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FAQs on State Tax Reform
• What makes the USA Tax better than the traditional sales tax?
While properly structured taxes on retail sales aim for the correct tax base - consumption - they are difficult to achieve and administer. Essentially, taxing transactions to generate money for government is a 20th-century solution to a 21st-century problem.
For one thing, no sales tax has ever been properly structured, at least not in the United States. It would have to apply to all goods and services sold at retail, and not apply to purchases that businesses make from other businesses. Otherwise, you distort the economy through what are called tax pyramids or cascades, as some goods or services bear higher effective taxes than others because of the number of intervening steps between production and consumption.
Why does sales taxes fall short of these ideals in the real world? Because some service industries have more political heft than others, allowing them to escape the sales tax, and because efforts to exclude business-to-business transactions often fail. These difficulties are not surprising when you consider the fact that collecting and remitting sales taxes is a burden. It is time-consuming and costly. In effect, sales taxes compel businesses to act as unpaid tax collectors for government. Broadening the sales tax base means imposing this burden on additional businesses, be they large law and accounting firms or small landscaping and cosmetology businesses. It's no wonder they resist the idea.
While problems with sales-tax administration preexisted the 1990s, the birth of the Internet as an international bazaar for buyers and sellers created a new one for transaction-based taxes. Brick-and-mortar retailers already see themselves as unfairly disadvantaged by sales taxes collected on what they sell but not on what their online competitors sell. Absent some kind of federal solution to the issue, which does not appear to be imminent, tax reform that raises the state's retail sales tax rate will make online commerce an even-more attractive way to avoid state taxes - and make North Carolina-based retailers even more concerned.
Because the USA Tax targets consumption indirectly, via the income-tax collection system, rather than directly via transaction taxes, it automatically takes care of the online-sales issue. Regardless of whether North Carolinians spend their consumption dollars in a North Carolina shopping mall, an online transaction, or a vacation to Mongolia, their state tax burden remains exactly the same.
Another advantage of the USA Tax over a broadened sales tax involves transparency. As much as possible, North Carolinians ought to know how much state government costs them. By preserving the collection system of the income tax, the USA Tax still provides taxpayers with an annual tax form - a bill or invoice informing them how much tax they paid. With a retail sales tax, consumers see mark-ups at the cash register but they never receive a full, annual accounting of their tax burden. Eliminating the corporate income tax is also a step towards transparency. Under the current system, the actual human beings who bear the incidence of the corporate tax have no idea how much it costs them as shareholders, employees, or customers. They deserve to know.
Finally, any tax reform that broadens the base and lowers the rate has short-term benefits and long-term risks. While fiscal conservatives may be in charge of state government at the time the tax reform is enacted, future elections may produce leaders with different priorities. Armed with a broader tax base, these big-spending politicians would be able to produce a large amount of new revenue with only a modest increase in the tax rate.
The safest way to prevent costly, economically ruinous tax increases in the future would be to insert a tax-rate cap into the North Carolina constitution. Policymakers could submit a constitutional amendment to the voters to cap the state's sales-tax rate. But there is no current plan to do so, and no guarantee that such a cap will be enacted. Fortunately, the North Carolina constitution has long capped the state income tax rate at 10 percent. Let's hope it never comes into play. Still, the insurance policy is already in place.
• How would North Carolina's adoption of a USA Tax affect North Carolinians' federal tax liability?
Because JLF's USA Tax begins with Adjusted Gross Income from the federal income tax, our state tax code would continue to be tethered to it to some degree. However, there is one way in which the adoption of a USA Tax would actually reduce taxes for North Carolinians who itemize their federal tax deductions.
Currently, taxpayers are allowed to take a federal tax deduction for either state income taxes paid or state sales taxes paid. For state income taxes, the computation is straightforward. For sales taxes, taxpayers can either tally up all their receipts for the year or take an estimated deduction (it is relatively small). Obviously, most North Carolinians who itemize are better off taking the income-tax deduction, and do so. The sales-tax deduction is most often taken in states such as Texas and Florida that lack personal income taxes.
