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South Carolina Governor Offers Tax Swap

4 min readBy: Liz Malm, Jared Walczak

Cut the 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. and raise the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. —that was South Carolina Governor Nikki Haley’s message in her 2015 State of the State address.

Though there aren’t a lot of details yet, it’s no surprise that South Carolina’s income 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. rate is a competitive disadvantage for the state. South Carolina’s top rate of 7 percent is 12th highest in the nation, but also the highest among its immediate neighbors and surrounding regional states. Governor Haley was correct when she noted that “[South Carolina’s] 7% income tax rate stands out and puts [South Carolina] at a disadvantage.”

More specifically, Governor Haley prosed reducing the state’s top individual income tax rate from its current 7 percent to 5 percent over the next ten years. This would put South Carolina’s rate below both of its neighbors (North Carolina’s flat rate currently sits at 5.75 percent and Georgia’s top rate rings in at 6 percent).

A key feature of her plan, however, involves swapping a gasoline tax increase for an income tax reduction. That increased revenue from fuel taxes would go directly to road funding (though she explicitly noted that she’d only accept these as a packaged deal, in addition to changes to transportation funding administration).

As transportation funding continues to be an important issue for elected officials, it’s important to understand how roads are currently funded and how this system could be improved. As our colleague Joseph Henchman pointed out early last year,

The lion’s share of transportation funding should come from user feeA user fee is a charge imposed by the government for the primary purpose of covering the cost of providing a service, directly raising funds from the people who benefit from the particular public good or service being provided. A user fee is not a tax, though some taxes may be labeled as user fees or closely resemble them. s (amounts a user pays directly for a service the user receives, such as tolls) and user taxes (amounts a user pays, based on usage, for transportation, such as fuel and motor vehicle license taxes). When road funding comes from a mix of tolls and gasoline taxes, the people that use the roads bear a sizeable portion of the cost. By contrast, funding transportation out of general revenue makes roads “free,” and consequently, overused or congested—often the precise problem transportation spending programs are meant to solve.

On average, user taxes and fees only fund just under half of road spending in the U.S., with the remainder coming from federal aid and state and local general revenues. (We include the following in “user taxes and fees”: fuel tax taxes, motor vehicle license taxes, and highway charges, such as tolls.) In the 2012 fiscal year (the most recent data available), South Carolina funded 50.7 percent of state and local road funding with user taxes and fees, as show in the chart below (click to enlarge).

South Carolina’s gas tax is one of the lowest in the nation—amounting to only 16.75 cents per gallon. This is comprised of two separate pieces: a 16 cent excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. and 0.75 cents in inspection and environmental fees

When the 16 cent base rate went into effect in 1989, it was actually above the average state gas tax of 13.4 cents (note that this is a weighted average). Twenty-six years later, the average state gas tax stands at 28.9 cents per gallon, while South Carolina’s remains far below that at its current 16.75 cents. Had the 1989 rate been indexed to 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. , the current rate would be 30.5 cents. In other words, inflation has eroded away almost half of the tax’s value since the last change.

Governor Haley’s tax swap proposal would take a step to correct this problem by increasing the gas tax by ten cents (to 26.75 cents per gallon) over a three year period. Once fully phased in, the new gas tax rate would be almost identical neighboring Georgia’s and nearly twelve cents lower than North Carolina’s (at their current rates).

According to state economic advisers, the income tax cut component would reduce revenue by $1.8 billion per year once fully phased in, while the gas tax would bring in an additional $340 million per year upon full phase-in. The overall plan would reduce state revenues by $9 billion over the first decade. Thus far, Governor Haley has proposed spending reductions with projected savings of $5.5 billion over the decade.

Other proposals are pending in the legislature, where the reception of the Governor’s plan was mixed, with some of the Governor’s Republican allies adopting a cautious tone. The Governor’s bold approach surprised many observers, who thought the gas tax off the table and didn’t expect such a substantial income tax cut proposal.

We will continue to follow the issue and provide updates as more information becomes available.

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