Opinion: Daily Journal

Right Thing for the Wrong Reason

RALEIGH — The main legislation enacted by the North Carolina General Assembly during its 2004 short session was grossly irresponsible: a massive increase in state spending, much of it funded with temporary revenues, and another bond issuance of nearly $500 million that will obligate future taxpayers without honoring their traditional right to vote on public debts.

As the details continue to emerge from the legislature’s disastrous weekend of fiscal binging, their poor fiscal choices became even more evident. For example, in the waning hours of the session the General Assembly doubled the taxpayer subsidy for a new motorsports test track, to $4 million, and stuffed yet another $1.6 million into the Global TransPark in Kinston, which after squandering tens of millions of tax dollars over the past dozen years now promises that it will come up with a true business plan to develop private-sector funding. Not exactly what I’d call reasonable spending priorities.

One fiscal item that didn’t get much public attention, but ended up in the compromise, had to do with the application of sales tax to manufacturing businesses. North Carolina had previously offered sales-tax exemptions on building materials and supplies to companies that invest nearly $100 million in plant and equipment in such industries as pharmaceuticals and bioprocessing. The 2004 proposal was to extend this tax treatment to manufacturers of computers, semiconductors, automobiles, and aircraft.

It passed along with the rest of the 2004-05 state budget and awaits Gov. Mike Easley’s signature. It was widely believed among state lawmakers that the provision was designed to make a Triad manufacturing site more attractive to Dell Computers and more generally to serve as an additional incentive for potential corporate relocations. Thus, one might expect the usual conflict over the role of business subsidies and incentives in North Carolina’s economic-development policy — and you’d be right, in that some of the same arguments were trotted out for this new tax policy.

Only they needn’t have been. This is an example of politicians doing the right thing for the wrong reasons. Indeed, I suspect that many didn’t even realize why the tax-law change was a good one. To put it simply, retail sales tax should never have been imposed on business purchases in the first place. By definition, they are not retail purchases.

I’m not just drawning a semantic distinction. The problem with sales taxes applied to business inputs is that they create a “cascading” effect down the line. That is, if businesses pay sales tax on what they use to produce a good, and then consumers pay sales tax on the finished good, a portion of the purchase price is covering the previous layer of taxation. This violates three key principles of tax policy: simplicity, or transparency, because consumers don’t really know the full tax imposed on their purchase; neutrality, because the cascade effect creates an artificial incentive for producers to integrate their operations to avoid outside (taxable) purchases; and equity, or proportionality, because the taxes consumers pay no longer have any rational connection with the benefits they receive from governmental services.

If it truly wanted a rational and pro-growth tax policy, North Carolina would eliminate all business purchases from the retail sales tax, regardless of the type of business or the extent of its investment in the state. Perhaps we’ll get there eventually — but not if lawmakers fail to realize why what they are doing is worth praise.

Perhaps they haven’t been thinking much about why fiscal conservatives might be happy with their work, since it happens so rarely.

EDITORIAL NOTE: I’ve posted over at the Locke Foundation blog a rundown of ways to get up to speed about today’s primary elections in North Carolina and to get analysis from me and my “N.C. Spin” colleagues on the election returns.

Hood is president of the John Locke Foundation and publisher of Carolina Journal.