Permanent Tax Cap Would Limit Future Investment in Early Childhood

A constitutional amendment passed by the NC Senate and currently being considered by the NC House would restrict future state revenue, limiting the funding available for investments in the state, including in early childhood. The amendment—to cap the income tax rate at 5.5 percent—would take away future legislatures’ flexibility to adjust state revenues to support investments in child- and family-serving systems.

How does NC’s tax system currently work?

At one time, North Carolina had a graduated income tax structure that ranged from 6 percent to 7.75 percent. Higher earners paid a higher percentage income tax rate than lower earners. That was changed by law in 2013 to a flat tax, meaning everyone pays the same income tax rate, regardless of income level. North Carolina’s current flat income tax rate is 5.499 percent of taxable income.1

The state’s income tax rate is currently capped in the NC Constitution at 10 percent, which means the legislature cannot raise the income tax rate to more than 10 percent of taxable income. This measure would lower that cap to 5.5 percent, about the current rate.

If the new cap is the same as the current rate, then why does this matter?

The new proposal is a Constitutional amendment, which is a more or less a permanent change. If future legislatures need to raise revenues to support investments, they will not have the authority to do so. The amendment would lock in via constitutional amendment tax cuts that were made in 2013 when the flat tax was introduced.

Tax laws – such as the law that shifted NC from a graduated tax to a flat tax in 2013—can be repealed or adjusted by future legislatures as needed, as state investment requirements change. If NC has a natural disaster or more rapid population growth than expected, future lawmakers can make the changes needed to address those challenges. Amending the NC Constitution, however, requires a three-fifths majority vote in both the NC House and NC Senate, and then a majority of the popular vote. This is a high bar. If the amendment passes, future legislatures will not have the flexibility they may need to support essential investments in early childhood.  

What are the long-term effects of this proposal?

In the long run, a 5.5 percent cap on the income tax rate could limit NC’s ability to fund essential services for children and families. Costs for health, early intervention, family supports, early childhood education and K-3 education increase every year, and may exceed capped revenues. For example, for several decades, health care costs have risen faster than general inflation.2

The change would also shift more of the tax burden onto low-income families. In 2016, 50 percent of North Carolina’s tax revenue came from income taxes, just under 43 percent came from sales taxes, 7 percent came from license fees, and less than a percent came from property taxes and other taxes.3 Over the long term, a cap on the income tax rate can force a shift in that ratio—as income taxes bring in less revenue and are no longer able to support essential services, lawmakers must increase sales taxes and fees to help make up the difference. That shifts the burden of state investments away from higher-income taxpayers and onto lower-income taxpayers, since lower-income earners pay a larger percentage of their salaries in sales taxes than higher-income earners do.

So what happens next?

The bill – Senate Bill 75 – was passed by the Senate in 2017 and approved last week by the House Finance Committee. The bill heads now to the House Rules Committee. If passed by the House, the constitutional amendment would go to the voters in November. If a majority of voters vote “for” on the statement: “Constitutional amendment providing that the rate of tax on incomes shall not exceed five and one-half percent (5.5 percent),” the amendment would go into effect.

Overwhelmingly, North Carolina’s citizens and lawmakers support investments in early childhood. Reducing the income tax rate cap in the NC constitution would make it that much harder to raise revenues to meet the future needs of North Carolina’s youngest citizens.