MOST PEOPLE would rather pay a 5 percent state income tax than a 7 percent tax. And that’s the very simple logic behind Gov. Nikki Haley’s tax plan.
But what if the 5 percent tax was on 75 percent of your income, and the 7 percent tax was on just 50 percent of your income?
If you like numbers, you’ve already recognized that the 7 percent tax would cost you less, and no matter how you feel about numbers, you’re probably wondering why I would raise such a bizarre, left-field question. Well, that’s the dirty little secret about comparing state income tax rates: Every state taxes a different amount of your income.
This isn’t simply — or even mostly — because different states allow you to deduct different expenses, or offer different tax credits. It’s because they give more or less credit for being a taxpayer, for having a child, and so on. They even use different starting points for calculating your taxable income.
The result is that even though South Carolina’s 7 percent top income tax rate is indeed the highest in the region and 12th highest in the nation, the percent of our income that South Carolinians actually pay in income taxes is nowhere near the top.
According to the latest version of a study done every few years by South Carolina’s chief economist, the tax that South Carolinians actually pay is on average just 3.1 percent of their income, or less than half of that top rate. That’s lower than what people pay in 32 states. Among those who pay a higher effective tax rate are Georgians, at 3.7 percent.
Unfortunately, I can’t give you North Carolina numbers, because our neighbor to the north lowered its top rate to 5 percent since the last study was done. What I can tell you, though, is that 19 of the 27 states that have lower top rates than South Carolina actually collect a larger percentage of residents’ income than South Carolina does.
What’s even more instructive, if we want to make our state more attractive to tax-shoppers without crippling our ability to provide the quality of life that newcomers expect, is why there’s such a huge difference between our tax rates on paper and our tax rates in practice.
Before we go any further, let’s make sure we understand the numbers. First, our effective tax rate is not low because of the 1.1 million South Carolinians who make too little money to pay state income taxes, and therefore would derive absolutely no benefit from lowering the top income tax rate. S.C. Chief Economist Frank Rainwater didn’t include those people in his study. Instead, he compared the total state income taxes collected in each state to the total federal adjusted gross income that each state’s residents reported to the IRS — that is, how much of everyone’s federal adjusted gross income got taxed by their states.
Federal adjusted gross income is total income minus a few selected deductions, including medical expenses and 401(K) contributions. A column in Sunday’s paper mistakenly said that it was income after personal exemptions and deductions are subtracted.
Next, federal adjusted gross income is not what you make; it’s your income minus a few selected deductions, including medical insurance and 401(K) contributions. Depending on how much you make and how you spend it, this can be significantly less than what you make. For example, my adjusted gross income for 2013 was only about three-quarters of my total income; and my federal taxable income, which we’ll get to in a moment, was barely more than half of my total income.
Now, getting back to why the amount that South Carolinians pay in taxes is so much less than our tax rate. What Mr. Rainwater discovered was that South Carolina is an outlier on three measures: The super-sized personal exemptions and the super-sized standard deductions that we offer on top of the federal exemptions, and the fact that South Carolina does not tax the first $2,760 in federal adjusted gross income. Add that $2,760 to an $11,600 standard deduction and personal exemptions of $3,700 per person, and a family of four pays no S.C. taxes on the first $29,160 of their federal adjusted gross income. That’s a larger exemption than any other state allows, and nearly double the national average.
What that means is that we could lower our rates significantly and still collect the same amount of money by, say, cutting our personal exemptions in half, or eliminating our standard deduction, as some states have done.
Or we could simply change the starting point, and let South Carolinians write down their federal adjusted gross income on the first line of their state tax return, like many states do, instead of their lower “taxable income.” That would allow us to lower our rates, and still generate the same amount of revenue, from the same people.
That’s not going to satisfy people who are convinced that South Carolinians are overtaxed. But the fact is that all sorts of studies by organizations that don’t care where South Carolina ranks have demonstrated that we are taxed less than people in most states, and specifically that we pay less of our income in income taxes than people in most states.
So if we’re looking for a way to address the perception problem that very well might make it more difficult for us to attract desirable new residents and businesses, there’s a pretty simple way to do that — without further diminishing the government services that those new residents and businesses expect.
Ms. Scoppe can be reached at email@example.com or at (803) 771-8571. Follow her on Twitter @CindiScoppe.