Refundable tax credits would be a credit to N.C.

RALEIGH -- Nothing is certain in life except death and taxes. Benjamin Franklin's adage was accurate when he penned it two-and-a-half centuries ago, and it's still accurate today. Everybody will eventually die, and everybody will pay taxes in the meantime.

A look at some North Carolina data confirms the accuracy of Franklin's observation. Everybody pays. Under current law, the poorest North Carolinians (households with incomes well below the poverty line) pay over 10 percent of their annual incomes in state and local taxes combined (income taxes, sales taxes and property, excise, energy taxes, etc.).

If any group of individuals comes closer to avoiding Franklin's law in modern North Carolina, it's the rich. Once various deductions are applied, the wealthiest 1 percent of households pay only about 6 percent of their incomes in state and local taxes.

Unfortunately, elected officials are acting as though Franklin's timeless rule has become obsolete. Not only are lawmakers seriously considering a proposal to cut income taxes on the rich, they're resisting the adoption of a special tax credit to help the poor called a refundable earned income tax credit, or EITC.

The hesitance concerning the refundable EITC appears to be a simple matter of failing to grasp the modern applicability of Franklin's law: Legislators think the poor don't pay taxes. They are incorrect.

With a refundable EITC, very low income families can actually receive more back on their income tax refund than they paid to the state in income taxes. This has led some to label the EITC "welfare." The concern is that the state would somehow be providing the poor with a free handout.

As the numbers above remind us, however, this concern is unfounded. While poor families might end up ahead with respect to their state income tax liability, the credit refunds only some of the other taxes they have contributed to state and local coffers.

Poor people will still pay a sizable portion of their incomes in state and local taxes even after they receive their refundable EITC. Franklin's law will be honored. And the federal EITC, enacted more than 30 years ago, has always been refundable and has won the support of both political parties.

The refundability issue is also critical to making the EITC serve its intended purpose of assisting very low income working families. A non-refundable EITC would provide no benefit to families below a certain income level, because they are already excused from paying income taxes (but not, as we've learned, many other kinds of taxes). As a practical matter, therefore, a non-refundable EITC would benefit only a relatively small group of lower-middle income taxpayers -- at most 125,000 North Carolinians, according to the General Assembly's Fiscal Research Division.

While this is a worthy group, a refundable EITC could benefit 825,000 people, or 700,000 more -- almost all of them people with very low incomes. For example, a family of four with an income of about $20,000 per year (roughly equal to the official poverty level) would fare much better with a refundable EITC.

In addition, the difference in the cost of the two proposals is only about $40 million annually. This is much less than the cost of a proposed income tax cut for the wealthiest North Carolinians that's currently on the table. That proposal would benefit only about 60,000 of the state's wealthiest people at a cost of more than $90 million per year. The refundable EITC set at 5 percent of the federal EITC (as passed earlier this year by the state House of Representatives) would cost the state about $69 million per year and would help nearly 14 times as many people -- all of them much more deserving of a tax break.

Of the 20 states that have adopted EITCs, 16 have made them refundable. The latter group has enjoyed the simplicity and ease of administration that comes with mirroring the federal model. While four states have chosen the nonrefundable route, some have already found such a system wanting. A recent University of Delaware study concluded that Delaware's nonrefundable EITC "generates distributional impacts that do not appear well-conceived or well-designed." In other words, a large proportion of deserving people are ineligible.

As lawmakers turn for home in the 2007 legislative session, they would do well to keep a couple of simple rules in mind when contemplating their tax cut plans: Rule No.1 -- Ben Franklin was right. Everybody, particularly the poor, pays taxes. Rule No. 2 -- Not even a refundable state EITC can change Rule No. 1.

(Rob Schofield is director of research and policy development at N.C. Policy Watch.)