RALEIGH — Efforts are under way to make North Carolina the first state since Alaska in 1980 to eliminate taxes on total personal income. Competing proposals also would launch a pro-growth tax reform renaissance that would scrap corporate income taxes that discourage capital investment and savings.
The John Locke Foundation introduced a plan Wednesday including those elements, along with a repeal of estate taxes and the retail sales tax at the state level. Researchers at the Tax Foundation, a nonpartisan Washington, D.C-based tax research group, are among those lauding the JLF plan.
“The whole point is economic growth. It’s not just to reform the tax code for the heck of it. It’s to get rid of a major drag on the economy,” said Roy Cordato, vice president for research and resident scholar at JLF. An independent review of the plan concludes it has the potential to create 80,500 new jobs and increase the state’s economy by $11.76 billion in the first year.
“Our main plan gets rid of the [state] sales tax also. We replace all of the state’s major tax sources of revenue. We think we get rid of the ones that are most damaging to the economy and replace them all with this Unlimited Savings Account plan, which is our term for it, the USA tax,” Cordato said.
“It’s a consumption tax” or consumed income tax and would be levied at a flat 8.5 percent of money withdrawn from the account for taxable purchases, Cordato said.
“North Carolina officials are asking the right questions and they’re heading in the right direction,” said Joe Henchman, vice president of legal and state projects at the Tax Foundation.
The foundation was asked by the Carolina Business Coalition to evaluate the state’s tax structure and propose alternatives options. It will issue a report next week.
Republican Gov. Pat McCrory and Senate leader Phil Berger, R-Rockingham, have expressed interest in taking up tax reform early in this session of the General Assembly.
State Sen. Bob Rucho, R-Mecklenburg, is exploring with the Raleigh-based Civitas Institute a separate tax reform plan drawn up by Arthur Laffer, an economist who championed supply-side economics during the Reagan era.
The JLF plan would plow new ground.
“It’s something that’s taught to students and it’s in the books on the theory of income tax. But it would be brand new if it were to be implemented in North Carolina,” Henchman said of the consumed income tax. “I think the theory is sound.”
The Civitas model would eliminate the personal and corporate income taxes, and the business franchise tax.
In their place would be a state retail sales tax assessed at a rate of 6.53 percent instead of the current 4.75 percent. The sales tax would be expanded to include all services currently taxed in at least one state and would close loopholes that give preferred rates to some goods. In addition, there would be an expanded 1 percent tax on commercial and residential real estate transactions, and all businesses would be levied a business license fee, similar to the current franchise tax but assessed at a much higher rate.
The business license fee would be, by far, the highest in the nation and generate some $4 billion, according to the Tax Foundation. That would represent nearly 22 percent of the $18.5 billion in state tax revenue collected in the 2011-12 fiscal year. Tax Foundation data say North Carolina generated only 6 percent of its revenue in 2010 from corporate income taxes.
The idea behind both the JLF and Civitas plans “is to reduce the tax burden on investment and job creation, and there’s plenty of economic evidence tying taxes on capital, taxes on economic activity, to lower economic growth,” Henchman said.
He views both plans as workable “for the most part” and suggests both would achieve “very similar” pro-growth results. He declined to state which plan he would prefer.
JLF consumed income tax
Economist Steve Entin, who reviewed the proposals being pitched in North Carolina, said he favors JLF’s consumed income-tax plan.
“If I were king for the day, I’d have the federal government go to a consumed income tax and have North Carolina piggyback on that,” said Entin. He is former president and executive director of the free market public policy organization Institute for Research on the Economics of Taxation. Prior to that he was deputy assistant secretary for economic policy at the U.S. Treasury Department, and was a staff economist with the Joint Economic Committee of Congress.
The consumed income tax is “a little problematic because the feds don’t have one” so new tax-return forms will need to be created, Entin said. “That would be “an administrative quirk.”
Henchman agreed, and said the JLF plan needs more detailed information about how the USA tax would be administered.
The “drawback” to the Civitas plan, Entin said, is the business license tax, which he views as a property tax that “can chase business right out of the state” because companies would be stuck paying it whether they have a good year or a dismal year.
“I’m a little leery of that portion of the Civitas proposal,” he said. “It seems to me the consumed income tax … would be the better thing.”
Henchman also raised red flags about the Civitas business license fee.
“How they see it is a tax on business assets, manufacturing, equipment and so forth, which is similar to the existing franchise tax,” he said. But it would be raised from the current 0.15 percent to 1.05 percent and broaden the tax to all businesses, not just the C corporations that are generally large companies taxed separately from their owners. Every business would pay at least $500 annually.
“This would be the highest rate anywhere. It would raise about $4 billion a year. The franchise tax right now raises about $700 million,” Henchman said.
“We call them capital stock taxes, but they call them franchise taxes in North Carolina. Right now the highest [rate] is in Connecticut, and that’s 0.31 percent,” Henchman said. That means North Carolina’s would be more than three times higher.
Need to build capital
“The way I look at it is the South’s historic problem economically is being able to accumulate capital and investment,” Henchman said. “The Civitas plan, on one hand, gets rid of the [personal] income tax and the corporate income tax, and that gets rid of a lot of obstacles” to building capital and investment.
But the business license fee “will deter a lot of investment,” he said. “The goal of tax reform in North Carolina is to create a tax system that doesn’t discourage capital formation.”
Brian Balfour, a Civitas policy analyst, argued that the study supporting the Civitas plan shows major benefits.
“One of the things they did in the study that I thought was interesting was to remodel the trajectory of North Carolina’s economy since 2000,” Balfour said.
“If we had used this new tax plan instead of the tax plan we actually had in place, they found, for instance, total personal income in the state would be as much as $25 billion more,” Balfour said. “Job growth would have been as high as 378,000 more relative to what we have today.”
Regardless of which reform approach gains favor — both are designed to be neutral — he believes there will be stiff opposition.
“I suspect it will be largely partisan,” Balfour said.
“There’s a couple differing kind of political philosophies on taxation. The left side of the aisle often looks at personal income tax as welfare redistribution [that] enables a social goal they have for evening out income,” Balfour said. Liberals “are going to fight really hard to preserve that.”
Dan E. Way (@danway_carolina) is an associate editor of Carolina Journal.