North Carolina Legislators Try to Reach Compromise, Media Reports Alleged “McCrory Option”

June 28, 2013

The NC tax debate continued this week as the Senate, House, and Governor tried to reconcile differences between their respective visions for state tax reform. After passing its second reading two weeks ago, the Senate substitute for House Bill 998 was pulled from the Senate calendar.

The legislative tax talk went radio silent for most of the week, until WRAL reported that Governor McCrory’s office may have their own plan, despite no explicit endorsement from the governor himself or his Budget Director Art Pope. According to WRAL,

[T]hose knowledgeable about the ongoing negotiations over a tax reform bill between the House and Senate say a spreadsheet circulating among lawmakers at the legislative building represents an offer from McCrory's office. Sources associated with both the House and the Senate say the document came directly from Pope and represented the governor's ante into the negotiations.

Both McCrory and Pope have denied this is an official proposal from the administration, but rather just one of many possible options. Major provisions can be found below, in addition to the fiscal impact once fully phased in (FY 2017-18).

Changes in “McCrory Option”

Fiscal Impact

Individual Income Tax Flatten three brackets into one; lower rate to 5.6 percent by 2016; eliminate personal exemption, standard deduction, and certain itemized deductions (itemized deductions would be capped at $7,500 for singles) and replace with zero bracket of $6,000; eliminate severance wage deduction, charitable contribution credit for nonitemizers, and $50k business income deduction -$1,050.8
Corporate Income Tax Lower rate to 5 percent by 2016 -$386.6
Estate Tax Repeal -$65
Sales, Privilege, and Other Franchise Tax Changes Convert electricity franchise tax and piped natural gas excise tax to sales tax; expand base to include repairs, maintenance, and installation of tangible personal property and service contracts; cap nonprofit sales tax refunds at $100k by 2016; repeal various exemptions and preferential rates $1,231.1
Revenue Transfers to Local Governments Distribute certain electricity and piped natural gas sales tax revenue to local governments; eliminate sales tax refund to local governments -$66.4*

*This number means the state would lose $66.4 million, which would now go to local governments.

The fiscal analysis spreadsheet, which outlines the scenario’s details, can be found here.

One provision worries me. The chart says the plan would “repeal various exemptions and preferential rates” under the sales tax. Though we don’t have more detail than that, legislators should be cautious not to remove exemptions for business inputs, because this leads to tax pyramiding, which generates economic distortions as taxes pile up along the production process.

We’ve seen the flat income tax, sales tax base broadening, estate tax repeal, and privilege and franchise tax simplification before—these elements appear in the other tax plans being vetted. These changes are good and would improve North Carolina’s business tax climate. What’s not included in this option, however, is reform to the state’s general franchise tax. Positive reform would cap the tax, lower the rate, and broaden the base to include all limited liability companies (similar to what is done in the Senate’s latest plan).

The News & Record reported today on the governor’s Friday visit to Jamestown, North Carolina this morning, where he worried no middle ground would be found:

The clock is ticking on tax reform, and if state leaders cannot reach an agreement over the next two weeks the issue should probably be set aside for now, Gov. Pat McCrory said during a local visit this morning.

Governor McCrory said that he’d like to see a revenue-neutral tax plan (this latest option is the closest we’ve seen to that—it would cut taxes by $215 million when fully phased in, while the House plan would cut taxes by $505.9 million and the Senate substitute $1.3 billion).

I hope to see a compromise among lawmakers soon, but that doesn’t seem to be happening. The News Observer noted,

The N.C. General Assembly is grinding to a halt as frustration mounts about Republican lawmakers’ inability to reach a consensus plan to cut taxes…Hidden behind the scenes for days, the feud between GOP leaders escalated Thursday when the Senate took the unusual step of removing 41 House bills from its calendar, sending them to the clerk’s office and an indefinite future. The House later announced it would not hold full sessions the week of July Fourth – meaning lawmakers will return to Raleigh on July 8, weeks after they had hoped to adjourn for the year.

At this point, it’s anyone’s guess what could happen. To buy time, the governor signed a continuing budget resolution on Wednesday that will fund the government at 95 percent of last year’s level until July 31. The Senate Finance committee just announced that their substitute for House Bill 998 will be heard in committee on Monday afternoon. Let’s hope this is a sign that the tax impasse will soon be resolved.

More on North Carolina here.

Follow Liz on Twitter: @elizabeth_malm.

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