The USA Tax is, legally, an income tax even though its base is limited to consumed income. North Carolina taxpayers would still be allowed to take the federal tax deduction for USA Tax paid. However, since the revenue once raised by North Carolina's sales tax will now be levied by a broad consumed-income tax, a far larger share of the state taxes that North Carolinians pay each year will be deductible from their federal income taxes. For some North Carolina taxpayers, the additional federal tax savings could be substantial.
• Wouldn't adopting a consumption-based tax system inherently harm poor North Carolinians?
Taxing consumption rather than total income is not an idea solely associated with conservatives or libertarians. Some economists and policy analysts who would consider themselves moderates or liberals also favor consumption-based taxes on economic grounds. In fact, there is a new movement in favor of a "progressive consumption tax" - one that would target consumed rather than total income, but used multiple rates and generous personal exemptions to make the resulting average tax burden rise steeply with household income.
Advocates of sales-tax-only systems, such as the Fair Tax at the federal level, argue that any regressivity concerns associated with a sales tax can be addressed either by sending tax rebates to lower-income households or by exempting certain goods, such as food or nonprescription drugs, from the sales-tax base. One benefit of retaining the collection structure for income taxes, however, is that policymakers can address these concerns directly by using personal exemptions. That's what JLF chose to do in our USA Tax plan.
It's important for these policymakers to know the real facts about tax fairness, by the way. Here's a handy set of statistics and explanations. In brief: state and local taxes in North Carolina are roughly proportional right now, not steeply regressive, and the taxes collected to fund North Carolina government as a whole -- including federally funded state and local spending -- is steeply progressive right now. Affluent households pay a much-higher share of their income in taxes than lower-income households pay, not just more tax in dollar terms.
• How would the USA Tax affect housing?
As previously noted, there are many different ways to pursue capital investment. If you put your money in stocks, bonds, mutual funds, REITs, or other cash-based instruments, tax-deferred vehicles such as IRAs, 401(k)s, and JLF's proposed USA accounts are relatively easy to understand, use, and administer.
But other kinds of capital investment are trickier. I already discussed the case of education, a form of investment in human capital. Another way people save and invest for future needs is by purchasing a capital asset directly, using it in the short-term for consumption, and then selling it later for an expected gain. The most familiar example would be residential housing, although the same concepts apply to other assets such as automobiles, boats, and collectibles.
The current income tax subjects housing to a confusing, convoluted mishmash of policies. Because homeowners receive tax breaks for mortgage interest but not for downpayments, the system encourages debt over equity. Current policies regarding depreciation, capital gains, and rental properties also create inequities and economic distortions.
Part of the problem, here, is that housing is both a consumption good and an investment good. Disentangling the two is impossible at the front end of the purchase. No one knows precisely how much of the cost of buying and maintaining the home over time serves to produce a future investment return, rather than to provide shelter and enjoyment to the owner-occupants.
Fortunately, there is a preexisting model for solving the problem: the Roth IRA. This current federal retirement-savings option allows taxpayers to pay tax on the amount of money they save but then withdraw their funds at retirement without tax, reversing the tax policies associated with traditional IRAs and 401(k)s. We recommend that North Carolina treat housing purchases and all other forms of direct investment in the same way. Under the USA Tax, households would use after-tax dollars for all costs associated with owning real property - downpayments, debt service, and maintenance. But selling that property would never be a taxable event. So all proceeds from selling your property would be tax-free, regardless of how many properties you own or what your income is.
• Why do you abolish the estate tax?
The proper rule for any tax system is to tax all consumed income once and only once. Don't exempt any consumption from tax, and don't levy multiple rates on some forms of future consumption (by taxing both investment principal and returns, for example, or taxing both corporate income and dividends or capital gains received from corporate stock).
Taxing assets accumulated at the time of death, or when those assets are distributed to heirs, is another example of taxing the same stream of income multiple times. This is unfair and injurious to small-business formation and growth. While it would be best to eliminate federal and state death taxes at the same time, because of how the two interact, North Carolina can set a valuable precedent by acting first, particularly given the fact that the estate tax doesn't generate much revenue, anyway.
