Get NC Tax Reform Right | Eastern North Carolina Now

    Publisher's note: This article appeared on John Hood's daily column in the Carolina Journal, which, because of Author / Publisher Hood, is linked to the John Locke Foundation.

    RALEIGH     After a lengthy and often messy process of both public and private negotiations, leaders of the North Carolina House and Senate appear to be on the cusp of completing a state spending plan for the 2015-17 budget biennium.

    Based on what's currently known about the deal, it has much to commend it to fiscal conservatives in North Carolina. General Fund expenditures will grow at a modest rate that keeps up with service needs while, over time, reducing the share of our personal incomes spent on government.

    Reportedly, state subsidies for some politically favored industries will shrink or disappear. And even in cases where they won't, such as the ridiculous grants for Hollywood film and television productions, the subsidies will at least be distributed as on-budget grants, subject to annual review, instead of littering the tax code with opaque, open-ended giveaways.

    Conservatives shouldn't expect to like everything in the new budget. There will be self-serving provisions inserted by powerful lawmakers. There will be pork. Nor should we shrink from criticizing a process even when it generates outcomes we generally like. Budget negotiations shouldn't have taken this long. House and Senate leaders should have spent more time earlier in the session comparing notes to ensure that the two budget plans didn't end up so far apart.

    Still, a budget that controls spending, shores up the Rainy Day Fund and other reserves, and fulfills prior commitments such as reforming the teacher-salary schedule is a budget deserving of praise. So at this late stage, it would be a big mistake to imperil the deal by trying to cobble together another round of sweeping tax reforms to fit inside it.

    I have championed tax reform in North Carolina for a quarter of a century. I consider it a high priority, essential to promoting broad-based economic growth and job creation in our state. I think that the 2013 tax reform bill represented a major step in the right direction. A net tax cut for most North Carolina families and businesses, the 2013 legislation gave our state a flat-rate income tax, steadily lower tax rates on corporate income, and a code less cluttered with extraneous or counterproductive exclusions, deductions, and credits.

    I also believe that more tax reform is needed, both to correct a few mistakes in the 2013 bill and to make North Carolina an even more attractive place to work, invest, and create new enterprises. However, I don't think September 2015 is the right time to do anything major in this area.

    For one thing, it's just too late to bring up a host of new tax issues, or to begin debating proposals that haven't gotten much public attention in the months since they were originally offered. Haste is the enemy of good tax policy. I heard, for example, that at one point the idea was tossed around to delay the corporate tax cuts already provided for in the 2013 legislation, so as to be able to "afford" other tax cuts. That would have been a horrible idea. Even if you don't think corporate tax relief are a high priority, taking back promised tax cuts is neither fair nor economically prudent. It inhibits sound planning.

    The more fundamental problem here is that tax reform is a process that ought to lead to a destination — but there is as yet no consensus about that destination. Some senators want eventually to abolish North Carolina's personal income tax and rely on a broader, higher sales tax to finance most General Fund spending, something akin to a state Fair Tax. Other lawmakers, and apparently Gov. Pat McCrory, have a different, albeit less well-defined destination in mind: a true Flat Tax. This would require not just levying a single tax rate on income, which we now do, but also ending the double-taxation of investment returns, which could be accomplished either by excluding dividends and capital gains from the tax base or adopting tax-free Unlimited Savings Accounts as JLF has proposed.

    Both the Fair Tax and the Flat Tax have pros and cons. Conservatives have been discussing them since the 1990s. The debate still isn't concluded, although I personally believe advocates of the Flat Tax have gotten the better of the argument.

    In any event, there is simply no reasonable chance of resolving the dispute before the end of the 2015 session. So it would be a mistake to attempt to advance either model through piecemeal action at this time — such as, for example, further broadening the base of the sales tax to include more services, and thus forcing more businesses to become unpaid tax collectors, in order to finance another reduction of the income tax rate. That might be consistent with the long-term vision of the Fair Tax camp. But Flat Taxers might prefer to focus on the double-taxation of savings, and to broaden the sales-tax base only if the proceeds were used to reduce the sales-tax rate.

    A few specific tax changes ought to appeal to all sides and pass this year. Fully or substantially restoring the tax deduction for high medical expenses, for example, is not only a popular idea but also a needed corrective to something the 2013 bill got wrong. When health insurance benefits are untaxed but out-of-pocket spending on medical services is taxed, that's a bias in the code. It ought to be fixed either by taxing benefits (which isn't going to happen anytime soon) or providing tax deductions for households to spend or save their own money for medical expenses.

    Furthermore, while the 2013 tax bill increased North Carolina's standard deduction in exchange for eliminating other deductions as well as personal exemptions, not everyone came out ahead in the swap. Some married couples with large families ended up with somewhat higher tax liabilities, even after accounting for a modest increase in per-child tax credits. Lawmakers could address this problem this year by further increasing the standard deduction, the child tax credits, or both.

    Large-scale reforms of North Carolina's tax system, however, can wait until next session or early in the 2017 session. Even if the General Assembly does nothing this year, taxes on North Carolina employers will fall by hundreds of millions of dollars as the next round of corporate tax cuts goes into effect and the payroll-tax surcharge for unemployment insurance goes away. If lawmakers would like to speed the process up by immediately cutting North Carolina's corporate tax rate to 3 percent, rather than waiting until the 2017 tax year, all the better.

    The point is that there is plenty of time to consider carefully what the next round of fundamental tax reform should look like, and what the final destination should be. Perhaps Senate advocates of the Fair Tax will convince the rest of us that their idea is workable and prudent. Perhaps advocates of the Flat Tax will convince senators that there is more than one way to get to a consumption-based tax system.

    By all means, let's keep talking about it. Fundamental tax reform is important. It's so important, in fact, that doing it right should be a higher priority than doing it right now.