A Tale of Two Tax Proposals

WELL, WHICH IS IT?

Despite lawmakers’ disingenuous claims that South Carolina has some of the “lowest taxes in the nation,” the truth is that South Carolina taxpayers and businesses pay far too much to the state. The principle is simple: Taxes should be low and equitable, and South Carolina’s tax structure, for the most part, is neither.

Consider:

• South Carolina’s manufacturing property tax rate is the highest in the country.
• South Carolina’s sales tax is higher than its neighbors, the 13th highest in the nation.
• South Carolina exempts billions of dollars in tax collections, which increases the overall rates for everyone in the state.

Things are even worse with regard to the state’s personal income tax structure. The average South Carolina family pays a top marginal rate of 7 percent. By comparison, only 12 states in the country have a higher rate than South Carolina’s. In New Jersey, for example, people making $450,000 pay a lower marginal rate than average South Carolinian families. In Connecticut, not even millionaires pay 7 percent of their income. Many states have opted to tax all citizens at the same rate – a flat tax – but none of these states has a rate over 6 percent.

Governor Nikki Haley recently put forward (along with her executive budget) a tax reform proposal to remedy the state’s poor tax climate. There’s only one problem with assessing it, namely that there are actually two proposals, and it’s not clear which is the real one. Below is an analysis of both.

The announced plan

In her press conference announcing her executive budget, the governor proposed introducing a lower, flatter tax system. Her announced plan would lower the tax rate on all taxable income over $5,600. Citizens making under $5,600 would pay at rates of 0 percent or 3 percent. People making over $5,600 would see their rates – currently 4, 5, 6, and 7 percent – cut to 3.5 percent. This would make it so just about half of tax filers pay either 0 percent or 3 percent, and the other half would pay 3.5 percent.

In essence, this plan would reduce the marginal tax rate from 7 percent to 3.5 percent for all taxpayers making over $5,600.

Judging by our criteria – taxes should be low and equitable – we believe that combining multiple tax brackets and reducing the top rate to 3.5 percent is a good idea. The plan would lower taxes and return a substantial sum to taxpayers. Under this plan, an average family of four would save $919 dollars a year.

Reducing the rate to 3.5 percent for income over $5,600 would give South Carolina the third lowest top marginal rate in the country, not including those states that have no personal income tax whatsoever. In addition, it would end the practice of taxing middle class South Carolinians at an inordinately high marginal tax rate.

The written plan

There’s a significant difference between what the governor verbally announced as her tax reform, and the initiative that she attached with her executive budget. Unfortunately for taxpayers, her written plan essentially maintains the state’s status quo.

In her written proposal, the governor proposes reducing the marginal rates only on income between $5,600 and $14,000. The rate would be reduced to 3.75 percent for income within this range. All income above $14,000 would continue to be taxed at a 7 percent rate.

The governor’s plan would provide some tax relief to taxpayers. Some is the key word. A middle class family of four would save just around $104 dollars a year under this plan. While any money returned to taxpayers is good, $104 for a middle class family is a pittance relative to that family’s overall tax burden. At $104, this tax plan would return less than 1/5th of 1 percent of a family’s yearly income back to them.

In addition to providing only minor tax relief, the governor’s written proposal does nothing to address the inherent injustice in the fact that middle class families are paying a rate of 7 percent. This rate is unfair to middle class families, and it makes our state uncompetitive. Any tax reform that’s serious about restructuring our system must address this high rate.

The rest of the plan

The governor’s proposal also includes a plan to phase out the corporate income tax over 4 years starting on January 1, 2013. Presumably the plan would cut the corporate income tax 1.25 percent each year for 4 years, until the rate was 0 percent. By eliminating the corporate income tax, we would join the ranks of 5 other states.

Eliminating the corporate income tax would be one of the best ways to generate real economic growth in the state. The elimination of the corporate income tax is one tangible step the state could take to increase our business competitiveness and decrease unemployment. Lowering taxes for all companies – as opposed to the current practice of only giving tax credits to those with good lobbyists and good connections – would signal to out-of-state firms that South Carolina is a fair place to do business.

Considering the fact that the corporate income tax generates so little revenue ($186 million out of a budget of $21.9 billion in FY11-12 – see here), it would be better if the state eliminated the corporate income tax immediately – thereby providing immediate relief to South Carolinians ailing economy.

In order to “pay for” eliminating the corporate income tax (assuming one thinks tax cuts need to be “paid for”), the state would only need to cut .85 percent of its budget. One could start with the millions paid by the state in tourism advertising dollars, or the $25 million proposed dollars for the “State Port Development Fund,” or the tens of millions of dollars spent on the Department of Commerce’s failed economic development projects.

What’s not in the plan(s)

Sales Tax

Some of the most critical and overdue reforms are not included in the Governor’s budget. For example, one of the most crushing and job-destroying aspects of our tax code – our sales tax – isn’t addressed.

South Carolina has a higher sales tax than either of its neighbors. That puts our state retailers as a competitive disadvantage, as people who live near a border can easily cross state lines and pay less money for the same items. What’s especially egregious about our sales tax is that there’s no reason it should be so high. The state exempts more sales tax than it collects. Why? Because state lawmakers use the tax code to dole out favors to well-connected industries.

If we simply ended the exemptions, we could significantly reduce the overall sales tax. At a time when jobs are scarce, the state can’t afford to put its retailers at a disadvantage. Instead of handing out favors via the tax code, the state should immediately end sales tax exemptions and substantially lower the overall rate.

Exemptions

In fact, the state should go a step further and put an immediate end to all exemptions in the tax code, not just sales tax exemptions. As it currently stands, the state gives out many generous special-interest tax credits to everyone from Hollywood producers to multinational companies. But these handouts cost money. By eliminating them, not only do we make the state’s business climate more competitive: we also can lower overall taxes for everyone.

The governor’s proposed tax plan would require the BEA to release a biennial report on the beneficiaries of tax credits and exemptions, as well as its impact on the State Treasury. One questions the impact this will have on actual tax policy. Instead of commissioning more reports on the issue, the state should actually get serious about ending exemptions.

Property tax relief

South Carolina has the highest manufacturing property tax in the nation. It is more than double the national average. If we are serious about job growth, we need to stop crippling industry with highest-in-the-nation tax rates.

The governor’s budget proposes changing the constitution so that property tax rates are set by law, and not by the constitution (as is currently the case). Whether or not property tax is constitutional or statutory is inconsequential and does not address the immediate problem of a job-destroying tax rate. It’s essential that the manufacturing property tax be lowered as quickly as possible in order to spur immediate economic growth.