One thing to understand, however, is that the USA Tax does seek to ensure that inherited assets are taxed at least once. If you pass away with unspent dollars remaining in your tax-deferred USA account, your heir would still be obligated to pay tax on that money when it is withdrawn.
• How would the USA Tax affect cross-border sales?
Our preferred approach to implementing a USA Tax, a "Plan A" that imposes an 8.5 percent USA tax rate and no separate state tax on retail sales, would make North Carolina an attractive place for others to visit and shop. With only the current local sales tax in place, North Carolina would have one of the lowest sales-tax burdens on the country - and by far the lowest sales tax in our region. Many residents of neighboring states would likely cross the border to North Carolina to purchase big-ticket items such as appliances, furniture, jewelry, and electronics. Tourists would also find North Carolina's prices lower than competing locations.
Remember that tax-free weekend the state holds every year just before school starts? This would be like allowing shoppers to buy anything they wanted, not just school supplies, with only a 2 percent to 2.5 percent sales tax - and allowing them to do this all year long!
Actually, some people see this as a disadvantage of the USA Tax, not an advantage. They would prefer out-of-state shoppers and tourists to pay a higher share of the cost of state services, allowing North Carolina residents to get a tax break. But this is an example of mixing up the concepts of tax liability and tax incidence. It is true that, under the USA Tax, these shoppers and tourists wouldn't see as much of a sales tax on their receipts. However, to the extent that North Carolina businesses make more sales as a result, those who own or work for those businesses will have higher, taxable incomes. State government will still get revenue from the arrangement - but mostly as a consequence of a larger private economy of taxable income, rather than by charging high tax rates at the point of sale.
• Are there difficulties in transitioning to a USA Tax?
Any fundamental change in longstanding tax policy will produce challenges in the transition from old to new. Households and businesses have made important decisions based on the current set of tax policies. Many of these decisions involve large amounts of money and long time horizons. If North Carolina decides to change our tax policies, we need to ensure that households and businesses are neither unfairly burdened by their past decisions nor given opportunities to game the new system in ways contrary to what tax reformers intended.
For the USA Tax, a key issue involves existing savings. To the extent that North Carolinians have already made extensive use of federal tax policies such as traditional IRAs, Roth IRAs, and 401(k)s to shield their retirement savings from punitive taxation, the USA Tax does nothing to damage their interests. USA accounts simply become a means of supplementing their current retirement savings, which receive both state and federal tax breaks, with a new savings vehicle that can be used for purposes other than retirement but that get only a state tax break.
Those North Carolinians who have already accumulated substantial savings in taxable brokerage accounts, mutual funds, or other accounts may well want to transfer these assets into Carolina USA accounts and take a state tax deduction. But our tax plan is designed to reduce penalties on future savings, not try to remedy the penalties imposed on past savings. Moreover, if free to move an unlimited amount of their existing assets immediately into USA accounts, some of these taxpayers may be able to eliminate their entire state tax liability for one or more years. That's not our intention, and could create a sudden shock to state revenues.
So we propose that during the first five years of implementation of a USA Tax for North Carolina, taxpayers be limited to a maximum net-savings deduction of 25 percent of their taxable income.
• What are some other ways that taxpayers might attempt to game a USA tax system?
Under any tax code, people have a financial incentive to pay as little tax as possible. If they follow the letter and spirit of the rules, no problem. But illegal tax evasions or unintended tax loopholes should be a legitimate concern.
For example, since the USA Tax system tracks only the amount of money you deposit into or withdraw from USA accounts, taxpayers might try to game the system by borrowing money, putting the money into USA accounts, and then claiming a deduction on their net savings - even though they aren't really engaging in net savings, since the debt they are incurring outside the USA account is offsetting the equity they are building within it. In practice, however, the net tax benefits of engaging in this practice would likely be small after subtracting debt service and other costs. Remember that withdrawals from USA accounts are taxable - individuals couldn't just shift money in and out of a USA account to claim a fake tax deduction and then pay off the short-term debt with the same money. They would end up with a tax deduction of zero.
