In North Carolina, it literally pays for residents to consult the state’s tax code before deciding whether to engage in some activities and stay away from others. That’s a sign of a tax code in need of reform, according to Roy Cordato, a Ph.D. economist and the John Locke Foundation’s vice president for research and resident scholar. Cordato discussed tax reform with Donna Martinez for Carolina Journal Radio. (Click here to find a station near you or to learn about the weekly CJ Radio podcast.)
Martinez: The tax code is a bunch of do’s and don’ts, and you say that’s poor public policy – that it’s bad for everybody. Why?
Cordato: Well, the purpose of taxes is to collect money so the government can do what I believe its proper function is – to protect rights. And we have a tax code in North Carolina, which, in large part, influences all kinds of behavior. And taxes, from an economic efficiency standpoint, and from a liberty point of view, should be neutral with respect to people’s decision making, to the extent possible. It should not impact whether people pursue one kind of investment over another, whether people save relatively more of their income or relatively less of their income, which is what our tax system does. It penalizes saving and investment, rewards consumption. Some kinds of behavioral activities – [it] penalize smokers, things like that. So, the fact is that policy should be – tax policy – should be neutral with respect to people’s decision-making.
Martinez: Roy, you also say that the way the system is put together now – that it actually ends up retarding economic growth in this state. How does that happen?
Cordato: Well, first of all, as I just mentioned, the way the income tax is set up is, it double taxes or penalizes saving, investment, entrepreneurship, and so on. And it does that by taxing the returns to saving or the returns to investment, returns to entrepreneurship, twice – and taxing the returns to consumption only once. So what happens is that when you tax a person’s income and then, say, if a person saves part of that income, you tax the returns on that, you are essentially double taxing those returns because you are reducing those returns when you tax the income in the first place.
Martinez: How did we get to this point in North Carolina? Are we typical of other states?
Cordato: Yes, we’re typical of states that have an income tax, and the same problems plague the federal tax system. That’s, in large part, one of the reasons why we’re in this predicament. North Carolina and most other states, although not all, tend to mimic the federal tax code, although the federal tax code is actually better than North Carolina’s. For example, North Carolina taxes capital gains the same as it taxes all other income. At least at the federal level, there’s a differential in capital gains. The bias against capital gains-earning investments is less in the federal tax code than it is in North Carolina’s tax code, and that’s because there is a differential. And there are certain kinds of things built into the federal tax code that North Carolina has not embraced, which makes it actually worse than the federal code.
Martinez: Roy, just based on your description of how complex this gets and how some things are [encouraged] and other things are discouraged, I guess that’s why we all have to have someone prepare our taxes for us.
Cordato: That’s right. It makes it very complicated, and complexity is another problem. I mean resources – lots of resources – should not be expended in having to comply with the tax code. That is what economists call a dead weight loss to society and to the economy, meaning these are resources that are not going to productive activities. They are essentially going to comply with the law. So simplification is another big issue in tax reform.
Martinez: Before we get to your recommendations for reform, Roy, which are really important, let’s talk very quickly about where the tax revenue comes from in this state. You mentioned individual income tax, but revenue comes in, in a couple of other ways. Sales tax, corporate income tax, and then everything else?
Cordato: Sure. The two big ones are the income tax and the sales tax. But corporate income tax is next. And we have, I believe, the highest corporate income tax in the Southeast. We’re at 6.9 percent.
Martinez: Now isn’t that a discouragement, then, to a business to actually move to this state?
Cordato: That’s right. It’s one of the ways in which the state of North Carolina penalizes entrepreneurship and investment, and that is through a high corporate income tax. And the fact is that we really shouldn’t have any corporate income tax. Corporations do not pay taxes. Besides being a tax on investment, it is a hidden tax because corporations are a legal entity. Legal entities can’t pay taxes. Only people can pay taxes. So every dollar that, quote, “a corporation pays” has to come out of somebody’s pocket. And that “somebody” will either be workers or customers in the form of higher prices, or shareholders in the form of smaller dividends. So corporations, per se, do not pay taxes; all the taxes are paid by one of those three entities. And people don’t realize it because their wages are lower, their prices are higher, or their dividends are lower. Because of that, it’s actually a dishonest tax.
Martinez: Now we also mentioned the sales tax, which we all pay when we go out and buy things in the marketplace. And then the other category – sin taxes – get thrown in there, do they not, where you’re talking about alcohol, cigarettes, these specialty taxes.
Cordato: Yes, and those are on the table right now in North Carolina. For some reason, Governor Perdue, for example, and probably the House and Senate, are going to do the same thing. And that is, try to balance the state budget on the backs of smokers and people who want to consume a beer while watching a basketball game.
Martinez: Uh-oh.
Cordato: Why? They deserve to be punished. And this is part of my point. I mean, it’s a matter of penalizing some behavior and rewarding others. But look, if the state has to balance the budget, why shouldn’t that be evenly spread among all taxpayers? Why do we single out a couple? I think it’s because they’re easy targets. You know, smoking is evil, so the people who smoke must be evil, so why don’t we make them shoulder the burden of the state’s tax debt.
Martinez: And thus the moniker “sin taxes.” Well, Roy, what do we do about this?
Cordato: Well, I think the state needs a major overhaul. I think, at the income tax level, we should adopt what’s called a consumed income tax, which is basically treating all savings like we do with IRAs. Anything that’s saved, people can deduct from their taxes, and when they take that money out of a savings account or cash in a bond or whatever, then they’re taxed on it, much like IRAs are, except without a penalty for early withdrawal. There would be no age limit on it. This is called the consumed income tax. That reduces the bias against entrepreneurship and saving and investment. In general, we should be moving towards consumption taxes and get away from sin taxes and income taxes and that sort of thing.
Martinez: All these do’s and don’ts. You want them gone.
Cordato: Yes.