N.C.’s top tax rate harms bottom line

By: - July 20, 2005 5:13 am

Raleigh News & Observer
8.25 percent is well above regional level


WINSTON-SALEM — Re-enactment for two more years of the state’s "temporary" extra one-half percent marginal personal income tax rate, which originated in the budget crisis of 2001, would be injurious to the economic and fiscal health of North Carolina.

Some say this tax rate increase on incomes over $120,000 for singles and $200,000 for joint filers should be renewed in the interest of fairness if the extra one-half percent sales tax is retained — but we must also be concerned about competitiveness of our rates with surrounding states.

North Carolina’s current 8.25 percent top personal income tax rate, which also applies to smaller businesses electing to be taxed as individuals, is substantially above other states in the Southeast with which we compete for residents and jobs. The top personal income tax rate is 7 percent in South Carolina, 6 percent in Georgia, 5.75 percent in Virginia and 5 percent in Alabama. Florida and Tennessee have no personal earned income tax.

The tax rate gap between our state and these neighbors began to widen during the state budget crisis of 1991 with another so-called "temporary" increase in the top personal rate from 7 percent to 7.75 percent which was continually renewed until made permanent. One can’t help getting the feeling that we are on that same path again.

Our inhospitable income tax rates are causing us to lose higher-income retirees who can live wherever they choose; venture capital and small business entrepreneurs who can easily locate across state lines; and economic development prospects who have many lower tax choices. It is interesting that the fastest-growing city in the Charlotte metro area is Rock Hill, S.C., whose population jumped 16.2 percent between 2000 and 2004 compared with 6.5 percent for Charlotte and only .9 percent for Gastonia.

What are the numbers, income and taxes of individuals vulnerable to loss? It is estimated that in 2004 about 70,000 tax returns, or about 2.5 percent of the state’s total, were in the 8.25 percent bracket and accounted for about 30 percent of state personal income taxes. Their taxable income averaged around $500,000 and they paid an average of about $39,000 in state income taxes and an estimated $9,000 in state sales taxes. Higher-income people expect to and should pay a higher proportion of taxes, but there are limits to what they will accept when there are less punitive alternatives.

No one knows for certain how many higher-income taxpayers leave or do not come due to our state’s higher income tax rates, but a conservative estimate is at least 750 per year on average. Based on the above figures, that would result in a permanent loss from our income and sales tax revenue base, which has grown for other reasons, of about $36 million per year on average, or a total of $144 million for the last four years.

Two more years at this rate would raise the estimated cumulative permanent loss from the tax base to around $216 million, which is more than the estimated revenue gain per year from the extra one-half percent "temporary" income tax increase. These estimates do not include lost city and county sales and property taxes or jobs and tax revenues lost due to economic development prospects being scared away by our higher taxes.

The loss of higher-income individuals can be seen in the below-average growth and ranking of North Carolina’s per capita personal income. In 2004 it ranked fifth in the Southeast behind four of the states with the lowest income taxes, and it dropped from 31st in the nation in 2001 to 37th last year. This is among the reasons for the difficulty in balancing the state budget and for the persistent structural deficit even after the economy has recovered. A return to rapid growth will not bail us out as in the past.

It should be clear by now that continuation of our noncompetitive income tax rates is shortsighted and at the sacrifice of much-needed jobs and tax revenues. If this is not corrected, our wealth and revenue base will further erode and our average per capita personal income will fall further behind. We need a tax structure which retains our higher-income taxpayers and attracts some new ones to help pay the growing cost of spending priorities such as education and assistance to the less fortunate.

It is very important to the future economic and fiscal health of North Carolina for the General Assembly to phase down and "sunset" the "temporary" increase in the top personal income tax rate as originally proposed for this biennium by the governor and Senate. For the future, it is critical to move expeditiously, as recommended in 2002 by the Governor’s Commission to Modernize State Finances, to reform the state’s outdated tax system to reflect the economic and competitive realities of the 21st century.

(John G. Medlin was a member of the Governor’s Commission to Modernize State Finances. He is a retired chairman of Wachovia Corp.)

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Chris Fitzsimon

Chris Fitzsimon, Founder and Executive Director of N.C. Policy Watch, writes the Fitzsimon File, delivers a radio commentary broadcast on WRAL-FM and hosts "News and Views," a weekly radio news magazine that airs on multiple stations across North Carolina. [email protected] 919-861-2066