Tax burden shifts to workers

As the General Assembly argues over the equity of different tax plans, one tax reality is not in dispute: The burden in North Carolina has been shifting steadily over the past decade to the paychecks of working people.

That trend could continue this year, depending on which tax plan lawmakers ultimately choose.

Two gradual changes in the state’s tax structure have redefined it in recent years, a number of budget analysts say. The first is a shift in the tax burden from corporations to individuals; and the second is a shift among individual taxpayers from the wealthy to those of more modest means.

Both have resulted in the same bottom line: a more regressive tax system, or one in which lower- and middle-income taxpayers are paying an increasing share of the state tax burden.

From 1995 to 2000, the share of total state tax revenue that came from corporate income declined from 8.9 percent to 7.7 percent, according to figures compiled by the state controller’s office. During the same period, individuals’ share of the tax burden increased from 49 percent to 55 percent. The other major source of state revenue is the general sales tax.

Meanwhile, the elimination of the inheritance tax and of the intangibles tax, which was levied on stocks and bonds, among other things, has shifted a portion of the tax burden from the wealthy, who paid the bulk of those two taxes. And a doubling of the sales tax rate since 1971 has helped shift the tax burden onto less wealthy families, who spend a larger share of their income on taxable goods.

“The overall tax system at best is proportional overall,” said Don Liner, an economist with the Institute of Government at the University of North Carolina at Chapel Hill. “When I came here in 1971, it was definitely progressive, because the income tax was able to offset the regressivity of the sales tax. But if you double the rate of the sales tax – and you go beyond, as we’re about to do – the income tax loses its ability to offset that.”

The wealthiest 1 percent of taxpayers in North Carolina earn more than $ 336,000 per year. Low- and middle-income taxpayers, or those in the bottom 40 percent in North Carolina, earn less than $ 26,000, according to Dan Gerlach, director of the N.C. Budget & Tax Center.

The latest tax proposal, approved in the House on Aug. 30, would further the trend, some say. It raises the sales tax by a half-cent and leaves behind a previous idea to provide a tax credit to the poor.

It also leaves off the table many of the corporate loophole closures that some lawmakers and other advocates have promoted to spread the burden of a tax increase to the business sector.

All told, the latest package would provide roughly $ 540 million in annual tax increases. Most of it – about $ 420 million

– would come from the half-penny increase in the sales tax.

“It increases the unfairness to low- and moderate-income workers,” said Gerlach, whose nonprofit group advocates on behalf of the poor and also analyzes state budget numbers for both Democrats and Republicans. “Our tax policy initiatives have been shifting clearly in that manner.”

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Growth of individuals’ share

Fifty years ago, corporate and individual income tax revenue represented roughly an equal proportion of overall tax revenue – between 10 percent and 15 percent each. Today, corporate income tax receipts represent less than 8 percent of all tax revenue, while individual receipts make up more than 50 percent.

There is the view that this shift is perfectly appropriate. Phil Kirk, president of the state’s largest business lobby, North Carolina Citizens for Business and Industry, believes there is no such thing as a business tax – that all corporate taxation eventually is passed on to consumers. Those who believe corporations should bear a larger share of the tax burden “don’t understand economic development or the business community,” Kirk said.

“If we didn’t have an attractive business climate, we wouldn’t be producing tax revenue to fund the programs that they’re advocating,” Kirk said of those pushing for more corporate taxes. “It’s shortsighted for the more liberal groups to criticize business.”

The shift toward individuals has occurred gradually and results partly from the evolution of North Carolina’s economy, once based exclusively on manufacturing and agriculture and now increasingly reliant on service industries. Corporations pay less taxes because they make fewer taxable products and hold minimal taxable capital investments.

The state’s population, meanwhile, has boomed, causing a dramatic increase in the amount of individual income taxes – as well as consumer taxes, from the general sales tax to levies on liquor and gas – that the state collects each year.

Sales and use tax receipts, for example, rose from $ 1.7 billion in 1991 to $ 3.4 billion in 2000. During the same period, individual income tax receipts rose from $ 3.5 billion to $ 7.1 billion.

State tax policy also has fueled the shift.

During the 1990s, the General Assembly enacted tax cuts with an annual price tag in current dollars of more than $ 1.4 billion, and tax increases worth $ 1.1 billion.

Among the cuts, $ 545 million was targeted to the wealthy and to businesses. Among the increases, $ 213 million was directed at those groups.

Some tax cuts during that period did benefit a broader base of taxpayers. A three-year phaseout of the sales tax on food, ending in 1998, is widely viewed to benefit lower- and middle-income families who spend a larger share of their wages on groceries. New child tax credits and a larger personal exemption helped the middle class.

But the general trend has been to raise taxes on the broadest categories of taxpayers while reducing them for smaller, special groups.

“The fact that there are so many deductions, exclusions and preferences in the calculation of an income tax means that different sectors of our society are favored at the expense of the total,” said Harlan Boyles, a Democrat and former state treasurer. “And that’s the reason that you’re seeing a lot of our middle-income people being heavily burdened compared to the others.”

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This year’s plans

Democratic lawmakers and Gov. Mike Easley have pushed for a tax increase this year with a promise not to unduly burden lower-income taxpayers. House budget writers have proposed increasing the highest individual income tax rate, which applies to single filers who earn at least $ 120,000 and married couples earning at least $ 200,000.

Easley also proposed launching an earned income tax credit, a concept in place at the federal level and in a handful of other states. The credit would apply only to the lowest-income taxpayers and would protect them from paying a greater proportion of their income in taxes than wealthier taxpayers.

For a broader swath of taxpayers, the governor and lawmakers threw in the elimination of the “marriage penalty,” as well as a doubling of the child tax credit. Finally, House budget writers proposed closing three corporate loopholes.

