As fiscal year 2023 draws to a close, North Carolina’s House and Senate have each passed their own versions of House Bill 259, the biennial budget for fiscal years 2024-25. While legislative leaders have generally agreed to overall spending levels, negotiations remain ongoing to resolve differences between the two versions of the bill. Among the details yet to be worked out are differing approaches to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy, including distinct priorities when it comes to tax reform and relief.
In short, the House-passed budget would slightly accelerate already enacted individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate reductions; increase the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. ; increase the child deduction; reduce the franchise tax rate; repeal the privilege license tax; and establish, re-establish, or increase various tax credits; among other tax changes.
The Senate-passed budget would substantially accelerate already enacted individual income tax rate reductions while reducing future rates beyond the levels already planned, but it omits the other aforementioned reforms and expands certain excise taxes, among other changes.
As lawmakers evaluate various tax policy trade-offs and negotiate a final budget, priority should be given to adopting tax relief provisions that will promote long-term economic growth while making the tax code more simple, neutral, transparent, and stable in the process. North Carolina policymakers should continue making the state’s income tax rates more competitive and simultaneously prioritize for reform the areas of the tax code in which North Carolina remains an outliner, including the franchise tax and the privilege license tax.
Accelerating Individual Income Tax Rate Reductions
Both the House- and Senate-passed budgets would accelerate already enacted reductions to North Carolina’s flat individual income tax rate, but the Senate version would reduce the rate faster and further than the House bill, as shown in the table below.
| Year | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 and Onward |
|---|---|---|---|---|---|---|---|---|
| Current Law | 4.75% | 4.6% | 4.5% | 4.25% | 3.99% | 3.99% | 3.99% | 3.99% |
| House | 4.75% | 4.5% | 4.5% | 4.25% | 3.99% | 3.99% | 3.99% | 3.99% |
| Senate | 4.75% | 4.5% | 3.99% | 3.99% | 3.5% | 3.25% | 2.99% | 2.49% |
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Source: N.C.G.S.A. § 105-153.7; H.B. 259. |
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Specifically, both the House and Senate propose reducing the rate to 4.5 percent one year earlier than planned under current law, skipping a planned incremental reduction to 4.6 percent. But while the House version leaves subsequent years’ rate reductions as-is, the Senate version reduces the rate to 3.99 percent by 2025 instead of by 2027, and it adds three additional reductions that would bring the rate to 2.49 percent in 2030.
If lawmakers phase down the rate to 2.49 percent by 2030, North Carolina would be on track to have the lowest individual income tax rate on wage and salary income in the country (contingent upon tax triggers and potential future reforms in other states).
Increasing the Standard Deduction
Currently, North Carolina offers a standard deduction of $12,750 for single filers and $25,500 for married couples filing jointly, slightly below the federal standard deduction amounts of $13,850 and $27,700, respectively. The House-passed budget would raise the single filer standard deduction by $250 and the married filer standard deduction by $500, bringing the deduction amounts to $13,000 and $26,000, respectively, beginning in tax year 2024.
Since North Carolina’s standard deduction is not indexed to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , some of its real value erodes over time in years in which it is not increased statutorily. Raising the deduction amounts as prescribed in the House budget would help ensure the real value of the deduction is preserved for tax year 2024. Even better, though, would be for policymakers to consider indexing the standard deduction to inflation to preserve its real value over time while providing greater predictability to taxpayers.
Reducing the Franchise Tax Rate
Another pro-growth and structurally sound tax reform included in the House-passed budget is a provision to reduce North Carolina’s franchise tax rate over time. North Carolina’s franchise tax is a tax levied on corporations for the “privilege” of doing business in North Carolina. It is a capital stock tax that is levied at a rate of $1.50 for every $1,000 of a corporation’s North Carolina-apportioned net worth.
The House-passed budget would reduce this rate by $.10 per year over five years starting in 2025, as shown in the table below:
| Year | Tax Rate |
|---|---|
| Current Law | $1.50 per $1,000 |
| 2025 | $1.40 per $1,000 |
| 2026 | $1.30 per $1,000 |
| 2027 | $1.20 per $1,000 |
| 2028 | $1.10 per $1,000 |
| 2029 and on | $1.00 per $1,000 |
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Source: H.B. 259. |
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Currently, North Carolina is one of 16 states levying a capital stock tax, but that number will soon decrease, with Oklahoma repealing its capital stock tax effective July 1, 2023, and Connecticut and Mississippi phasing out their capital stock taxes by 2028. Additionally, Louisiana has sent a bill to the governor that would phase out its franchise tax over time, subject to revenue availability, and Tennessee enacted a law this session to make its franchise tax less burdensome by increasing the exemption.
North Carolina’s franchise tax is economically harmful in that it penalizes businesses for investing in North Carolina, is owed even when businesses do not turn a profit in a given year, is owed in addition to any corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. liability a business may owe, and is uncapped, exposing businesses to franchise tax liability without limit. Given these drawbacks, North Carolina should reduce reliance on this burdensome tax over time.
Repealing the Privilege License Tax
Another worthwhile reform included in the House-passed budget is the repeal of North Carolina’s privilege license tax, a tax levied annually on certain workers—including physicians, attorneys, engineers, architects, photographers, certain real estate professionals, and funeral directors, among others—for the “privilege” of practicing these professions in North Carolina. This tax generates only a fraction of one percent of North Carolina’s general fund revenue but is burdensome to comply with, requiring taxpayers to physically mail a check or money order to the Department of Revenue with the associated paperwork, as the state does not offer a way to file and pay this tax electronically. As such, some professionals expend more resources complying with this tax than they owe in tax liability. Furthermore, this tax departs from the principle of neutrality in that it is levied arbitrarily on some professionals but not others, injecting preferential treatment into the tax code. Repealing this tax would reduce compliance burdens and tax liability for taxpayers while also reducing administrative burdens for the state.
Other Provisions
In addition to the notable tax reform and relief provisions mentioned above, both the House- and Senate-passed versions of the budget include various changes to the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. and certain excise taxes. For example, both versions of the budget would expand—or extend the sunset dates for—various sales tax exemptions for business-to-business purchases. The Senate budget would also create a new sales tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. for breast pump devices and supplies, an issue we discuss further here. Under an ideal retail sales tax structure, final personal consumption of goods and services should be taxable, but business inputs should be exempt to prevent tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. .
The Senate budget also proposes expanding the state’s rental car excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. to include peer-to-peer rentals, an issue we discuss in detail here. Separately, the Senate budget proposes expanding the other tobacco products (OTP) tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. to include alternative nicotine products like nicotine patches and gum, as well as switching from a cost-based to a weight-based approach to taxing OTP, issues we discuss further here.
Analysis
North Carolina has been one of the foremost leaders in pro-growth state tax reform and relief over the past decade, and the state has an opportunity to further reinforce that legacy this year. As policymakers make final decisions on which tax provisions to include in the final budget, priority should be given to provisions that would provide tax relief in a pro-growth or structurally sound manner. That can include further reductions to the individual income tax rate, but reducing the franchise tax rate and repealing the privilege license tax offer even greater “bang for the buck,” since the franchise tax is a tax on in-state capital investment (and thus discourages it), and the privilege license tax has anomalously high compliance costs for a tax that raises so little revenue. Both the House and Senate plans are pro-growth, and either approach would further improve North Carolina’s competitive standing, but the franchise tax in particular is the greatest outlier in an otherwise competitive tax code, and reducing its rate is a goal worth pursuing.
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