As the House and Senate work to fashion a compromise tax-reform bill, one of the sticking points is how much to cut North Carolina’s corporate-income tax. The Senate wants to do away with it entirely over the next five years. In its latest proposal, the House wants to cut the corporate rate to 5 percent from the current 6.9 percent.
Why should the state slash or eliminate the corporate income tax? Because it is an inefficient, opaque, and economically destructive way to raise revenue.
Let’s start with the problem of inefficiency. North Carolina’s corporate tax generates just over $1 billion a year. That may sound like a lot. But in the context of $21 billion in annual General Fund revenue, and $50 billion in the total state budget, it’s not exactly massive. In order to produce that $1 billion-plus in revenue, however, the corporate income tax imposes significant costs on both companies and tax collectors. Here’s one way to think about it: state corporate taxes generate about 15 percent of the nation’s total corporate-tax collections but account for as much as 30 percent of the tax-compliance costs of corporations, depending on the size and reach of the firm.
The corporate tax is really a roundabout way of taxing personal income. “Roundabout” is another way of saying inefficient. It is also another way of saying opaque, because those who actually bear the cost often don’t know how much of the corporate tax burden they shoulder — or even that they shoulder it at all.
Keep in mind that corporations are bundles of contracts among people. You can’t tax a bundle of contracts. You tax the incomes of the people involved. There are three main groups: customers, owners, and workers.
Although some business taxes are passed along to customers, most economists doubt that corporate income taxes have a large effect on consumer prices given an increasingly global marketplace. If corporations try to pass along their state income taxes as higher prices, consumers can buy alternatives produced in lower-taxed jurisdictions.
Owners of corporate stock also have some freedom to respond to state taxes, although not as much as customers do. Workers have the least amount of flexibility. If the state raises corporate taxes, and managers cope with the higher tax bill in part by paying out less in salary and benefits, how many employees are really in a position to respond by moving somewhere else?
In practice, then, corporate taxes don’t just reduce after-tax dividends and capital gains to shareholders. They also reduce worker pay. Tax specialists disagree about the relative percentages. Some say that shareholders bear as much as 80 percent of the cost, with 20 percent borne by workers. Other scholars flip the percentages to about 60 percent worker and 40 percent shareholder. Last year, a study published in the journal European Economic Review concluded that for every dollar of corporate tax hike, total worker wages decline by an average of 49 cents.
The effects get worse if you take into consideration the fact that states and nations find themselves increasingly in competition for corporate investment and expansion. If your raise your tax rates, or keep your taxes level while others are cutting theirs, you will experience some loss of investment, and thus fewer jobs. Indeed, a paper in the September 2012 issue of the Journal of Economic Surveys found that international tax competition, not changes in political party or ideology, explained why corporate taxes have dropped in most industrialized countries over the past three decades.
Like it or not, North Carolina is part of that international competition for investment — and we are no longer competitive. As I wrote in my 2012 book Out Best Foot Forward, if North Carolina were a separate country, our combined tax rate on corporate income would be the highest in the developed world.
State legislators are determined to do something about that. They’re right. The House plan to cut North Carolina’s corporate tax by about a quarter is good. Cutting the rate in half, to 3.5 percent, would be better. Zeroing it out would be best.
Hood is president of the John Locke Foundation.