Still, a handful of lawmakers and others have criticized various tax plans considered throughout the summer because they have included as much as a one-cent increase in the sales tax – another turn toward regressivity.

More business-minded advocates, meanwhile, have questioned the proposed income tax increase on higher-income taxpayers, saying it would scare off corporate executives who might otherwise move with their businesses and companies to North Carolina.

Budget writers “had a significant increase in revenue this year,” said Jonathan Hill of the anti-tax group Citizens for a Sound Economy. “What they should do is take the revenue and spend it, rather than saying they need another $ 200 million. Just like everybody else, they need to live within their means.”

The result of such concerns – emerging from the House two weeks ago – is a plan that raises the sales tax by just a half-cent instead of a whole penny, and also raises the highest income-tax rate by half a percentage point instead of a whole point.

“That really spreads the burden of the deficit that we’re facing now out among everybody in the whole state community,” said state Rep. Mickey Michaux, a Durham Democrat. “That’s the goal.”

But somewhere in the negotiations of the past few weeks, the earned income tax credit got dropped. The result, according to Gerlach, is a tax plan that actually hits the bottom 40 percent of taxpayers harder than previous plans did.

The real solution, some say, is a wholesale revamping of the state tax system. The governor and General Assembly should eliminate the targeted preferences for industries and wealthy taxpayers that are scattered throughout the tax code, they say. And when enacting new taxes or reducing existing ones, they should target the broadest possible levies to ensure an equitable distribution of the burden or benefit, whichever the case may be.

“Our whole taxing mechanism is antiquated,” said state Rep. Leo Daughtry, a Republican from Smithfield and the House minority leader. “The package that Democrats have passed is taxing everybody. I think the burden is probably on the poor more than anyone else, and I really think the time has come to revisit the entire taxing structure.”

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General Assembly and taxes

The state’s last major tax increase occurred in 1991, when the General Assembly overcame a $ 1.2 billion shortfall in revenue with a combination of budget cuts and the state’s largest-ever tax increase. The tax package included increasing the state corporate income tax rate from 7 percent to 7.5 percent, adding a new individual tax bracket of 7.75 percent, and increasing the state’s sales tax by a penny, from three cents to four cents. Here’s a look at major tax changes made by the General Assembly from 1993 through 1999.

Tax changesAmount (in millions of 1999-00 dollars)

1993 Legislative Session

– Various business tax incentives- 3.2

– Increase credit for qualified child care expense- 4.9

– Miscellaneous1.3

Total- 6.8

1994 Legislative Session

– Miscellaneous- 2.6

Total- 2.6

1995 Legislative Session

– Increase personal exemption from $ 2,000 to $ 2,500- 181.6

– Enact a $ 50 per child tax credit- 102.0

– Eliminate intangibles tax-147.3

– Lower soft drink tax from two cents to 1 cents per can- 11.3

– Miscellaneous- 4.2

Total- 446.4

1996 Legislative Session

– Reduce state sales tax on food consumed

at home from 4 percent to 3 percent- 95.0

– Reduce corporate income tax from

7.75 percent to 6.75 percent over four years- 120.1

– Expand JOBS tax credit- 7.8

– Investment tax credit- 19.7

– Enact worker training tax credit- 2.2

– Selected research and development tax credits- 10.0

– Targeted investment tax credit- 29.5

– Phase out soft drink tax over three years- 34.9

– Inheritance tax reform- 4.3

– Eliminate most privilege license taxes- 12.2

– Allow certain charitable deductions for non-itemizers- 5.5

– Severance pay exemption for manufacturing- 4.3

– Reduce sales tax on piped natural gas and electric

power for certain industries from 3 percent to 2.83 percent- 6.6

– Partial federal retirees rebate- 38.4

– Repeal income tax credit for

distributing North Carolina wine0.1

– Repeal income tax credit for dividends from

North Carolina domiciled corporations13.2

– Repeal corporate income tax deduction for

dividends from North Carolina domiciled corporations2.3

– Miscellaneous- 7.4

Total-382.3

1997 Legislative Session

– Reduce state sales tax on food consumed

at home from 3 percent to 2 percent- 91.5

– Update reference to the Internal Revenue Code- 9.3

– Expand various business tax incentives- 8.7

– Expand tax credit for using North Carolina ports- 3.0

– Expand severance pay exemption to all sectors- 2.2

– Exempt certain audiovisual masters from sales taxes- 1.6

– Expand federal retiree tax exemption- 1.1

– Increase income tax credit for

rehabilitating historical structures- 3.3

– Increase income tax credit for donations to

the state of real property for conservation- 3.5

– Miscellaneous- 12.4

Total- 136.6

1998 Legislative Session

– Repeal state sales tax on food- 178.6

– Repeal inheritance tax- 72.3

– Local school board sales tax refund- 14.3

– Long-term care insurance tax credit- 7.7

– Economic Opportunity Act of 1998- 13.1

– Limit nonresident withholding- 7.2

– Non-itemizer charity tax credit- 7.3

– Simplify privilege license tax2.3

– Child health insurance credit-18.9

– Miscellaneous-46.2

Total-363.3

1999 Legislative Session

– Corporate income tax credit for manufacturers

who export cigarettes- 8.7

– Investment tax credit- 2.1

– Bill Lee Act changes (economic development incentives)- 30.9

– Expand sales tax refund for community colleges- 4.4

– Require individuals to declare interstate purchases3.3

– Miscellaneous9.4

Total- 33.4

Grand total- $ 1,371.4

source: state office of budget and management;

fiscal research division, general assembly

GRAPHIC: graphic Shifting Burden Woody Vondracek/Staff