RALEIGH – The $50,000 business income tax deduction created by North Carolina’s General Assembly last year was intended to support small business and job creation, but a new report finds that the deduction is unlikely to do so – at a high cost to the state.
The deduction could ultimately cost North Carolina well above the estimated $336 million, pulling funds away from significant public investments, according to a new report from the Budget & Tax Center, a project of the North Carolina Justice Center. While the deduction is costly in terms of revenue lost, even at its maximum value of $3,875 it is unlikely to spur new hiring or enable any significant capital investment.
The 2011 budget included a deduction for the first $50,000 in non-passive income for businesses filing through the personal income tax. The types of businesses that can benefit from the deduction are primarily sole proprietorships, partnerships, or S corporations. Yet a recent study of businesses eligible for the deduction found that only 49 percent of non-passive, positive -income-reporting partners and S corporation shareholders were also employers, and just over half met the criteria for both a business and small business. Small businesses reported just 17 percent of their total and net business income, the report added, and only 1 in 5 met the IRS definition of an employer.
The actual monetary impact of this deduction on state revenue will not be known until April 2013, the report said, yet there is sufficient evidence to suggest that the cost of the policy may be more than the Fiscal Research Division’s estimate of $336 million. A micro-simulation model from the Institute for Taxation and Economic Policy (ITEP) showed a possible $552 million cost for the deduction. Even the estimated $336 million presents an extreme redirection of funds away from important investments that yield measurable short- and long-term economic returns, such as supporting early childhood education and closing the Medicaid shortfall.
In addition, the deduction disproportionately benefits high-income businesses and individuals, the report finds. According to the ITEP model, 70 percent of the tax cut goes to the top 20 percent of taxpayers with some net positive business income, with the remaining 31 percent of the tax cut spread out amongst the lower 80 percent of taxpayers.
“As North Carolina embarks on revenue modernization in 2013, it is critical that state policymakers review tax policies for their abilities to achieve important public goals,” said Alexandra Forter Sirota, director of the Budget & Tax Center. “The extension of the business tax deduction passed in 2011 only further contributes to North Carolina’s upside-down tax system and erodes the availability of revenue for other critical public structures with greater potential to yield long-term job creation.”