A group of professors recently released a study that finds insufficient discussion of the total cost of taxes in public finance textbooks. They find that common textbooks fail to fully include the total cost of taxes...
- North Carolina Tax Reform Options: A Guide to Fair, Simpl...
North Carolina Tax Reform Options: A Guide to Fair, Simple, Pro-Growth Reform
OTHER TAX REFORM SUGGESTIONS
See page 32.
In broad economic terms, franchise taxes (or capital stock taxes, as they are sometimes called) are destructive because they discourage investment and the accumulation of assets. Several states have recognized this harmful effect and are moving away from franchise taxes as a source of revenue. West Virginia and Pennsylvania will fully phase out their tax by 2015 and 2014, respectively, and Kansas completely repealed its tax in 2011. Only three of North Carolina’s neighbors retain the tax.
North Carolina’s current franchise tax is 0.15 percent and raises approximately $700 million per year. The tax does not apply to pass-through businesses, but those subject to it must pay it even in unprofitable years. Many tax reform proposals seek to expand the tax to all business forms, including the recent Civitas Institute’s recommendation to tax business net assets (i.e., equipment and inventory) at a 1.05 percent annual rate, seek to expand the tax to all business forms. A better approach would be to end this tax on business investment.
A more limited alternative that could be considered would be to cap liability for each legal entity, as is done in other states and as is done in North Carolina for holding companies. Other potential reforms include revisiting how intercompany debt is adjusted and linking statutory terminology to GAAP terms of art.
See page 29-30.
Twenty-six states and the District of Columbia (including Florida, Georgia, South Carolina, and Virginia) allow businesses to use past losses to offset current tax obligations for up to 20 years; North Carolina only allows 15 years. Fifteen states (including Georgia and Virginia) allow businesses to carry back losses against past taxes for 2 or 3 years; North Carolina does not allow any loss carrybacks.
See page 36-39.
Business inputs should be exempt from sales tax not because businesses deserve special treatment, but because failure to do so results in “tax pyramiding,” the process whereby taxes stack on top of each other as raw goods move through the production process. Sales taxes on business inputs make up 24 percent of total state and local business taxes collected in North Carolina. Many states try to avoid these problems by engaging in the laborious task of picking products that are frequently used as business inputs and individually carving out exemptions for them in the sales tax code. This approach is a step in the right direction but does not and cannot ever comprehensively address all the items that businesses use in the production process and should therefore not pay sales taxes on.
North Carolina is one of 12 states that still have some form of intangible property tax. These taxes historically were imposed on the value of trademarks and stocks and are distortive in that they attempt to tax an abstract, future, unrealized value. They tax stock values that may not ever be attained (stock prices are in constant flux) and tax trademark values that may also fall (as a business loses brand integrity). North Carolina has repealed most of its taxation of intangibles, except for the taxation of leasehold interests in real property.
Residential housing sales and rentals are generally not subject to sales tax but are sometimes subject to a real estate transfer tax. North Carolina has this tax at a 0.2 percent rate, raising approximately $120 million per year. A broadened sales tax should include or be accompanied by a tax on some level of housing services and transactions, and the existence of property taxes and the large numbers involved suggest that the state should proceed thoughtfully. While Delaware and Washington have real estate transfer taxes of over 2 percent, they are usually 1 percent or less. All four tax plans we modeled include a 0.5 percent real estate transfer tax as a placeholder but can be substituted with some level of sales tax base expansion to housing.
Estate and inheritance taxes are undesirable because they discourage the accumulation of capital, which hurts economic growth. They affect different businesses differently, as corporations do not pay them but family businesses are subject to them each generation. This distortion can prohibit family businesses from achieving an efficient business scale, which in turn makes them less able to compete with corporations on prices.
There are several practical considerations that make estate taxes undesirable as well. Several sources indicate that the compliance costs associated with estate planning to avoid the estate tax actually are greater than the amount the tax collects. In North Carolina, the estate tax brings in just 0.2 percent of state and local revenues, all at tremendous costs to taxpayers and to economic growth. Among its neighbors, only Tennessee has the tax (see Figure 49):
Figure 49: State Inheritance & Estate Tax Rates and Exemptions, 2012
In 2009, North Carolina collected $130 per capita in tangible personal property (TPP) taxes, thirteenth highest in the nation. TPP taxes are levied on business personal property such as office equipment and machinery, and are less preferable than taxes on real property because they distort business decisions by discouraging investment in new technology and the production processes.
Many states have recognized this undesirable outcome and have limited or eliminated their TPP taxes in recent years (see Figure 50). Between 2000 and 2009, TPP tax collections per capita have decreased by an average of 20 percent. In the last decade, Ohio has completely phased out TPP taxes, Maine has exempted most newly purchased property with the goal of eventual phase-out, and Vermont has adopted local options to reduce or repeal TPP taxes. Especially for high-tech industries that have lots of expensive capital and relatively less labor, TPP tax repeal would be helpful in luring new firms to the state.
Figure 50: Tangible Personal Property Tax Collections Per Capita, 2009
North Carolina residents face the 17th highest state-local tax burden in the country, paying 9.9 percent of annual income in state and local taxes. Even with simplification and restructuring, taxes can only go so low while still funding essential and desired government services. Each of the recommended plans in this report is revenue-neutral: they raise the same amount of revenue as the current tax system. Whether North Carolina should aim to spend less or more on government services is beyond the scope of this report and beyond the expertise of the authors. Ultimately that question is up to the people of North Carolina and their legislative representatives, and we are happy to develop tax scenarios that adjust to reduced levels of state and local spending.
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