South Carolina’s Uncompetitive Income Tax

 HERE’S WHY WE’RE LOSING: OUR TAXES ARE HIGHER

We’ve leveled a lot of criticisms at the South Carolina Department of Commerce over the last several years, and will no doubt level more in the future. Presently, however, an excellent report the agency put together in 2010 deserves for more attention than it ever got when it came out. The report’s title: “Personal Income Tax: Statewide Economic Growth and Taxation Issues in South Carolina.”

Among its conclusions: (a) our income tax system’s rates are too high, (b) the brackets are outdated, and (c) exemptions too excessive. Predictably, the legislature hasn’t moved on any of the conclusions.

High Tax Rates on the Poor

According the report, as of 2010, South Carolina had the “highest marginal tax rate on the lowest level of taxable income in the Southeast (and third in the nation).” In other words, South Carolina has a high top-bracket tax rate (7 percent), and that rate kicks in at a very low amount of income ($13,350 in 2010 and roughly $14,000 today).

The fact is that South Carolinians living barely above the federal poverty line are paying the highest marginal tax rate (in comparison, the 3rd lowest bracket for the federal income tax kicks in at $36,250, while the top bracket doesn’t kick in until $400,000). In 2008, individuals in the highest tax bracket (7 percent) accounted for a whopping 42 percent of the returns filed that year.

There is a striking lack of change in bracket thresholds from when these brackets were made in 1959 to 2010. Over the last half-century, the amount of income in which the highest tax rate kicks in increased only $3,350 (that’s a 33.5 percent increase, compared to the 649.3 percent cumulative rate of inflation during that time). Why the miniscule increase? According to the report, the threshold for each bracket is adjusted annually to offset inflation in terms of the Consumer Price Index. But these changes are made at the discretion of the SC Board of Economic Advisors, only periodically performed, done only at half the rate of CPI growth, and can’t exceed a maximum of 4 percent per year. As seen in the chart above, the top bracket, if it were properly adjusted to CPI growth, would not kick in until a person makes over $73,000 – and the other brackets would have much higher thresholds as well.

And because the brackets are indexed improperly, according to the report (and according to reality), “many individuals are catapulted into higher tax brackets quicker than the rate at which their wages increase. This phenomenon serves as an implicit tax increase.” Thus, every year that the brackets thresholds aren’t increased properly, taxes increase for South Carolinians. This flatly contradicts the bogus claim, made by elected officials who ought to know better – indeed who probably do know better – that South Carolinians have some of the “lowest taxes in the nation.”

South Carolina’s income tax system also makes it uncompetitive with other Southeastern states, as seen in the report’s chart below.

*North Carolina’s Highest Marginal Tax Rate is now 5.75 percent and Standard Single and Joint Deductions are now $7,500 and $15,000 respectively after recently enacted tax reforms.

Given North Carolina’s reforms that passed this year, South Carolina now has the highest marginal tax rate in the Southeast (not listed are Florida, which has no personal income tax, and Tennessee, which only taxes dividends and capital gains). These high tax rates make South Carolina less attractive to those people and business owners who are contemplating moving to our state and growing our economy. Moreover, these high rates make South Carolinians less free by taking more money out of their pockets and putting it in the hands of lawmakers and bureaucrats, and thus, taking away the decision of what to do with part of their working income. Not to mention, South Carolinians have less incentive to work when they know 7 percent of most of their income will be going to state government.

Too Many Exemptions

The Commerce study notes, too, that South Carolina’s tax deductions and exemptions are too generous and plentiful. These exemptions coupled with high marginal tax rates result in an increased number of individuals who bear no tax liability (people who end up paying $0 in income tax after exemptions and deductions) and leaves the tax burden to fall on fewer and fewer individuals. In 2008, 41 percent of filers had no income tax liability at all, leaving the tax burden on the other 59 percent.

Adding more exemptions and deductions doesn’t lessen the burden of South Carolinians as a whole – it lightens the load for those with the best connections at the State House. The Commerce report is absolutely correct when it says, “All exemptions, deductions, and tax credits create loopholes in the tax code and set one group (the one receiving the tax break) at a particular advantage over another (the one not receiving the tax break).” We couldn’t agree more, especially with regard to corporate taxes and “economic development.” It’s ironic that the Department of Commerce, which in this report preaches against the excessive use of exemptions, deductions, and credits, is the very agency that promotes corporate welfare by handing out millions of dollars in credits, deductions, exemptions, and outright cash to companies. The agency does this ostensibly to “attract industry,” but by its own logic the tax codes scores of exemptions, deductions, and credits drive away industry.

How to Fix It

The best kind of income tax is no income tax. Eliminating taxation on money earned from labor would be an essential component of becoming the freest state in the nation. The more earned money South Carolinians get to keep to provide for themselves and their families, they freer they will be, and the more prosperous our state will become through having more money being exchanged in the free market.  A “0 percent” income tax is not an “extreme” or “fringe” idea. Seven states currently have no personal income tax, and legislative leaders in North Carolina are planning to eliminate their personal income tax as well. If South Carolina wants to stay competitive with its neighbors, it should seriously consider axing its current unsustainable “economic development by corporate welfare” policy – a policy that simply hasn’t produced any verifiable results beyond the anecdotal – and eliminate its tax on personal income.

But if eliminating the tax seems too politically infeasible, the least lawmakers could do is follow the Commerce report’s simple recommendations:

• Reduce the marginal tax rate
• Index tax brackets for inflation
• Reduce dependency on federal taxable income
• Evaluate the equity of targeted deductions and exemptions

These simple reforms, according to the report, would “serve as a catalyst for instituting a more equitable, efficient, stable, and simple personal income tax structure.” We agree.