The North Carolina House has officially approved its tax-reform bill. It would create a 5.9 percent flat income tax — replacing the current rates of 6 percent, 7 percent, and 7.75 percent — and cut the corporate tax to 5.4 percent by 2018, down from 6.9 percent today. The Senate has now proposed a new plan of its own that creates a 5.25 percent flat tax and phases out the corporate tax by 2018.
Among the various liberal arguments against these tax-reform proposals is that they would rob state government of the revenues necessary to fund public services. Let’s take a closer look at the numbers.
Both proponents and opponents of tax reform tend to report the cumulative revenue impact over three to five years. It makes everything look bigger. But it also counts the same tax changes multiple times.
A more straightforward approach is to report annualized statistics. If the House tax plan passed into law, the state would actually receive $47 million more revenue in the 2013-14 fiscal year, because only some of the tax changes go into effect in the first year. It won’t be until FY 2014-15 that most of the major provisions will be in place. In that year, according to fiscal analysts, the House plan would reduce state tax revenue by about $300 million — or about 1.4 percent of the $21.5 billion in state General Fund revenue projected for FY 2014-15. The new Senate tax plan is more ambitious. Its fiscal note pegs the state revenue impact in 2014-15 at $510 million — or about 2.4 percent of General Fund revenue.
So within the timeframe of the current General Assembly and budget biennium, the fiscal impact would be between 1.4 percent and 2.4 percent of revenue. Apocalypse? Not. In fairness to the excitable Left, however, both plans have larger effects in the out-years. By 2017-18, the House tax plan would save taxpayers about 2 percent off the revenue baseline. The comparable statistic for the Senate tax plan is 5 percent.
In other words, even the effects of the Senate plan on future state spending are more modest than today’s rhetoric might lead one to believe. Moreover, keep in mind that these are static revenue forecasts. They assume that dramatic reductions in North Carolina’s marginal income tax rates will have no effect on the state’s economy. That’s not realistic. Under either plan, the after-tax rate of return on building, expanding, and investing in North Carolina businesses would rise. Our labor market would pick up, as would revenue collections from newly reemployed North Carolinians.
For the sake of argument, let’s assume the two chambers meet in the middle on the final tax package, and that the resulting economic growth replaces just a tenth of the static revenue forecast. That would put the long-term fiscal impact of tax reform at just over 3 percent of projected General Fund revenue. Gosh, we might just muddle through.
The debate about economic policy in North Carolina would benefit from adopting a long-term perspective. Our problems didn’t start yesterday, or last year, or five years ago. Measured as gross domestic product per person, economic growth in North Carolina outpaced the national average in most years from the early 1960s to the mid-1990s. But since 1997, our per-capita growth rate has trailed the national average, in some years by a large margin.
There is no one public policy that, if implemented by Gov. Pat McCrory and the North Carolina legislature, can restore the state’s fortunes overnight. Tax reform alone won’t do it. Neither will regulatory reform, better roads, or better schools. Moreover, the state’s economy is affected by many factors completely out of the control of state politicians, such as monetary policy, technological change, and international trade.
When liberal activists call for a “balanced” approach to economic policy in North Carolina, then, they are speaking the right language. Unfortunately, they don’t always seem to understand the words. Their argument is that in order for North Carolina’s economy to grow more rapidly, state government should spend significantly more than it currently does on public education and infrastructure, even if it means maintaining or raising North Carolina’s already-high marginal tax rates.
There is nothing balanced about this argument. It assumes — indeed, liberal activists often explicitly state — that state tax rates have little to no effect on state economic growth. Such a belief is contrary to common sense and the latest research on economic growth. In just the past six years, studies published in the American Economic Review, Economic Development Quarterly, Southern Economic Journal, Public Choice, Contemporary Economic Policy, and other academic or professional journals have revealed significant negative relationships between the cost of government and economic measures such as business starts, employment, or per-capita income. In many of these models, public expenditures that might appear to boost economic growth in isolation — such as infrastructure or education — don’t actually generate enough growth to offset the economic costs of the taxes needed to pay for them.
That certainly doesn’t mean that investing in infrastructure and education is a bad idea. What it means is that, given our current levels of spending and taxation, the best way for North Carolina to proceed right now is to 1) reform our tax code and reduce marginal tax rates, 2) restructure our infrastructure and education programs to increase the value they deliver per dollar spent, and 3) fund future spending increases for infrastructure and education with future revenue growth and by redirecting current state spending on Medicaid and other public assistance programs that, studies show, hamper rather than hasten economic growth.
That’s a truly balanced and empirically based strategy for rejuvenating North Carolina’s economy. And it is already underway in Raleigh.
-30-
Hood is president of the John Locke Foundation and author of Our Best Foot Forward: An Investment Strategy for North Carolina’s Economic Recovery, published by JLF in 2012.