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John Hood's Syndicated Weekly Column

Real Story on NC Business Taxes

Feb. 20th, 2004
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RALEIGH – It’s official, according to a much-touted new study: North Carolina’s mining and oil industries are smaller than Alaska’s.

Well, actually that’s not how the study in question, conducted by the accounting firm Ernst & Young for a group called the Council on State Taxation, was recently spun by Gov. Mike Easley, newspaper editorialists, and others trying to tamp down talk of North Carolina’s self-inflicted tax woes. They said that the Ernst & Young/COST study showed “business taxes” in North Carolina to be among the lowest in the nation.

“Our overall tax burden keeps business costs low in our state,” Easley said in a Feb. 13 statement. Weighing in a few days later, The News & Observer of Raleigh argued the study undercut Easley’s critics, including Republican candidates for governor, who say a different policy is needed to stimulate growth and job creation. “Starting that discussion with a push for tax cuts would be like calling a taxi for a ride across the Atlantic,” the newspaper editorialized. “Not only will a cab fail to get us where we’re going, but we’ll miss the boat while we wait for it.”

Talk about missing the boat. The Ernst & Young study is, to put it simply, preposterous. It offers North Carolina policymakers no useful guidance at all in fashioning fiscal or economic policies. Common sense alone should have hoisted some red flags about a report suggesting that Texas, Florida, Wyoming, and “Live Free or Die” New Hampshire imposed a higher tax burden on business than did Massachusetts, Connecticut, or California.

But common sense was obviously lacking both in the study’s authors and in the politicians grasping desperately for vindication. A closer look at the study reveals some of its most-glaring flaws.

For one thing, the authors decided that individual income taxes and most retail sales taxes were not “business taxes.” Really? This might come as a bit of a shock to executives and investors whose business investment decisions are affected by the capital-gains tax, to retailers trying (and often failing) to pass along increases in sales taxes to their customers, and to small businesses – who account for half of North Carolina employment and 80 percent of net job growth in recent years – that are mostly unincorporated and thus pay tax on their profits via individual-income taxes.

Excluding these major sources of revenue yields perverse results. States with low overall taxes but a high concentration of land-intensive or extractive industries, such as oil, mining, ranching, and agriculture, rank poorly on the Ernst & Young’s list. Obviously, the fact that Texas oil companies pay a lot of property tax has little to do with whether manufacturers, professionals, or financial-services firms will face a higher tax burden in Houston than they will in Boston, Hartford, or Charlotte. More generally, states with a heavier reliance on income and sales taxes, like North Carolina, look artificially attractive if you exclude these taxes from your analysis.

Other, more useful studies truly do examine all taxes affecting business activity and economic growth. A 2003 ranking by the Tax Foundation put North Carolina near the middle of the pack nationally and near the top in tax burden among Southeastern states. Another report from the Small Business Survival Committee, which puts particularly emphasis on marginal tax rates, ranks North Carolina costs as far above that of any other state in the region and among the costliest in the nation for entrepreneurs creating new enterprises and employment opportunities.

It bears repeating at this point that the amount of taxes collected in North Carolina, even when adjusted for population or income, does not capture the full extent of the problem. What matters most in economic decisions are marginal rates – that is, rates on the next dollar an investor, worker, or customer will spend or receive. States with relatively high marginal rates, and North Carolina imposes some of the highest tax rates in income in the United States, can end up collecting relatively low revenues per person precisely because their punitive taxes shrink the size of the economic pie.

I’m not arguing that, taking all forms of taxation into consideration, North Carolina is one of the nation’s highest-taxed states. We are roughly in the middle, which is bad news since we were a low-tax state not too long ago and are in a region that continues to boast many low-tax states. The best available data and research on why state economies grow make the case for tax cuts as an effective way to boost North Carolina’s languid economy.

The Ernst & Young study is not among the “best available.”

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Hood is president of the John Locke Foundation, publisher of Carolina Journal.com, and host of the statewide program “Carolina Journal Radio.”