Who really pays the taxes in North Carolina? (Hint: it’s not who you think)

By Meg Gray Wiehe and Elaine Mejia
February 2008

Executive Summary

North Carolina lawmakers made several changes to state tax policy in 2007, including the creation of a 3.5% refundable earned income tax credit, the elimination of the top income-tax bracket, and the continuation of the state sales-tax rate at 4.25%.

Taking the 2007 changes into account, North Carolina’s state and local tax system remains regressive, meaning that it requires the poorest households to pay a greater share of their incomes in taxes than the wealthy.

The poorest 20% of households, whose average annual income is $10,000, pay 10.7% of their incomes to state and local taxes. In contrast, the wealthiest 1% of families, whose average annual income is $970,000, pay only 7.1%.

The state income tax, which constitutes about a third of all state and local tax revenues, is moderately progressive by national standards. However, its progressivity is not sufficient to outweigh the regressive impact of North Carolina’s sales, excise, and property taxes.

One key reason the wealthiest taxpayers pay the smallest share of their incomes in state and local taxes is they benefit disproportionately from the ability to deduct what they pay in state income taxes and property taxes from their income for federal tax purposes.

There are several policy changes that would make North Carolina’s system fairer, such as increasing the amount of the state earned income tax credit, expanding the sales-tax base to include more personal services, and establishing a circuit-breaker credit to offset the property tax bills of low- and moderate-income homeowners.

Currently in North Carolina, the incomes of wealthier residents are growing much faster than those of low- and moderate-income residents. Therefore, a tax structure that disproportionately targets lower-income residents, like North Carolina’s, will not experience adequate revenue growth over time.