South Carolina Lawmakers Have Other Options for Achieving a Flat Income Tax

South Carolina lawmakers recognize the need for taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform to boost the state’s competitiveness and to benefit taxpayers. Now, a unified contingent of lawmakers together with Governor Henry McMaster (R) intend to have the Palmetto State join the flat tax revolution. Unfortunately, while the plan would implement a low, flat rate that is highly competitive with other states’ systems, it yields a significant tax increase for many households that have historically had very little liability in South Carolina.

In recent years, South Carolinians have seen individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rates decrease and brackets collapse. In 2022, the legislature reduced the top marginal rate to 6.5 percent and called for further reductions, subject to revenue triggers, to 6 percent (the current top marginal rate is 6.2 percent). This has helped South Carolina become the highest recipient of in-migration relative to population, gaining nearly 33,000 additional income tax filers in the most recent year for which data are available (2022).

Through H.4216, lawmakers are seeking a 3.99 percent flat individual income tax with revenue triggers for further reductions to 2.49 percent. The plan also decouples from the federal standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and personal exemption, replacing both with a complicated South Carolina Income Adjusted Deduction, which phases down at certain levels of taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. .

A flat rate of 3.99 percent represents an aggressive reduction but is feasible given recent General Fund surpluses. But the less generous deduction, paired with the rate applied to all income, leaves the state’s lowest-income residents with higher taxes—a non-neutral and unsound tax policy.

The current tax code features a standard deduction and exemptions that help protect the lowest-income residents. As income rises, taxpayers are subject to higher marginal rates of taxation. This is a disincentive for wealth creation and productivity which lawmakers seek to remove through the flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. . But substantially raising taxes on lower earners—even if their tax burdens would still be highly competitive in comparison to many other states—is a non-starter.

A 2023 study conducted by the state’s Revenue and Fiscal Affairs Office found that only 10 percent of tax returns accounted for 63 percent of revenue, with 44 percent paying nothing. South Carolina lawmakers are right to use the state’s healthy financial position to provide income tax relief and broaden the base. Under a lower-rate flat tax, higher-income residents will inevitably pay less, but lower-income taxpayers should not pay disproportionately more of their income in taxes to provide this relief.

Fortunately, lawmakers have options. In 2018, we published a road map with several paths that would make South Carolina’s tax code more competitive and pro-growth. Several of the options featured a flat individual income tax ranging from 4.75 percent to 5.2 percent. Our recommendations called for retaining a standard deduction of $12,000 (for single filers; double for married couples) and personal exemption, while also eliminating other income tax credits and freezing the earned income tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income rather than the taxpayer’s tax bill directly. at 2018 levels. Reforms of this nature help protect the lowest-income earners, while broadening the base to ensure that the wealthiest are not overly burdened.

Lawmakers should pair the above with well-designed triggers that would reduce the rate permanently when revenue targets are met. This would allow state officials to closely monitor the revenue impacts of the change and ensure stability for state and local coffers.

Flat taxes are attractive for a variety of reasons. First, they are simple—both for taxpayers and administrators—and remove the need to annually adjust multiple brackets for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . Revenue projections also become easier under a flat tax. Moreover, given the current economic uncertainty, a more cautious and pragmatic approach would be prudent, allowing the state to adjust to market realities without risking the state’s financial health.

For these reasons and others, lawmakers are right to enact a single-rate individual income tax. However, lawmakers should consider the full effects of the reform, ensuring that relief is not financed by shifting the tax burden to lower-income individuals and families.

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