Ending “Temporary” Sales Taxes Would Grow Economy, Benefit Working Poor More Than EITC

As the House and Senate continue their budget negotiations, reports from the General Assembly indicate that House members are proposing a plan that would entail extending the one-fourth cent “temporary” sales tax another two years in exchange for enacting a state-level Earned Income Tax Credit (EITC). Advocates for the state EITC claim it will help offset the high sales tax burden for North Carolina’s working poor. Simple economics, however, suggests otherwise. Our analysis reveals that lowering the sales tax rate would be much better for the working poor than an EITC.

State EITC Offers Minimal Benefits

The House plan currently being discussed would set the state EITC rate at 5 percent of the federal credit. Eligible recipients must be employed and earn an income no more than $38,348 for an individual who is married filing jointly with two or more qualifying children. The amount of the credit is paid on a sliding scale according to the recipient’s income level, marital status and number of dependents. The state EITC would also be refundable, meaning that those who have no state income tax liability would still receive payments.

According to the NC Justice Center – a vocal advocate of a state EITC – a refundable state EITC would “ensure that paying taxes does not push lowand moderate-income working families closer or deeper into poverty.” A closer examination of the numbers shows that the actual benefit to working families is virtually nonexistent. Based on the NC Justice Center’s own estimates, a 5 percent state EITC would cost taxpayers $67 million in FY2007-2008 alone, and benefit roughly 825,000 workers and their families. The end result would be an average payout of $6.75 a month for each recipient. This is barely enough to pay for two Happy Meals at McDonalds, let alone lift anyone out of poverty.

High Sales Taxes Hurt Working Poor

By contrast, the impact of extending the “temporary” sales tax would hurt the working poor by: 1) reducing jobs in the retail sector and other industries; 2) increasing the price of food and manufactured goods; and 3) reducing investment in North Carolina’s economy.

1) More Than 80,000 New Jobs Lost

North Carolina has 33 counties that border South Carolina and Virginia. Both of these states have significantly lower sales taxes (5.48 percent and 5 percent, respectively) than North Carolina’s current rate of 6.75 percent (7.25 percent for Mecklenburg County). The disparity between these tax rates is creating what economists call a “cross-border” effect that encourages shoppers to cross state lines to buy products at a lower sales tax rate.

• 28.4 percent of North Carolina’s population lives in counties that border South Carolina and Virginia. These areas can expect to continue to lose significant retail business to neighboring states due to high tax rates, resulting in stunted economic growth and fewer jobs.
• As of 2006, more than 450,000 North Carolinians worked in the “retail trade” sector – an industry in which many of the state’s working poor are employed. A high sales tax relative to neighboring states will continue to reduce the number of these job opportunities.

The retail sector, however, is not the only industry that has been hurt by North Carolina’s high sales tax rate. In 2001, the John Locke Foundation analyzed various econometric models that simulated the economic effects of raising sales taxes in Ohio, Texas and California. Their findings concluded that raising the sales tax rate by one-half cent in North Carolina would cause a net loss of 20,000 to 26,000 jobs each year. Based upon these initial projections:

• Keeping the “temporary” sales tax in place past the originally scheduled sunset date has resulted in the loss of roughly 60,000 to 78,000 jobs – many of which would have legitimately helped “lift people out of poverty.”
• Using the same forecasting model, we can expect that another 20,000 to 26,000 jobs will either be lost or never created as a result of the General Assembly’s plan to renew the one-fourth cent “temporary” sales tax increase for another two years.

The cumulative effect of keeping the temporary sales tax on the books has cost the state roughly 80,000 to 104,000 jobs. To put this loss into perspective, the addition of 80,000 workers to the labor force between 2003 and 2009 would lower North Carolina’s unemployment rate to 3 percent by 2009, compared to the current rate of 4.8 percent (tied for 11th highest in the nation).

2) Higher Prices for Necessary Goods

North Carolina also imposes its sales tax on business inputs for manufacturing equipment, utilities and farm equipment – the only state in the Southeast to tax all three types of inputs (other states provide exemptions). Taxing these inputs is bad enough in itself, but keeping the sales tax at a higher rate exacerbates these problems:

• Production of goods in these industries is more expensive, putting North Carolina companies at a disadvantage.
• The higher input costs are passed along in the sale price, making many necessary items more expensive to buy – thus hurting the poor disproportionately. For example, household staples such as corn and wheat produced on North Carolina farms becomes more expensive as a result of these taxes.
• Taxing inputs raises the price of productive capital investments, discourages the in-migration of capital from other states, and encourages North Carolina businesses to locate production facilities elsewhere.

3) Economic Growth: The Ultimate Cure for Poverty

The greatest antipoverty measure known to man is an innovative and expanding economy. Taxation takes resources out of the more productive private sector and diverts these resources to the public sector, which is less productive. Consider the following:

• Using estimates from previous General Assembly Fiscal and Budgetary Action reports, the “temporary” sales taxes have drained more than $1.46 billion from North Carolina’s economy since their originally scheduled sunset date of 2003.
• Keeping the state sales tax rate at its current level for another two years would cost taxpayers $544 million. This adds up to more than $2 billion taken out of the hands of North Carolina consumers, investors and entrepreneurs in just six years. This money could have been utilized by the private market to create thousands of jobs and raise overall wage rates.

Conclusion

• A 5 percent state EITC would cost taxpayers $67 million in FY2007-2008, but only provide an average disbursement of $6.75 a month for each recipient.
• The cumulative effect of renewing the temporary taxes has cost the state roughly 80,000 to 104,000 jobs.
• Keeping the state sales tax rate at its current level for another two years would cost taxpayers $544 million. This adds up to more than $2 billion drained from the state’s economy in six years.

A low rate of economic growth always disproportionately harms the working poor, who are at the margins of employment and job security. Instead of relying on high levels of taxation to fund an EITC, lawmakers should free up more money to private consumers, investors and entrepreneurs. This would create more job opportunities and more choices for North Carolina’s most needy families.