A Guide to Tax Reform Options for North Carolina
January 28, 2013
This morning we released our new book: North Carolina Tax Reform Options: A Guide to Fair, Simple, Pro-Growth Reform. Commissioned by the Carolina Business Coalition and authored by us, we hope it provides useful information and observations for North Carolina policymakers, journalists, and citizens as they evaluate their state's tax system.
The book reviews North Carolina's tax system and suggests possible improvements. These include repealing the state's antiquated "franchise tax" on business assets, removing business-to-business transactions from the sales tax base, reforming net operating loss treatment, repealing the inheritance tax, and reforming the tangible personal property tax system.
We also outline four comprehensive tax reform options, which would fundamentally simplify the state's tax structure. Each option is designed to be revenue-neutral relative to the existing tax system:
"Option A" makes North Carolina the most pro-growth tax system in the country, simplifying the personal income tax at 6 percent (after subtracting a $5,000 personal exemption for each taxpayer and dependent), lowering the statewide sales tax to 3.5 percent while expanding its base to services, and repealing the corporate income and franchise taxes. This option would be distributionally similar to the existing tax system and, if it had been in effect in 2012, would have ranked the state 5th on our State Business Tax Climate Index (rather than 44th).
“Option B” keeps all the major taxes, but simplified and at low rates: a 5 percent income tax (after subtracting a $10,000 personal exemption for each taxpayer and dependent), 5 percent sales tax, and 5 percent corporate tax. A similar positive reform was adopted in Utah, contributing to its economic success. This option would be distributionally similar to the existing tax system and, if it had been in effect in 2012, would have ranked the state 13th on our State Business Tax Climate Index (rather than 44th).
“Option C” would eliminate taxes on individual and corporate income and broaden the sales tax base to services to make up the revenue. The total state sales tax rate would have to be raised to 8.75 percent to fully fund current levels of state spending, but the benefit of this option is that North Carolina would be one of the few states with no taxes on investment or job creation. (Spending reductions or property tax increases could reduce the rate, but the state should avoid taxes on gross receipts or expanding the franchise tax on business assets.) Had it been in effect in 2012, would have ranked the state 3rd on our State Business Tax Climate Index (rather than 44th).
“Option D” eliminates taxes on retail sales and corporate income, paying for these reductions with a single, simple tax on individual income at a flat 10 percent rate (after subtracting a $5,000 personal exemption for each taxpayer and dependent). Taxes on income would be high, but with low property taxes and no state taxes on corporate profits or business assets. Had it been in effect in 2012, would have ranked the state 5th on our State Business Tax Climate Index (rather than 44th).
While these tax options look very different, each would move North Carolina to a more neutral tax treatment so the code is not picking winners and losers in the economy. For example, of the options that retain the sales tax, all expand the tax base to services and use the extra revenue to lower tax rates. This is a stark contrast to the current North Carolina sales tax system, which unfairly applies to sellers of goods but not sellers of services. (Click here to see how each option compares to the existing tax system, and how different taxpayers would fare under each option.)
Our report contains background information on the state's economic development, the current tax system and its components, sales tax base broadening options, recommendations from past reform efforts, an overview of each of the reform options, and other tax reform suggestions.
A PowerPoint on the report, highlighting the key findings, is embedded below: