RALEIGH – According to the Triangle Business Journal, special state tax credits for renewable energy, research & development, and capital purchases reduced North Carolina’s corporate-tax collections by nearly a quarter of a billion dollars last year.
Given that total revenue from the corporate income tax in FY 2011 was only about $1 billion, you can see how sizable a role these tax credits play in the system. They are not the only ones. North Carolina’s tax code is riddled with special credits, exemptions, and other preferences – many of them intended to make the state more competitive in national and international markets.
To be blunt, the entire enterprise is simply not worth it. The cost of compliance are high, the revenue generated is relatively low, and the distortions of North Carolina’s economy are myriad. To tax income first at the corporate level and again when shareholders receive their returns as dividends or capital gains is to encourage households to spend rather than save and to encourage companies to finance their operations with tax-deductible debt instead of taxable equity.
That’s why the corporate income tax doesn’t need to undergo yet another round of reform. It doesn’t need to be offset by additional, targeted tax credits or other schemes to lighten the load for politically favored businesses at the expense of other businesses.
As part of a broader tax reform, North Carolina should phase out its state tax on corporate income and rely on a single, broad-based, flat-rate tax on consumed income. We can do that either by abolishing the income tax and relying on a reformed state sales tax, or by abolishing the state sales tax and relying on a reformed state tax on personal income that exempts net savings and charitable donations. The two tax bases are precisely the same: consumption. They only differ in how the taxes are collected.
Under either of those two reform models, North Carolina would be taxing everyone’s stream of income once and only once, at the same marginal rate. That means that if a rich person receives and spends five times as much money as you do next year, he will pay about five times as much in state taxes – not eight times as much, or six times as much, or half as much (just because he chooses to make films instead of flan, work out of a rehabilitated textile mill instead of a new facility, and drive an eco-car powered by sunflower seeds and righteous indignation).
At current rates, corporations doing business in the United States face the highest marginal tax rate on their income in the industrialized world. Most of our competitors have been reducing their corporate tax rates for years. If you further consider the personal income tax paid on dividends and capital gains, the marginal tax rate on corporate investment in North Carolina is 53 percent. That’s the 4th highest rate in the industrialized world.
Do most corporations actually pay 40 percent of their income to state and federal governments? Do most investors actually surrender 53 percent of their returns from corporate investment to government? No. Some take advantage of various special tax breaks and exemptions to pay much less than that. But others have tax burdens only a few percentage points less than the marginal rate. Such a wide variation in tax incidence – a function of the complexity and biases inherent in the system – is one of the best arguments for doing away with the whole messy business.
We ought not to be playing favorites. We ought to require North Carolinians to pay into state government according to their respective standards of living, which is what a consumption-based tax system accomplishes.
Today’s corporate income tax is like a massive Gordion Knot that binds our economy. Trying to untie it is not worth the trouble, given its relative insignificance in paying for state services. The proper tool for addressing the problem is not a set of nimble fingers. It’s an ax.
Hood is president of the John Locke Foundation.