Final budget deal could affect NC tax system’s progressivity

Those following the ongoing state budget impasse know that a key point of contention involves the pace of cutting income tax rates.

Another key difference between House and Senate budget plans has attracted much less attention. It will determine whether our existing income tax becomes even more progressive in future years.

“A progressive tax is one where the average tax burden increases with income,” the Tax Foundation tells us. “High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden.”

Since 2014, North Carolina has assessed a flat-rate income tax. Every taxed dollar faces the same amount of tax. A flat rate is neither progressive nor regressive.

That’s not the end of the story. Other elements of the tax code create progressivity. These elements rarely attract comment from critics who slam GOP lawmakers for cutting taxes for “millionaires and billionaires.”

North Carolina’s flat-rate tax stands at 4.75% for 2023. We paid 4.99% in 2022. Existing state law already calls for lower rates of 4.6% in 2024, 4.5% in 2025, 4.25% in 2026, and 3.99% in 2027.

If lawmakers do nothing, taxpayers will see rate cuts.

Both the House and Senate propose speeding up next year’s rate cut from 4.6% to 4.5%. The House would stop there. The Senate would keep cutting. The Senate budget would drop the rate to 3.99% in 2025 and 2.49% by 2030.

Competing tax plans differ on more than just rates.

The House would raise the standard deduction and child deduction in 2024. Both deductions add progressivity to North Carolina’s income tax.

Under current law, any married couple filing jointly can deduct $25,500 of income. On a sliding scale, any couple with up to $140,000 can claim deductions for each child. The child deduction is highest for couples earning less than $40,000 in taxable income.

The House would boost the standard deduction to $26,000 for a married couple. The child deduction would jump from $3,000 to $3,600 for couples at the lower end of the income scale.

The Senate did not include either deduction increase in its budget.

Current law allows a family of four to pay zero tax on income up to $31,500. Under the House budget, that threshold would jump to $33,200 next year. For the $33,200 household, the House plan would wipe out what would otherwise be a $76 income tax bill with the likely 4.5% tax rate.

Let’s look at families with taxable incomes of $50,000, $100,000, $200,000, or $1 million. I will calculate tax burdens using only the flat tax rate and the standard and child deductions.

In 2023, the $50,000 household will owe $926. That’s an effective tax rate of less than 1.9%. The $100,000 household will owe $3,396 (3.4% effective rate). The $200,000 household will owe $8,288 (4.1%). The $1 million household will owe $46,288 (4.6%).

The $100,000 household makes twice as much income as the $50,000 household but pays 3.7 times as much tax. The $200,000 household makes four times as much as the first household but owes nearly nine times as much tax. The $1 million household makes 20 times as much income but owes almost 50 times as much tax.

Earn more money, and you bear a higher income tax burden. It’s a progressive tax. That’s current law.

With a likely 4.5% rate in 2024, tax bills would drop for all four families. The $50,000 household would owe $877 (1.8% effective rate). The $100,000 household owes $3,217 (3.2%). The $200,000 household owes $7,852 (3.9%). The $1 million household owes $43,852 (4.4%).

Relative burdens remain roughly the same, with the $1 million household still paying 50 times as much tax as the $50,000 household.

Now factor in the House’s deduction changes. The $50,000 household sees its bill drop an additional $77 to $810 (1.6% effective rate). The $100,000 household would owe $3,168 (3.2%). The $200,000 household would owe $7,830 (3.9%). The $1 million household would pay $43,830 (4.4%).

The $100,000 household, still making twice as much as the $50,000 household, now owes 3.9 times as much tax (up from 3.7 with the current deductions). The $200,000 household owes 9.7 times as much tax. The $1 million household owes 54 times as much.

Everyone pays less income tax, but the House plan also shifts the overall burden toward higher-earning households.

It’s unclear whether the final budget will incorporate increased standard deductions or child deductions.

If so, higher earners will pick up an even larger portion of the state’s income tax tab.

Mitch Kokai is senior political analyst for the John Locke Foundation.