As the General Assembly continues to work through the 2016-17 budget, part of the final package should build on the tax reforms first implemented in 2011.
The 0 percent tax bracket will be increased, offering a real tax cut to the 70 percent of N.C. taxpayers who file with the standard deduction, mostly middle- and low-income folks. There is talk of further sales tax expansion and lowering the personal income tax rate. North Carolina is on the right track.
But there is more to be done. Eliminating the bias in our tax code against savings, investments, and entrepreneurship is the next important step. Repealing capital gains taxes, changing the way business investments are deducted, and eliminating business-to-business taxes are worth serious consideration.
Capital gains taxes penalize saving, investment, and entrepreneurship by applying an extra layer of taxation on equity investment, discouraging the very activity we should be encouraging. North Carolina taxes capital gains from the sale of stocks and bonds, real estate, homes, and businesses at the same rate as regular income. Instead, the tax on capital gains should be repealed.
Complete repeal at one time might be too much of a hit to state revenue. Calculations by the Beacon Hill Institute of Suffolk University estimate that complete repeal at the current 5.75 percent personal income rate would result in a $502 million revenue loss. Using next year’s personal income rate of 5.499 percent, revenue loss would be about $480 million.
Understanding that, a prudent consideration would be phasing out the tax over several years or adopting the federal practice of taxing capital gains at half the rate of regular income.
Another approach would be to exempt some capital gains from taxation — say 30 or 40 percent — as several other states do. Whatever the approach, North Carolina should encourage saving, investment, and entrepreneurship by changing the way we tax capital gains.
Changing how business expenses are deducted is another worthy tax reform. Both the federal and state tax codes allow businesses to deduct from their taxes expenses and investments in assets that are meant to produce goods and services for sale — land, office equipment, machinery, buildings, vehicles, and such.
Companies can deduct these investments over time, depending on the kind of investment. For those classified as “long-lasting,” like an office building, the deduction is spread out over a long period of time. For a “shorter-lived” investment like computer equipment, the deduction is written off more quickly.
This system creates an incentive to make investments in short-term assets rather than more durable ones.
North Carolina’s tax code should treat all asset investments the same and allow business owners to make the best decision for their business. The decision to depreciate a tax deduction over time, or to expense that deduction in the year the investment occurs, should be up to the business owner, not written into the tax code.
Restructuring how business deductions are taken will open options for business owners and help North Carolina attract new investment and additional capital and encourage economic growth.
North Carolina imposes a privilege tax on certain mill machinery and equipment at a rate of 1 percent with a maximum of $80 on each article. The House budget repeals this tax. Forty percent of North Carolina’s sales tax base comprises business-to-business taxes, which penalize investments and result in double taxation.
With about a $50 million revenue impact, repealing the tax will not affect the state budget significantly. To remain competitive with our neighbors — Virginia, Georgia, South Carolina, and Tennessee — North Carolina should exempt this equipment from the state sales tax, as our neighbors have done.
North Carolina’s current tax code penalizes savings and investments while discouraging entrepreneurship. Let’s fix that.
Becki Gray (@beckigray) is vice president for outreach at the John Locke Foundation.