax exemptions will cause the lowest tax bracket to pay more in taxes than ever before. The main beneficiary of this tax break is the highest income bracket, while the lowest income bracket is stuck in the same position as prior to the changes or are even worse off. The more a person’s income rises, the more he or she will benefit from the new flat rate income tax. The reform is increasing the margin between the upper and lower tax bracket, which is counterproductive to our economy and income distribution. In order to improve the economic status of North Carolina, the focus should be promoting family income growth that stimulates economic development rather than on sole economic growth. Investing in higher wage jobs for workers creates a strong infrastructure, enabling future prosperity.
Although the North Carolina 2013 tax reformation directly impacts those who live in North Carolina and pay income taxes, it also affects anyone who plans to gain employment or resides in North Carolina. Those who do not have jobs still pay sales tax on everyday purchases. Even if one is not directly impacted in a negative way like the lowest income bracket, at some point the tax modifications this year will impact one’s future life. The term “lower class” is not just families below poverty line; it includes us, the college students who are now becoming independent from our parents and possibly working minimum wage jobs. This is why the topic of taxes is so important. It affects everyone, in every tax bracket, whether or not a person voted or favors the current politics. Since subjects like the tax reform are relevant in everyday life, people should think more about how the changes will affect them and the population as a whole, and pay closer attention to the news concerning government matters. Once doing this and realizing the effects could negatively impact them, hopefully readers will want to be active in voting and take a stance in political debates to change policies for the better.
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