Another potential strategy for gaming the system might be to reside in North Carolina during your highest-earning years, accumulating assets in your Carolina USA account and receiving annual tax deductions, and then move to another state when you decide to retire and spend your money. Although legally North Carolina's state government would still be entitled to state tax on your withdrawals from your USA account, it might be difficult to enforce this tax obligation on people who no longer live in the state.
To the extent this is a problem, by the way, it applies to consumption taxes in any form. In states that currently don't levy personal income taxes, such as Florida and Texas, residents are taxed only on what they spend. What they save accumulates untaxed. Upon retirement, they could then move to a state with an income tax and a correspondingly lower sales tax to spend their money. The fact that this rarely occurs under current conditions - Texans do not typically retire to North Carolina to escape Texas's higher sales tax on their purchases - should tell us that this potential loophole is probably not worth exploiting for most taxpayers.
• Why are you offering a Plan B that retains a state sales tax alongside a USA consumption tax?
In policymaking as much as in scouting, it's always wise to be prepared. Tax reform is a complicated issue. It isn't just an economic or fiscal issue. Politics will inevitably play a role. While we strongly believe in the merits of our Plan A - an 8.5 percent USA Tax to replace current sales, personal income, corporate income and estate taxes - we recognize that there may be compelling reasons to choose another route to reform. That's why we are offering Plan B, which would retain the current state sales tax at a lower rate (4.5 percent) and levy a 6 percent USA Tax to replace current income and estate taxes. Such a mix of policies would still go a long way to resolving the current tax bias against savings and investment, with a positive effect on state economic growth and job creation.
After enactment of Plan B, lawmakers could then monitor its implementation and adjust accordingly. If revenues come in stronger than expected, the General Assembly could continue reducing the sales tax rate or other taxes. If not, lawmakers could hold off on additional tax-reform steps until the economy improves, or until they identify additional budget savings with which to finance tax-rate reductions.
Go Back
While properly structured taxes on retail sales aim for the correct tax base - consumption - they are difficult to achieve and administer. Essentially, taxing transactions to generate money for government is a 20th-century solution to a 21st-century problem.
For one thing, no sales tax has ever been properly structured, at least not in the United States. It would have to apply to all goods and services sold at retail, and not apply to purchases that businesses make from other businesses. Otherwise, you distort the economy through what are called tax pyramids or cascades, as some goods or services bear higher effective taxes than others because of the number of intervening steps between production and consumption.
Why does sales taxes fall short of these ideals in the real world? Because some service industries have more political heft than others, allowing them to escape the sales tax, and because efforts to exclude business-to-business transactions often fail. These difficulties are not surprising when you consider the fact that collecting and remitting sales taxes is a burden. It is time-consuming and costly. In effect, sales taxes compel businesses to act as unpaid tax collectors for government. Broadening the sales tax base means imposing this burden on additional businesses, be they large law and accounting firms or small landscaping and cosmetology businesses. It's no wonder they resist the idea.
While problems with sales-tax administration preexisted the 1990s, the birth of the Internet as an international bazaar for buyers and sellers created a new one for transaction-based taxes. Brick-and-mortar retailers already see themselves as unfairly disadvantaged by sales taxes collected on what they sell but not on what their online competitors sell. Absent some kind of federal solution to the issue, which does not appear to be imminent, tax reform that raises the state's retail sales tax rate will make online commerce an even-more attractive way to avoid state taxes - and make North Carolina-based retailers even more concerned.
Because the USA Tax targets consumption indirectly, via the income-tax collection system, rather than directly via transaction taxes, it automatically takes care of the online-sales issue. Regardless of whether North Carolinians spend their consumption dollars in a North Carolina shopping mall, an online transaction, or a vacation to Mongolia, their state tax burden remains exactly the same.
