North Carolina House, Senate, and Governor Announce Tax Agreement

Today at 4:00 pm EST, North Carolina lawmakers announced that an agreement had finally been reached in the state tax debate—a process that’s been going on for months. Governor Pat McCrory, Senate President Pro Tempore Phil Berger, and House Speaker Thom Tillis all spoke at a press conference outlining early details of the plan. The agreement would make the following changes:

Individual Income Tax

• Flatten and lower rate to 5.75 percent by 2015;
• Increase standard deduction to $7,500 (for singles);
• Allow full deductibility of charitable contributions;
• Fully exempt Social Security income from state income tax;
• Allow for certain itemized deductions (total of mortgage interest and property taxes paid would be capped at $20k); and
• Retain current child credit of $100 for those earning $40k and increase credit to $125 for those earning under $40k.

Corporate Income Tax

• Reduce rate to 5 percent by 2015;
• If certain revenue targets are met, rate would decrease to 4 percent in 2016 and 3 percent in 2017.

Other Changes

• Retain full sales tax refund for nonprofits;
• Cap gasoline tax; and
• Fully repeal estate tax.

During earlier discussions, lawmakers were having a difficult time coming to an agreement on the status the sales tax refund for nonprofits and the tax treatment of Social Security income. The former would be fully retained and the latter would remain fully exempt for the state income tax. Senator Berger also noted that projections show local governments will likely see increased funding, implying that future property tax increases no longer need to be a concern.

Unfortunately, there is virtually no reform to the state’s existing franchise tax ($1.50 per $1,000 of tax base), which is complicated, non-neutral, and doesn’t have a cap. More comprehensive tax reform would have made the tax more neutral by levying it on all limited liability companies and capping the amount that can be paid (similar to the most recent Senate plan). Even better, lawmakers could fully repeal the tax.

The latest plan also doesn’t do any corporate income tax base broadening. There are multiple carve-outs in the North Carolina tax code that attempt to incentivize certain industries and activities (for a full list of these CIT tax benefits, see the Corporation Income Tax section, starting on page 29, of the North Carolina Biennial Tax Expenditure Report). These programs cut out large chunks of revenue, forcing the rate to be higher on firms subject to the tax. The film industry production expenses credit, for example, cost the state nearly $36 million in 2011. Other credits to incentivize job creation and “investing in business property,” among others, often don’t meet expectations and are expensive.

There wasn’t any mention of sales tax base expansion, either—something that was included in both the previous House and Senate plans to some degree. The House plan would have added service contracts, alteration, repair, maintenance, cleaning, and installation to the sales tax base. The Senate proposal would have only expanded the base to cover service contracts. Making a change such as this brings in additional revenue and increases neutrality between the goods and service markets.

Despite these minor criticisms, the plan would most definitely improve North Carolina’s State Business Tax Climate Index score. Currently, North Carolina ranks 44^th in the country. The new agreement would move the Tar Heel State up to 17^th best. Scores for other tax categories are found below:

Though not as comprehensive as earlier reform proposals, the income tax rate reductions are a good move, as is the flattening of the individual income tax. We’ll update the blog as more details are made public and once actual legislation is introduced.

Update (7/16/2013 at 11:22am EST): Additional details were released and can be found here.

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