Any North Carolinian paying personal income tax would see a lower tax rate at the suggestion of the Republican legislature. At the same time, earners with higher incomes should pay a higher proportion of the bill.
To understand why, examine the interplay between the state’s flat tax rate and its standard deduction.
North Carolina introduced a “flat tax” in 2013. A tax rate replaced a three-tier system. The old system’s peak rate was 7.75%. As a result of successive tax cuts, the current lump sum was 5.25%.
That 32% cut in the top tax rate makes a difference. Ask businesses and individuals across the country about moving. However, critics of a flat-rate tax claim consider it unfair that higher earners should pay the same tax as those on lower incomes. It is important to address these concerns.
The name “flat tax” adds to the problem. The label implies that everyone – rich and poor – pays the same tax. But it is not a flat tax amount. It’s a flat rate tax.
With no other deductions or credits, you pay more tax as you make more money. At the current tax rate of 5.25%, a taxpayer earning $ 10,000 would pay $ 525 in income tax. A taxpayer earning ten times as much, $ 100,000, would pay ten times as much in tax: $ 5,250. A millionaire earner would owe $ 52,500. That’s ten times as much as the $ 100,000 taxpayer and 100 times as much as the $ 10,000 earner.
Higher earners pay significantly more. However, critics believe that high-income taxpayers should spit off a larger percentage of their tax income. They want the North Carolina tax system to be somewhat progressive.
It already does.
Since the legislature has lowered the flat income tax rate in recent years, it has continuously increased the standard deduction. This is the amount of income that will be deducted from the helmsman’s consideration.
The current standard deduction is $ 10,750 for a single applicant and $ 21,500 for a married couple filing together.
Use these numbers to look back at the example above. First, consider three individual taxpayers at the three different income levels. Instead of paying $ 525 in income tax, a $ 10,000 earner actually pays no income tax. Once the $ 100,000 earner receives his standard deduction, he owes $ 4,685. Once the $ 1 million taxpayer has made their deduction, they’ll pay $ 51,935.
All three taxpayers benefit from the deduction. However, the low earner sees the greatest impact. His entire state income tax burden will be wiped away. Meanwhile, the standard deduction will cut approximately 10% of the earner’s income tax burden of $ 100,000. For the $ 1 million taxpayer, the standard deduction cuts 1% of their bill.
In the case of a married couple, the differences are even more pronounced. Once again, the $ 10,000 household pays no income tax. This also applies to couples who earn twice as much. Meanwhile, the $ 100,000 household owes $ 4,121. The standard deduction reduces your tax burden by more than 21%. The $ 1 million couple owe $ 51,371. The standard deduction reduces about 2% of the tax burden.
Before considering the changes proposed this year, it is time for two reservations.
First, the examples above assume that taxpayers are not making any other deductions or credits. It is unrealistic. The $ 1 million earner is likely to be listing deductions or taking other steps to lower a state income tax greater than $ 50,000. Even the $ 100,000 taxpayer is likely to ask for more than the standard deduction.
However, if other credits and deductions distort tax laws in such a way as to unduly favor higher earners, that is an argument for reviewing those credits. This discussion has no impact on the interaction between flat tax and standard deduction.
The second limitation concerns children. My examples say nothing about households with children. That is useful. North Carolina tax laws specifically provide child-related deductions to help lower-income families. These deductions lead to a progressive tax law that is widely supported.
Now back to this year’s proposals. Senate Republicans have discussed lowering the flat tax rate from 5.25% to 4.99% (a cut of about 5%) while increasing the standard withholding from $ 10,750 to $ 12,750 (an increase of nearly 19%).
Let’s look at the projected changes in income tax bills for single earners without children who make $ 20,000, 30,000, 50,000, 80,000, 100,000, 200,000, and $ 1 million.
The $ 20,000 earner would see his income tax drop from $ 485 to $ 361. That’s a cut of more than 25%. At $ 30,000, the bill drops from $ 1,010 to $ 860 (15% cut). At $ 50,000, the bill drops from $ 2,060 to $ 1,858 (almost 10% less). At $ 80,000, the bill drops from $ 3,635 to $ 3,355 (8% cut). At $ 100,000, the bill drops from $ 4,685 to $ 4,353 (7% cut). At $ 200,000, the bill drops from $ 9,935 to $ 9,343 (a 6% cut). At $ 1 million, the bill drops from $ 51,935 to $ 49,263 (5% less).
Note that every taxpayer sees their NC income tax cut by at least 5%, with earners at the lower end of the income scale seeing larger percentage cuts. (Repeat this exercise for a married couple, and lower-income households will do even better.)
It is also interesting to examine the relative burden on each taxpayer. The $ 80,000 taxpayer makes four times as much as the $ 20,000 taxpayer. According to today’s tax code, he owes 7.5 times as much taxes. With the changes, he would owe nine times as much. For the $ 200,000 taxpayer who earns ten times as much as the $ 20,000 earner, the burden increases from 20 times as much tax liability to 25 times as much.
This happens when the legislator combines flat tax cuts with increases in the standard deduction. Critics of the North Carolina system should take a closer look.