The Easley administration is touting a study recently released by the accounting firm of Ernst and Young, claiming that North Carolina is among the five most favorable states in the nation for tax burdens on business. In reality, the study ignores entire categories of business taxation and the most basic principles of tax analysis.
The study attempts to determine the amount of state and local taxes in each state paid by the business sector. They base their calculations on “property taxes [paid by businesses], sales and excise taxes paid on business purchases, gross receipts taxes, corporate income and franchise taxes, license taxes, and unemployment and workers compensation payroll taxes. But because of what is left out the research is useless as an accurate assessment of the taxes businesses actually pay.
First, the study ignores personal income taxes. North Carolina has the highest top marginal income tax rate in the Southeast and one of the highest in the nation. Owners of sole proprietorships, partnerships, limited liability companies, and subchapter-S corporations, making up most of North Carolina’s businesses, pay their taxes through the personal income tax. Also, capital gains taxes from the sale of these businesses, paid as part of regular income in North Carolina, are also not included by Ernst and Young.
Imagine a small-business owner who builds a successful chain of pizza restaurants. Each year his profits are reported on his personal income tax forms. At retirement he decides to sell the business and live on the net proceeds, i.e., the capital gain. As a result he is required to pay a hefty capital gains tax. Ernst and Young include none of these taxes in its study.
Also, employers share the burden of the income tax paid by their employees. The income tax is an excise tax, i.e. a sales tax, on the sale of labor services. Both sellers and buyers, in this case, employees and employers, share the burden of excise taxes. Part of personal income taxes paid by workers is reflected in higher wages. Since workers are concerned about their after tax, take-home pay, employers in higher income tax states, everything else equal, will have to pay higher wages to attract workers than employers in lower income tax states. That additional amount is the part of the personal income tax paid by employers. Clearly this “business share” of the tax should also be included in Ernst and Young’s calculations. To ignore it is negligent.
The study also ignores the retail sales tax. It assumes that the entire burden of state and local retail sales taxes is born by consumers. But in reality, sales taxes are always paid in part by the stores selling the products in the form of a lower price received. The higher the sales tax that a customer has to pay the lower the price the seller will be able to charge. No seller can charge more than the total amount a customer is willing to pay, which includes the price and the tax. This does not mean that the entire retail sales tax will be offset by lower prices. What it does mean is that to some degree, depending conditions of supply and demand in individual markets, the burden will be shared. North Carolina has a very high, 7 percent retail sales tax. To assume that businesses bear none of the burden of this tax is no less absurd than to assume that they bear all of it.
Since the Ernst and Young study includes property taxes, which are very low in North Carolina, and excludes personal income and sales taxes, which are very high, it is no surprise that the state comes out smelling like a rose. This also explains why New Hampshire, without an income tax or a sales tax, does very poorly.
Compare the Ernst and Young report to a similar study by the Tax Foundation, ranking states according to their “business tax climate.” In this study, which includes sales and income taxes, North Carolina’s performance is an unexceptional 24th in the nation. New Hampshire, ranked so poorly by Ernst and Young, was ranked by the Tax Foundation as having the country’s second most favorable business climate.
The Ernst and Young study has given North Carolina a free ride by leaving out the state’s most oppressive business taxes. But it is not surprising that in an election year the Easley administration is anxious to hang its hat on such a report. In doing so, Gov. Mike Easley is misleading the public and obfuscating the fact that the state’s oppressive tax burden is stifling both entrepreneurship and job creation.