Three crucial tax reforms for South Carolina

The S.C. Legislature convened for session this week, renewing calls to fix South Carolina’s dated and uncompetitive tax structure. This focus comes as our northern neighbor passed a significant tax cut last year, with Georgia making a smaller cut, making the Palmetto State’s years of inaction even more baffling.   

Taxes can be complicated – our problems, however, are not. This report makes three simple recommendations to ease the tax burden on citizens and get government out of the way of doing business.   

.

1) Slash and simplify the personal income tax  

By now, you have probably heard that South Carolina’s top personal income tax rate of 7% is the highest in the Southeast. This is true, but it isn’t the only factor contributing to our flawed tax structure. The bracket system, specifically our version of it, creates serious disparities in tax liability depending on a person’s income and eligible deductions.

Here are some tax scenarios to consider (based on tax year 2020; amounts factor in deductions but not tax credits or reductions to adjusted gross income): 

Single filers: 

• A single filer making $35,000 has a state tax liability of approximately $1,058
• A single filer making $50,000 has a state tax liability of approximately $2,108  
• A single filer making $100,000 has a state tax liability of approximately $5,608

Joint filers: 

• A married couple with two children (over age 6) making a combined $75,000 has a state tax liability of approximately $2,394
• A married couple with two children (over age 6) making a combined $100,000 has a state tax liability of approximately $4,144
• A married couple with two children (over age 6) $150,000 has a state tax liability of approximately $7,644

As you can see, South Carolina’s tax structure causes a sharp acceleration in tax liability with only moderate increases to income. This jump is felt most by those transitioning from lower-middle income to middle class. A visual representation of this trend can be seen in graphics provided by the S.C. Revenue and Fiscal Affairs Office (scroll to the very bottom).

This is bad policy, and a better system is long overdue. South Carolina should impose a low, flat income tax in the range of 4-5%, similar to North Carolina, which just voted to cut its rate significantly. Our use of federal deductions to calculate taxable income, however, is a good measure that should be preserved.

This would lower taxes for a significant number of residents; it would also let people keep more of their money as income rises. The governor’s recent proposal to keep the bracket system but lower each rate by 1% would simply maintain the status quo to a lesser degree.   

.

2) End discretionary incentives for select businesses 

South Carolina might be a “red state” politically, but that doesn’t mean its public officials necessarily believe in the free market. State and local government rely on an array of incentives, including taxpayer-backed grants, to attract certain businesses to move or expand their operations. These can be broken down into two broad categories: discretionary and non-discretionary, the former of which is primarily where the problem lies.  

As you would expect, businesses seeking discretionary incentives must meet certain eligibility requirements and get approval from a particular government body, either a county and/or the Coordinating Council for Economic Development (housed within the Department of Commerce). Here are a few key discretionary incentives: 

• Grants – The coordinating council pays out millions each year in taxpayer-backed grants for certain business projects at its discretion. According to the council’s latest annual report, during calendar year 2020, it awarded 79 new grants totaling almost $83 million. Funds are paid from three grant programs; the program which saw the highest number of individual grants paid out in 2020 (Set-Aside Fund) is funded through a 3-cent tax on gasoline.  

• Fee-in-lieu-of-taxes (FILOT) – Instead of paying local property taxes, a qualifying business can negotiate with a county to pay a reduced fee over a certain period. The terms of each FILOT agreement must be approved by a county. As one example, according to Richland County, this can lower property tax payments by 43% on average. 
• Job Development Credits – Despite their name, these aren’t used to lower a company’s tax liability. The program takes the personal withholding taxes of new employees and pays it back to companies for certain kinds of investment. In addition to other eligibility requirements, companies must pay a non-refundable $4,000 application fee, and an annual $500 renewal fee.  

We won’t deny that these incentives are lucrative for companies that are lucky enough to receive them, but they have considerable downsides. First, they come at a substantial cost, not only for taxpayers on the hook for millions in grant payouts, but also for the tax base at-large that has to pick up the slack left by companies that don’t fully pay for government services. When some groups get a discount, others pay a premium.

One could argue this is true of most tax policies in some form, as credits, deductions and exemptions generally apply to select groups – but things become more pernicious when government has direct control over their application. This raises our second point: With discretionary incentives, instead of the economy developing organically, it becomes shaped based on what government thinks it should look like. If a project isn’t viewed favorably by the necessary government official(s), it won’t be rewarded with incentives.  

This is especially true for grants. According to the Department of Commerce, a commerce project manager must be “actively involved” in the recruitment of a project for it receive grant funding. Why is this level of involvement necessary, and who is ultimately served by this requirement? 

For these reasons, we urge that discretionary incentives be eliminated. If state and local government must rely on incentives, bureaucrats and elected officials should be taken out of the decision-making process to ensure they are applied fairly.  

.

3) Eliminate needless sales tax exemptions, lower the rate 

South Carolina’s sales tax code suffers from a long, complicated list of exemptions that stand in the way of a lower, more competitive rate. The statewide rate is 6%; however, counties may impose a set of additional local sales taxes ranging from 0.1% – 3% (all but four counties have at least some form of local sales tax.)

Two of the most well-known and used exemptions apply to groceries and prescription drugs, which are not at the top of our removal list. Rather, our focus is on the many narrower exemptions that have a less immediate impact on everyday life. These include exemptions on: 

• Machinery used in the production of tangible goods; 

• Resources for manufacturers, transportation companies, and electric power companies; 
• Packaging materials; 
• Digital software;  
• Research and development machinery and equipment; 
• Construction materials for certain large-scale projects; and 

• Other equipment and materials related to economic development projects (for more details scroll to the bottom)

It’s likely no coincidence that many of the items on this list are used by industries with considerable lobbying resources. Related or not, eliminating these kinds of exemptions and broadening the base would allow us to lower the overall rate, making South Carolina a better place for businesses and consumers.  

.

No time like the present 

Addressing these issues must be top priority for lawmakers this year. For too long, South Carolinians have put up with uncompetitive taxes, watching as our neighbors slash their rates. A few tweaks to the system, as lawmakers tend to prefer, will not suffice. The Palmetto State needs serious reform, and that starts with the three proposals outlined here.  

The timing for change could not be more perfect. South Carolina ended last fiscal year with a whopping billion-dollar surplus, and that doesn’t include the state’s massive reserve of federal Covid money. Even if these changes result in less revenue for government, its bottom line shouldn’t be hurting anytime soon. In fact, a reduction may be the only cure for the state’s addiction to excessive spending.  

Going forward, we will be monitoring the legislative session to keep you updated on bills dealing with tax reform, highlighting those that match our policy recommendations.