Another advantage of the USA Tax over a broadened sales tax involves transparency. As much as possible, North Carolinians ought to know how much state government costs them. By preserving the collection system of the income tax, the USA Tax still provides taxpayers with an annual tax form - a bill or invoice informing them how much tax they paid. With a retail sales tax, consumers see mark-ups at the cash register but they never receive a full, annual accounting of their tax burden. Eliminating the corporate income tax is also a step towards transparency. Under the current system, the actual human beings who bear the incidence of the corporate tax have no idea how much it costs them as shareholders, employees, or customers. They deserve to know.
Finally, any tax reform that broadens the base and lowers the rate has short-term benefits and long-term risks. While fiscal conservatives may be in charge of state government at the time the tax reform is enacted, future elections may produce leaders with different priorities. Armed with a broader tax base, these big-spending politicians would be able to produce a large amount of new revenue with only a modest increase in the tax rate.
The safest way to prevent costly, economically ruinous tax increases in the future would be to insert a tax-rate cap into the North Carolina constitution. Policymakers could submit a constitutional amendment to the voters to cap the state's sales-tax rate. But there is no current plan to do so, and no guarantee that such a cap will be enacted. Fortunately, the North Carolina constitution has long capped the state income tax rate at 10 percent. Let's hope it never comes into play. Still, the insurance policy is already in place.
• How would North Carolina's adoption of a USA Tax affect North Carolinians' federal tax liability?
Because JLF's USA Tax begins with Adjusted Gross Income from the federal income tax, our state tax code would continue to be tethered to it to some degree. However, there is one way in which the adoption of a USA Tax would actually reduce taxes for North Carolinians who itemize their federal tax deductions.
Currently, taxpayers are allowed to take a federal tax deduction for either state income taxes paid or state sales taxes paid. For state income taxes, the computation is straightforward. For sales taxes, taxpayers can either tally up all their receipts for the year or take an estimated deduction (it is relatively small). Obviously, most North Carolinians who itemize are better off taking the income-tax deduction, and do so. The sales-tax deduction is most often taken in states such as Texas and Florida that lack personal income taxes.
The USA Tax is, legally, an income tax even though its base is limited to consumed income. North Carolina taxpayers would still be allowed to take the federal tax deduction for USA Tax paid. However, since the revenue once raised by North Carolina's sales tax will now be levied by a broad consumed-income tax, a far larger share of the state taxes that North Carolinians pay each year will be deductible from their federal income taxes. For some North Carolina taxpayers, the additional federal tax savings could be substantial.
• Wouldn't adopting a consumption-based tax system inherently harm poor North Carolinians?
Taxing consumption rather than total income is not an idea solely associated with conservatives or libertarians. Some economists and policy analysts who would consider themselves moderates or liberals also favor consumption-based taxes on economic grounds. In fact, there is a new movement in favor of a "progressive consumption tax" - one that would target consumed rather than total income, but used multiple rates and generous personal exemptions to make the resulting average tax burden rise steeply with household income.
Advocates of sales-tax-only systems, such as the Fair Tax at the federal level, argue that any regressivity concerns associated with a sales tax can be addressed either by sending tax rebates to lower-income households or by exempting certain goods, such as food or nonprescription drugs, from the sales-tax base. One benefit of retaining the collection structure for income taxes, however, is that policymakers can address these concerns directly by using personal exemptions. That's what JLF chose to do in our USA Tax plan.
It's important for these policymakers to know the real facts about tax fairness, by the way. Here's a handy set of statistics and explanations. In brief: state and local taxes in North Carolina are roughly proportional right now, not steeply regressive, and the taxes collected to fund North Carolina government as a whole -- including federally funded state and local spending -- is steeply progressive right now. Affluent households pay a much-higher share of their income in taxes than lower-income households pay, not just more tax in dollar terms.
• How would the USA Tax affect housing?
As previously noted, there are many different ways to pursue capital investment. If you put your money in stocks, bonds, mutual funds, REITs, or other cash-based instruments, tax-deferred vehicles such as IRAs, 401(k)s, and JLF's proposed USA accounts are relatively easy to understand, use, and administer.
