North Carolina’s tax system needs radical reform to maximize prosperity and minimize harm to individual liberty. That’s the theme of the John Locke Foundation’s latest Macon Series Policy Report.
“The state’s current system of taxation aggressively interferes with individual liberty and retards economic growth,” said report author Dr. Roy Cordato, JLF Vice President for Research and Resident Scholar. “The existing tax system rewards some activities and penalizes others without any sound economic basis. It places multiple layers of taxation on certain kinds of activities, such as interest income, dividends, and capital gains. It also promotes forms of taxation — such as the corporate income tax — that are completely hidden from those who pay the tax.”
Cordato is releasing his report as some legislators push for tax changes that would take away freedom, rather than promoting it. “The state tax code does not need new taxes on cigarettes, alcoholic beverages, or other products these legislators don’t like,” he said. “The state should repeal separate sales taxes for these items, as well as taxes on restaurant meals and soft drinks.”
Lawmakers should focus on more than just the amount of revenue particular taxes generate, Cordato said. “Taxation inherently interferes with both personal freedom and economic decision-making, so policymakers need to be vigilant about how revenues are collected,” he said. “Some types of taxation are more damaging to freedom and prosperity than others.”
Cordato urges lawmakers to adopt the “liberty principle” as they consider tax reform. “The liberty principle stands in direct opposition to the redistributionist principle,” he said. “The redistributionist principle says the more people earn, the greater proportion of their income should be paid in taxes. There’s no relation to the benefits received from taxes, and there’s no indication that any level of taxation is too high.”
“In stark contrast, the liberty principle focuses on minimizing the extent to which the tax system interferes with individual freedom or the ‘pursuit of happiness,'” Cordato added. “This liberty principle is consistent with the North Carolina Constitution. Article I, Section I of that document lists our inalienable rights, including the enjoyment of the fruits of our own labor.”
This right guarantees other inalienable rights, Cordato said. “To the extent that we are denied the right to make use of the fruits of our labor — our incomes — we are denied our rights to life, liberty, and the pursuit of happiness.”
The implication for tax reform is clear, Cordato said. “North Carolina’s tax system should interfere as little as possible with individual decision-making, both personal and economic, and it should strive to keep the tax burden as low as possible.”
In contrast with that goal, North Carolinians now pay higher tax bills than residents of many neighboring states, Cordato said. “The Tax Foundation in Washington, D.C., says North Carolina taxpayers pay 9.8 percent of their income in state and local taxes,” he said. “That’s higher than the national average of 9.7 percent and well above the average for the Southeast region and for the states that compete with North Carolina for new industry and new investment.”
Boosting prosperity and freedom requires a tax system that emphasizes “neutrality and simplicity,” Cordato said. “By neutrality, we mean tax policy should strive neither to penalize nor favor taxpayers’ decisions about how much time to work versus pursuing leisure activities, how much money to save or invest versus how much to spend, what kinds of goods and services to purchase, and what kinds of investments to make.”
A simpler tax code would help taxpayers avoid spending a great deal of time or money ensuring compliance, Cordato added. “Ideally, there is no reason why a typical taxpayer should have to hire a professional to fill out tax forms.”
Increased transparency would also improve the state’s tax system, Cordato said. “There’s no reason why any tax should be hidden from the people paying it,” he said. “The tax system should serve the function of making it clear to people how much they pay for the services their government provides them. For example, the state should consider eliminating income tax withholding.”
Cordato’s report focuses most of its attention on the N.C. income and sales taxes, the “cornerstones” of the state’s tax system. Individual and corporate income taxes plus sales taxes generate more than 80 percent of the revenue for North Carolina’s General Fund, he said.
Each of these taxes needs changes, Cordato said. “The income tax penalizes work effort, saving, investment, and entrepreneurship,” he said. “North Carolina’s tax rates and progressive rate structure cause particular problems compared to neighboring states. That’s not to mention a corporate income tax that adds extra layers of taxation and hides taxes from the workers, customers, and corporate stockholders who pay the bill.”
Cordato recommends changes. “The best option is to follow the lead of states like Florida and Tennessee and abolish North Carolina’s income tax,” he said. “If that’s not possible, policymakers should strive to keep rates low and avoid progressive taxation. If some progressivity is seen to be a political necessity, it should be accomplished with a ‘zero tax bracket.’ That means charging no tax up to a certain level and then charging a flat rate on all additional income.”
Another approach would be to move toward a “consumed income tax,” Cordato said. “In this approach, taxes would kick in only when income is spent. All other forms of taxation related to income would be abolished — especially the corporate income tax.”
The sales tax requires less tweaking, but North Carolina taxpayers would benefit from changes such as lower rates, Cordato said. “The state should also repeal so-called ‘sin taxes,’ and it makes sense to exempt businesses from sales tax on any purchases related to the provision or production of their products.”
Adopting these ideas would help align North Carolina’s tax system more closely to basic principles of tax policy, Cordato said. “That’s a good goal to pursue, since the current system is an incoherent hodgepodge of penalties and subsidies that unnecessarily infringes on personal liberty and causes the state to be much less prosperous than it otherwise could be.”
The Nathaniel Macon Research Series generates annual papers from JLF analysts. The Macon Series applies free-market principles to current N.C. controversies. Its papers examine whether N.C. fiscal and regulatory policies help or hinder individuals as they seek to create or expand economic opportunities.