The 2008 state budget revisions approved by the legislature Tuesday are a good example of the difficulties legislators face trying to tinker with the state tax code without upsetting the revenue structure.
Many lawmakers wanted to do two things in the upcoming budget: repeal the state's gift tax and expand the earned income tax credit for low-income families. They wound up approving both measures but delaying their implementation until 2010 – because making them effective immediately would have undermined support for other state services.
Repeal of the gift tax would have cost the state more than $18 million the first year, and expanding the earned income credit from 3.5 percent to 5 percent of the federal earned income credit would cost about $20 million. With revenue slowing as the economy cools, lawmakers simply delayed those tax breaks a year.
When the 2009 General Assembly convenes, lawmakers could increase or delete those tax breaks. But a better course of action would be taking another crack at restructuring the state's revenue system to better reflect the 21st-century economy and come closer to meeting the state's needs in education, transportation, public safety, courts and health care.
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The revenue system worked remarkably well for the manufacturing economy that prevailed in the 20th century, when textiles, tobacco and furniture were the key forces driving economic activity. And the legislature has sought to make sensible changes in incremental ways. But so far, wholesale revenue reform has eluded the best efforts of legislators, governors, nonprofit advocates and academics.
That leaves legislators trying to make a credible case for repealing the gift tax, for example, while boosting the earned income tax credit. There are arguments for each, depending on whether you think the state receives more benefit from cutting taxes for the wealthy or for low-income residents. The federal earned income tax credit has been effective in putting more money in the pocketbooks of low-income families, and the state earned income credit has begun to do the same.
The gift tax is a more complicated issue. It was created in part to discourage the wealthy from making large gifts to family members as one way to avoid taxes on their estates when they die. Without the state gift tax, levied on gifts of $12,000 or more, the wealthy could give larger gifts to their children or other relatives and thus reduce their eventual estate tax liability.
That may or may not fit into long-term state tax policy. It's hard to make that judgment because North Carolina has not had the political will to reassess its revenue system effectively and design one to meet the needs of state and local governments in the 21st century. Until it does, the annual urge to tinker with an outdated tax system will substitute for visionary leadership.