North Carolina Should Refine Its Tax Reduction Triggers

North Carolina has significantly bolstered its standing in the 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. Foundation’s State Tax Competitiveness Index over the past decade, from 44^th in 2013, when transformative tax reforms were initiated, to 12^th today. These reforms simplified the tax code by reducing rates, broadening tax bases, and phasing out economically distortive targeted incentives. The state’s 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. rate, at 2.25 percent, is the lowest among states levying such a tax. The 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. , currently a flat 4.25 percent with a competitive 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. , is scheduled to drop to 3.99 percent in 2026. These policies have positioned North Carolina as a national leader in tax competitiveness, fostering an environment conducive to business growth and individual prosperity.

Tax Reduction Triggers: A Structured but Imperfect Mechanism

A key component of North Carolina’s tax strategy is the planned elimination of the corporate income tax by 2030, paired with a trigger-based system to gradually lower the personal income tax rate. Enacted under S.L. 2023-134, this mechanism allows for up to three individual income tax rate reductions between 2027 and 2034, contingent on General Fund revenue exceeding predefined statutory thresholds. The Office of State Budget and Management (OSBM) and the Fiscal Research Division annually certify revenue collections, with reductions abandoned if targets are not met. For fiscal year 2025-26, projected General Fund collections of an estimated $34.842 billion surpass the $33.042 billion threshold, setting the stage for a 0.5 percentage point reduction in the personal income tax rate to 3.49 percent, effective January 1, 2027, provided forecasts hold.

Source: North Carolina Code 2025; Tax Foundation calculations.

While revenue-based triggers promote fiscal discipline by tying tax cuts to available resources, North Carolina’s current design is overly rigid. The fixed revenue targets, codified in statute, fail to account for critical economic variables such as 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. , population growth, or macroeconomic shifts. Inflation has consistently exceeded the Federal Reserve’s 2 percent target in recent years, eroding the real value of revenue thresholds. Additionally, federal policy changes—such as anticipated reductions in state transfers and the extension of Tax Cuts and Jobs Act (TCJA) provisions—introduce further uncertainty, particularly as the new federal government seeks to curb spending and reduce deficits.

The state’s static thresholds, which lack consistent year-on-year growth or alignment with economic indicators like GDP or inflation, risk triggering tax cuts at the wrong time, potentially straining the state’s ability to fund essential services.

Refining the Trigger Mechanism for Sustainable Tax Reductions

To ensure that North Carolina’s tax reduction strategy remains both competitive and fiscally responsible, policymakers could refine the trigger mechanism with the following enhancements:

1. Inflation Adjustment: The legislature should reset existing revenue thresholds to account for inflation since the triggers were established, and index future thresholds to a reliable metric, such as the Consumer Price Index (CPI) or the GDP deflator. This adjustment would preserve the purchasing power of state revenues, ensuring that tax cuts do not outpace the state’s ability to deliver public goods and services in an environment of rising costs.
2. Population Growth Adjustment: A better mechanism should incorporate population growth into the trigger formula to reflect the increased demand for public services driven by North Carolina’s substantial population influx over the past decade. By tying revenue thresholds to population changes, the state can better align tax policy with the marginal costs of providing infrastructure, education, and other services to a growing populace.
3. Rainy Day Fund Contingency: An amendment should be made requiring that the state’s rainy-day fund be fully funded before any consequent tax rate reduction is triggered. This precaution would enhance fiscal resilience, enabling the state to weather unexpected emergencies—such as economic recessions or natural disasters—without resorting to tax increases or service cuts.

These refinements would create a more adaptive and prudent trigger mechanism, ensuring that tax reductions are sustainable and responsive to the state’s fiscal and economic context. By addressing inflation, population growth, fiscal reserves, and economic variability, North Carolina can maintain its commitment to tax competitiveness while safeguarding its ability to meet future challenges.

Balancing Growth with Fiscal Prudence

North Carolina’s tax reforms have established a pro-growth tax climate, attracting businesses and residents, while still providing a broad range of services to its residents. However, the existing trigger mechanism’s lack of flexibility threatens to undermine these achievements if fiscal conditions deteriorate or unexpected challenges arise. It is better for triggers to pause on their own than to expect lawmakers to pause them. Not only is that a potentially difficult vote to cast, but any legislative pause might end the triggers altogether, rather than delaying further reductions until economic conditions improve. Meanwhile, the alternative to a pause could be proceeding with unaffordable reductions that strain public services and prompt calls to reverse the state’s significant progress on tax reform and tax relief over the past decade. By implementing a more sophisticated and nuanced trigger system for its tax reduction goals, North Carolina can sustain its trajectory toward lower tax rates, reinforce its reputation as a business-friendly state, and ensure long-term fiscal stability in an ever-changing economic landscape.

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