South Carolina Governor Offers Tax Swap

Cut the individual income tax and raise the gas tax—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 tax rate is a competitive disadvantage for the state. South Carolina’s top rate of 7 percent is 12^th 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 fees (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 tax 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 inflation, 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.

Follow Liz on Twitter @elizabeth_malm. Follow Jared on Twitter @JaredWalczak.

More on South Carolina here. More on road funding here.