But other kinds of capital investment are trickier. I already discussed the case of education, a form of investment in human capital. Another way people save and invest for future needs is by purchasing a capital asset directly, using it in the short-term for consumption, and then selling it later for an expected gain. The most familiar example would be residential housing, although the same concepts apply to other assets such as automobiles, boats, and collectibles.
The current income tax subjects housing to a confusing, convoluted mishmash of policies. Because homeowners receive tax breaks for mortgage interest but not for downpayments, the system encourages debt over equity. Current policies regarding depreciation, capital gains, and rental properties also create inequities and economic distortions.
Part of the problem, here, is that housing is both a consumption good and an investment good. Disentangling the two is impossible at the front end of the purchase. No one knows precisely how much of the cost of buying and maintaining the home over time serves to produce a future investment return, rather than to provide shelter and enjoyment to the owner-occupants.
Fortunately, there is a preexisting model for solving the problem: the Roth IRA. This current federal retirement-savings option allows taxpayers to pay tax on the amount of money they save but then withdraw their funds at retirement without tax, reversing the tax policies associated with traditional IRAs and 401(k)s. We recommend that North Carolina treat housing purchases and all other forms of direct investment in the same way. Under the USA Tax, households would use after-tax dollars for all costs associated with owning real property - downpayments, debt service, and maintenance. But selling that property would never be a taxable event. So all proceeds from selling your property would be tax-free, regardless of how many properties you own or what your income is.
• Why do you abolish the estate tax?
The proper rule for any tax system is to tax all consumed income once and only once. Don't exempt any consumption from tax, and don't levy multiple rates on some forms of future consumption (by taxing both investment principal and returns, for example, or taxing both corporate income and dividends or capital gains received from corporate stock).
Taxing assets accumulated at the time of death, or when those assets are distributed to heirs, is another example of taxing the same stream of income multiple times. This is unfair and injurious to small-business formation and growth. While it would be best to eliminate federal and state death taxes at the same time, because of how the two interact, North Carolina can set a valuable precedent by acting first, particularly given the fact that the estate tax doesn't generate much revenue, anyway.
One thing to understand, however, is that the USA Tax does seek to ensure that inherited assets are taxed at least once. If you pass away with unspent dollars remaining in your tax-deferred USA account, your heir would still be obligated to pay tax on that money when it is withdrawn.
• How would the USA Tax affect cross-border sales?
Our preferred approach to implementing a USA Tax, a "Plan A" that imposes an 8.5 percent USA tax rate and no separate state tax on retail sales, would make North Carolina an attractive place for others to visit and shop. With only the current local sales tax in place, North Carolina would have one of the lowest sales-tax burdens on the country - and by far the lowest sales tax in our region. Many residents of neighboring states would likely cross the border to North Carolina to purchase big-ticket items such as appliances, furniture, jewelry, and electronics. Tourists would also find North Carolina's prices lower than competing locations.
Remember that tax-free weekend the state holds every year just before school starts? This would be like allowing shoppers to buy anything they wanted, not just school supplies, with only a 2 percent to 2.5 percent sales tax - and allowing them to do this all year long!
Actually, some people see this as a disadvantage of the USA Tax, not an advantage. They would prefer out-of-state shoppers and tourists to pay a higher share of the cost of state services, allowing North Carolina residents to get a tax break. But this is an example of mixing up the concepts of tax liability and tax incidence. It is true that, under the USA Tax, these shoppers and tourists wouldn't see as much of a sales tax on their receipts. However, to the extent that North Carolina businesses make more sales as a result, those who own or work for those businesses will have higher, taxable incomes. State government will still get revenue from the arrangement - but mostly as a consequence of a larger private economy of taxable income, rather than by charging high tax rates at the point of sale.
• Are there difficulties in transitioning to a USA Tax?
Any fundamental change in longstanding tax policy will produce challenges in the transition from old to new. Households and businesses have made important decisions based on the current set of tax policies. Many of these decisions involve large amounts of money and long time horizons. If North Carolina decides to change our tax policies, we need to ensure that households and businesses are neither unfairly burdened by their past decisions nor given opportunities to game the new system in ways contrary to what tax reformers intended.
