The poposal by N.C. House Democrats to raise the top income tax rate and increase the sales tax flies in the face of all rational economic analysis and is a prescription for sending the state’s economy into a full-fledged recession. In addition, their companion proposal to increase the standard deduction and the child tax credit is little more than a cynical attempt to divide the electorate through the use of class warfare.

There is one overriding principle of fiscal policy upon which both liberal and conservative economists agree - the best time to cut taxes and the worst time to raise them is when unemployment is rising and economic growth is falling. These are exactly the economic conditions facing North Carolina. In spite of this, House Democrats are proposing to raise nearly $600 million in new taxes. Their plan includes increases in the top income tax bracket for singles earning more than $120,000 and married couples earning more than $200,000 from 7.75 percent to a punitive 8.75 percent, and a half-penny increase the state sales tax to 6.5 percent.

While any tax hike would hurt the economy, there is no question that an income tax increase is potentially the most detrimental. This is because income taxes, by definition, penalize production by taxing activities that generate income. This harms the entire economy regardless of whether the tax is on those who are earning $200,000 or $20,000 a year. All income-generating activities, whether working on a construction crew or investing in a business, benefit the economy as a whole by generating jobs, income and goods and services for others. The higher the tax rate, the lower the return on working, saving and investing. This translates into fewer of these activities being pursued. Any reduction in productivity will mean slower economic growth, lower levels of job creation and higher unemployment rates.

In addition, an 8.75 percent top marginal rate would give N.C. the 6th highest top rate in the nation, discouraging high-wage earners and the companies that would employ these individuals, from moving to the state. These are people whose investment activities and purchases of new homes, automobiles, entertainment services, etc., would generate jobs and income for others who are not likely to be at the upper end of the state’s income distribution.

All of this represents a loss not only to the state’s economy, but to the state’s treasury as well. Although, from an economics perspective, hiking income taxes is potentially the worst aspect of the Democrat’s plan, it should be pointed out that a tax increase of any kind would be bad news for the state’s already precariously positioned economy.

Any increase in taxes will come at the expense of private sector productivity. All taxes transfer revenues from the private sector, where consumer spending and entrepreneurial investments allocate resources, to the government, where resources are allocated based on politics and the interplay of special interests. Because of this, revenues will always be used more efficiently, i.e., in a way that will promote more economic growth, by the private sector. Tax increases, which transfer money to government, will always harm the economy. This is why, in analyzing the effects of a half-cent increase in the state sales tax, the John Locke Foundation found that the state will lose anywhere from 20,000 to 26,000 jobs.

Beyond the economic impact of the Democrat’s proposal, this tax package reflects a politically motivated class-warfare mentality. In addition to the changes in the top income tax rate, the Democrats propose to increase both the standard deduction and the child tax credit. This is a blatant attempt to pit lower and middle-income earners against the upper income earners who will shoulder the burden of the income tax increase. They are portraying this as a net tax cut for low- and middle-income families, but it is not. Ninety- to ninety-five percent of North Carolina households would see a net tax increase under the Democrats’ plan.

If members of the N.C. House of Representatives care at all about economic growth and job creation, and not just the perpetuation of their favorite government programs, then all attempts to raise taxes should be rejected. There is only one way to both maintain the integrity of the state budget and to enhance the well being of the state’s economy, and that is by reducing, not increasing, government spending.

(Dr. Roy Cordato is Vice President for Research and Resident Scholar at the John Locke Foundation, a non-profit, non-partisan public policy research institute in Raleigh.)

 

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