North Carolina is one of 10 states most reliant on income tax revenue, according to a recent report by Standard & Poor’s.
And it turns out the state has lost more income tax revenue than expected from the General Assembly's cuts to the individual income tax in 2013, according to a July memo from state legislative analyst Brian Slivka and chief economist Barry Boardman.
The state had forecast a $475 million loss in revenue from the cut, but as of July the cost had soared to $680 million.
North Carolina wages have not increased to the levels projected in 2013, which was much of the reason for the $205 million difference, the memo stated.
But the news might stir budgetary concerns for a state that relies significantly on the income tax.
In North Carolina, state revenue growth has fallen from 9.7 percent to 3.7 percent during the last three decades.
Rising income inequality is responsible for this decline in tax revenue, according to S&P, which issues credit ratings for corporations, financial institutions and governments. The drop has caused states to tighten purse strings and cut spending as smaller incomes leads to lower income and sales tax revenue.
“One of the big things that should be noted is that the tax plan that went into place last year (in North Carolina) went from a progressive tax system to a flat tax system,” said Cedric Johnson, a policy analyst at the N.C. Budget and Tax Center. “A flat tax is going to drastically reduce revenue.”
Before the state legislature amended the tax code last year, North Carolina had a three-tier system where top earners in the state paid more than middle-class and lower-income residents. But under the new code, everyone pays the same rate 5.8 percent, which is scheduled to lower further in 2015.
The widening gap between wealthy families and low-income families is exacerbating the revenue problems in the state, as there is a smaller pool of income to draw from, taking away from public investments like education, Johnson said.
He said one solution to lagging revenue could be a return to a progressive tax model.
“Revenue is lagging according to state estimates and further tax cuts will only make things worse off,” he said. “A flat tax doesn’t require people to pay the same proportion of their paycheck — a progressive tax ensures everyone pays a fair rate.”
A 5 percent tax rate will have larger effect on someone with a $30,000 income than someone with a $100,000, he said.
But the S&P report cautioned that changing tax policy was not a simple fix to the problem.
“The move toward more progressive tax rates may help states generate faster tax revenue growth than would flatter tax regimes,” S&P said.
“But given that rising income inequality is fundamentally an economic problem, changes to state tax policies alone won't likely fully reverse any fiscal trends that have emerged as a result.
"While such an approach might help to partly counteract the slowdown in revenue collections, it does so at the expense of revenue stability, making it a second-best option.”
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