For the USA Tax, a key issue involves existing savings. To the extent that North Carolinians have already made extensive use of federal tax policies such as traditional IRAs, Roth IRAs, and 401(k)s to shield their retirement savings from punitive taxation, the USA Tax does nothing to damage their interests. USA accounts simply become a means of supplementing their current retirement savings, which receive both state and federal tax breaks, with a new savings vehicle that can be used for purposes other than retirement but that get only a state tax break.
Those North Carolinians who have already accumulated substantial savings in taxable brokerage accounts, mutual funds, or other accounts may well want to transfer these assets into Carolina USA accounts and take a state tax deduction. But our tax plan is designed to reduce penalties on future savings, not try to remedy the penalties imposed on past savings. Moreover, if free to move an unlimited amount of their existing assets immediately into USA accounts, some of these taxpayers may be able to eliminate their entire state tax liability for one or more years. That's not our intention, and could create a sudden shock to state revenues.
So we propose that during the first five years of implementation of a USA Tax for North Carolina, taxpayers be limited to a maximum net-savings deduction of 25 percent of their taxable income.
• What are some other ways that taxpayers might attempt to game a USA tax system?
Under any tax code, people have a financial incentive to pay as little tax as possible. If they follow the letter and spirit of the rules, no problem. But illegal tax evasions or unintended tax loopholes should be a legitimate concern.
For example, since the USA Tax system tracks only the amount of money you deposit into or withdraw from USA accounts, taxpayers might try to game the system by borrowing money, putting the money into USA accounts, and then claiming a deduction on their net savings - even though they aren't really engaging in net savings, since the debt they are incurring outside the USA account is offsetting the equity they are building within it. In practice, however, the net tax benefits of engaging in this practice would likely be small after subtracting debt service and other costs. Remember that withdrawals from USA accounts are taxable - individuals couldn't just shift money in and out of a USA account to claim a fake tax deduction and then pay off the short-term debt with the same money. They would end up with a tax deduction of zero.
Another potential strategy for gaming the system might be to reside in North Carolina during your highest-earning years, accumulating assets in your Carolina USA account and receiving annual tax deductions, and then move to another state when you decide to retire and spend your money. Although legally North Carolina's state government would still be entitled to state tax on your withdrawals from your USA account, it might be difficult to enforce this tax obligation on people who no longer live in the state.
To the extent this is a problem, by the way, it applies to consumption taxes in any form. In states that currently don't levy personal income taxes, such as Florida and Texas, residents are taxed only on what they spend. What they save accumulates untaxed. Upon retirement, they could then move to a state with an income tax and a correspondingly lower sales tax to spend their money. The fact that this rarely occurs under current conditions - Texans do not typically retire to North Carolina to escape Texas's higher sales tax on their purchases - should tell us that this potential loophole is probably not worth exploiting for most taxpayers.
• Why are you offering a Plan B that retains a state sales tax alongside a USA consumption tax?
In policymaking as much as in scouting, it's always wise to be prepared. Tax reform is a complicated issue. It isn't just an economic or fiscal issue. Politics will inevitably play a role. While we strongly believe in the merits of our Plan A - an 8.5 percent USA Tax to replace current sales, personal income, corporate income and estate taxes - we recognize that there may be compelling reasons to choose another route to reform. That's why we are offering Plan B, which would retain the current state sales tax at a lower rate (4.5 percent) and levy a 6 percent USA Tax to replace current income and estate taxes. Such a mix of policies would still go a long way to resolving the current tax bias against savings and investment, with a positive effect on state economic growth and job creation.
After enactment of Plan B, lawmakers could then monitor its implementation and adjust accordingly. If revenues come in stronger than expected, the General Assembly could continue reducing the sales tax rate or other taxes. If not, lawmakers could hold off on additional tax-reform steps until the economy improves, or until they identify additional budget savings with which to finance tax-rate reductions.
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