South Carolina’s Flat Tax Ambition: Opportunity and a Pitfall for Low-Income Earners 14

South Carolina lawmakers are rightly pursuing tax reform to enhance the state’s economic appeal and benefit its residents. A unified effort, spearheaded by Governor Henry McMaster, aims to introduce a flat income tax, joining a growing national trend. While the proposed low, single rate promises strong competitiveness, the current plan risks increasing taxes for many lower-income households who have historically had minimal tax liability in the state.

South Carolina has already made strides in income tax reduction, lowering the top marginal rate to 6.2 percent after a 2022 cut and further reductions tied to revenue targets. This has contributed to the state’s impressive in-migration, attracting nearly 33,000 new income tax filers in 2022.

House Bill 4216 proposes a 3.99 percent flat individual income tax, with future reductions to 2.49 percent contingent on revenue triggers. However, it also suggests eliminating the federal standard deduction and personal exemption, replacing them with a complex South Carolina Income Adjusted Deduction that phases out at higher income levels.

While a 3.99 percent flat rate is an ambitious yet potentially achievable reduction given recent state budget surpluses, the less generous deduction structure, applied uniformly, could lead to higher taxes for the state’s lowest earners. This outcome would create a non-neutral and regressive tax policy.

Tax code

The existing tax code’s standard deduction and exemptions serve to protect those with the lowest incomes, while higher earners face increasing marginal tax rates. The proposed flat tax seeks to remove the disincentive for wealth creation inherent in progressive rates. However, significantly raising taxes on lower-income individuals to facilitate tax cuts for higher earners is a problematic proposition.

A 2023 state study revealed that a small percentage of high-income earners contribute the majority of the state’s income tax revenue, with a significant portion of filers paying no income tax. While broadening the tax base under a lower flat rate is a sound goal, it shouldn’t disproportionately burden lower-income taxpayers to provide relief at the top.

Fortunately, alternative approaches exist. A 2018 analysis outlined several competitive and pro-growth tax reform paths for South Carolina, including flat tax options ranging from 4.75 percent to 5.2 percent. These recommendations emphasized retaining a standard deduction and personal exemption while eliminating various tax credits and freezing the earned income tax credit at 2018 levels. Such reforms can protect lower-income individuals while broadening the base without unfairly increasing their tax burden.

Lawmakers should also incorporate well-designed revenue triggers to ensure the flat tax rate is reduced permanently and responsibly as the state’s finances allow. This cautious approach would enable the state to adapt to economic fluctuations without jeopardizing its financial stability.

Adopting a single-rate income tax offers simplicity for both taxpayers and administrators and streamlines revenue projections. However, South Carolina lawmakers must carefully consider the full implications of their reform, ensuring that the benefits of a flat tax are not achieved by shifting the tax burden onto the state’s most vulnerable residents.