Six Simple Tools for Cutting Your Taxes

RALEIGH – In North Carolina politics, the issue of how to address the state’s tax burden is more important that the issue of how to improve public education.

Don’t believe me? I would submit two pieces of evidence. First, Gov. Mike Easley has spent the past few weeks running TV and radio ads that warn North Carolinians of Republican challenger Patrick Ballantine’s secret scheme to raise taxes. Apparently, after enacting a series of tax packages costing North Carolinians about $1 billion a year, the governor now believes that tax increases are a bad thing (though he won’t rule one out if re-elected, unlike Ballantine). Whatever you think of the governor’s ever-shifting, Kerryesque positions on taxes, you have to admit that he (and Ballantine) are making quite a fuss. Must be important.

The second piece of evidence is that in a recent media poll, there were more voters citing the issue of state spending and taxes as their prime concern than there were voters citing education. Their concern is justified.

In keeping with a previous theme, North Carolina policymakers should employ six simple tools for cutting your taxes:

Use benchmarks. North Carolina’s average state and local tax burden is near the national mean. But it is now the highest in the Southeast. More importantly, the average tax burden isn’t really the critical benchmark to use. Marginal tax rates – the rate you pay on the next dollar of income, for instance – have a greater influence on economic decisionmaking, and North Carolina sticks out like a sore thumb by levying some of the highest marginal income tax rates in the country.

Limit tax growth over time. A Taxpayer Protection Act that imposes a cap on the growth of either revenue or spending would be a useful instrument to enforce fiscal discipline on irresponsible legislators. If the cap were set to allow growth only at the rate of inflation and population growth, then the real tax burden per person would stay the same over time – and the tax burden as a share of personal income would decline over time. Just to be clear: that’s a good thing.

Use taxes only to raise revenue. Don’t seek to reward or punish the private behavior of individuals or businesses. Eliminate extra excise taxes on alcohol and tobacco products and targeted exclusions for favored businesses or products. But related to that . . .

Shield capital formation from double-taxation. Some elements of the tax code look like special breaks but really aren’t. Remember that taxing the principle of an investment – the money initially deposited in a savings account, for example – is automatically to tax the future return on that investment by the same percentage. If you also levy a tax on dividends, interest, or capital gains, you are taxing investment income twice. That isn’t fair and will discourage the very kind of capital formation that leads to job creation and income gains. One solution to the problem is a “consumed-income tax” in which each household’s net savings is subtracted from its annual income before tax is applied. Which reminds me. . .

Treat human capital like other capital. Just as deposits into IRAs should be tax-deductible if withdrawals are taxed (or vice versa), some of what families spend on education, job training, medical care, and child-rearing should be free of tax because the expenditures generate future taxable income (when the children grow up and become employed, for example). This is the proper justification for such policies as tax exemptions for dependents, tax credits for children (even refundable ones, because they offset payroll taxes paid on such spending), tax-free health savings accounts, and tuition tax deductions or credits for preschool, K-12, or college.

Don’t “reform” the sales tax. The favorite option for those who favor tax “reform,” by which they mean another tax increase, is to broaden the base of the sales tax to include more catalog sales, Internet purchases, and services. This is a horrible idea and reflects a combination of shoddy thinking, poor definitions, and bad math. A consumed-income tax is a better way to tax consumption. Let the archaic sales tax fade away over time.

Among the various factors influencing North Carolina’s economy, tax policy is among the few that state politicians can actually control. So let’s see some action.

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