Sunday, January 20, 2013

Civitas tax proposal and senior citizens

The proposal by the John W. Pope Civitas Institute to eliminate North Carolina's income, corporate, and franchise taxes and replace them with a new business tax, a transfer tax on real estate, and a higher and expanded sales tax has a curious omission.

The proposal acknowledges that the changes would be regressive--would reduce tax obligations for wealthy households that have extra money that they can save and increase obligations for poorer households that spend most of their money on consumption goods.

The proposal doesn't mention the impact on retirees--probably for the reason that retirees would suffer disproportionately.

Civitas has called for a "revenue neutral" reform, which means that each dollar in foregone income, corporate, and franchise tax revenue must be replaced by a dollar of new or increased tax revenue. There will be winners and losers. In general, people who currently pay a lot in income taxes will see their total tax obligations go down, while people who currently pay little (or nothing) in personal income taxes will see their total tax obligations rise.

Senior citizens and retirees fall into this latter category. The personal income tax in NC has many provisions that reduce the tax they pay.

First, NC excludes all Social Security retirement income from taxation. Because of a NC Supreme Court decision in Bailey v. State of North Carolina, the state also excludes income from many other state and federal retirement plans for people who had five years of creditable service before August 1, 1989. NC also has smaller exclusions for non-Bailey government retirement income ($4,000 per person) and for private retirement income ($2,000 per person).

Second, NC provides special deductions for seniors. Single seniors can claim an extra $750 deduction, while married seniors can each claim a $600 deduction. These deductions come on top of the regular personal exemptions of $2,500 each, and the standard deduction or any itemized deductions. Thus, most seniors only pay state personal income taxes after their incomes (excluding Social Security and some other retirement amounts) reach $6,250 if they are single or $12,200 if they are married.

Finally, retirement income itself tends to be lower than earned income. The retirement income for women is especially low. Even if retirees didn't have the favorable tax provisions, their tax obligations would be low. Also, retired people tend to spend a higher proportion of their income on consumption items (tend to dissave), so their exposure to the sales tax is relatively high.

Right now, poor seniors and seniors who are completely or mostly dependent on Social Security pay no state income taxes whatsoever. Because they don't pay income taxes now, they would not get any benefit from the elimination of the personal income tax. They would, however, end up paying higher sales taxes.

Consider a middle-income elderly couple, receiving $30,000 per year in Social Security income and $15,000 in other retirement income ($45,000 total). The couple pays no state income tax under NC's current laws. Suppose further that the couple spends a third of its income on items that are now covered by state and local sales taxes of 6.75 percent. The couple's total tax bill is $1,002.

Now consider what happens under the Civitas proposal. The income tax is eliminated, but this doesn't save the couple anything. The sales tax rate on items that the couple was already purchasing increases to 8.05 percent, raising the annual tax payment on those items to $1,195. But the Civitas proposal also expands the taxable base by approximately two-thirds. Assuming this applies to the couple, they would pay about $800 on newly taxed items and services. Overall, their total tax bill jumps by nearly $1,000 (nearly doubles).

Even seniors who have large retirement incomes could end up as losers under the proposal. For example, a couple with $50,000 in combined Social Security benefits and $25,000 each from the husband's and wife's private pensions ($100,000 total) who took the standard deduction, exclusions, and exemptions would only pay taxes on $33,800 of that income. Currently, that couple would pay $2,154 in personal income taxes (or less if they are able to itemize). Suppose that they too spend one third of their income on items that are currently taxable, making their current sales tax bill $2,228. Under the Civitas proposal, this high-income couple would save the $2,154 in personal income taxes but pay $2,200 more (assuming a two-thirds expansion in the taxable base) in sales taxes. Their net tax bill would increase by at least $46.

Last year when Kansas and Oklahoma considered similar ALEC-inspired proposals to eliminate personal income taxes and replace them with sales taxes, the reforms were blunted, in part because of  howls of outrage from seniors.

Much of the fervor that stoked the Tea Party came from seniors who were apoplectic about possible changes to their retirement health benefits. It's ironic that conservative legislators and institutions are now targeting seniors' purses and wallets.

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