Assessing the House Tax Plan | Eastern North Carolina Now

   Publisher's note: The article below appeared in John Hood's daily column in his publication, the Carolina Journal, which, because of Author / Publisher Hood, is inextricably linked to the John Locke Foundation.

    RALEIGH     Last week, I assessed the tax reform plan offered by Senate leader Phil Berger and his colleagues. While crediting the Senate plan for setting the proper goals -- to reduce North Carolina's punitive tax rates on investment and to produce a net tax cut -- I criticized it for increasing the tax-compliance burden for too many businesses and for raising taxes on large families of modest incomes.

    Speaker Thom Tillis, Rep. David Lewis, and other House leaders have now offered their version of state tax reform. It pursues the same goals as the Senate plan but moves at a slower, more careful pace. Observers will score this feature as a plus or a minus, depending on their views and expectations. To this observer, it's a plus. It produces a bill that advances fundamental tax reform in North Carolina without creating excessive regulatory burdens or regressivity - which means it has a better chance of gaining public and legislative support.

John Hood
    The architecture of the two plans is similar. Both broaden the base of North Carolina's income and sales taxes while lowering their marginal rates, in the process converting the state's income tax into a Flat Tax. Both reduce marginal tax rates on corporate income and franchises. Both eliminate North Carolina's foolish inheritance tax. Both result in a significant net tax cut over the next three fiscal years.

    But the plans hit different marks. The Senate plan phases in a cut in the state's marginal tax rate on personal income to 4.5 percent, down from the current rates of 6 percent, 7 percent and 7.75 percent. The House plan cuts the rate to 5.9 percent. Furthermore, the House caps rather than eliminates itemized deductions and increases North Carolina's per-child tax credit by between $125 and $150, depending on household income.

    On sales tax, the Senate plan applies it to some 180 services not currently taxed and uses the resulting revenue both to offset its large income-tax cut and to pull the statewide sales tax rate down a quarter-point to 6.5 percent (in most counties). The House plan does much less to the base, by taxing new services primarily in situations in which a business already collects sales tax on the goods it sells but not the services it sells, such as repairs and warranties. Thus, the House plan's resulting statewide sales-tax rate is a bit higher, at 6.65 percent, and it doesn't generate as much revenue to transfer to income-tax reduction.

    Corporate tax bills would drop under both plans. The Senate plan phases in a cut in the corporate income tax to 6 percent by 2016, down from the current 6.9 percent. It also broadens the base of the franchise tax to include non-corporate businesses and while cutting its rate a bit. The House plan cuts the corporate tax to 6.75 percent and matches the Senate's cut in franchise tax, but doesn't subject more businesses to the latter tax.

    My understanding is that the Senate tax reform, when filed as a bill, will likely be scored as a $1 billion cut from the revenue baseline over the next three years. The House tax cut would amount to about half of that -- a cumulative $485 million by 2015-16 (reaching $1.2 billion by 2017-18). Keep in mind that neither of these tax-cut figures reflects the likelihood that tax reform will increase the growth rate of North Carolina's economy, thus generating a positive feedback loop in revenue. No, I'm certainly not claiming that state tax cuts pay for themselves. I'm saying that the revenue reduction over the next three years will be less than static estimates for either the Senate or House plan, because unemployed people will find jobs and employed people will receive higher wages.

    I know that's a lot of detail -- but tax policy is all about details. To make a long story short, the House plan is a good first step towards fundamental tax reform. It appears to avoid the major pitfalls lying ahead of the Senate plan, although I'll wait for more specific tax-incidence numbers before saying that definitively.

    On the other hand, the Senate plan accomplishes a bigger reduction in the effective tax rate on savings and investment, and would therefore result in somewhat-stronger economic growth. With regard to state taxes on investment returns from purchasing stock in a North Carolina corporation, for example, the Senate's combined effective tax rate would include:

    • 4.5% on the income initially received and invested, and
    • 6% on corporate income generated, and
    • .135% annual franchise tax on the assets of the corporation, and
    • 4.5% on corporate dividends or capital gains paid out to shareholders.

    Whereas the House's combined effective tax rate would include:

    • 5.9% on the income initially received and invested, and
    • 6.75% on the corporate income generated, and
    • .135% annual franchise tax on the assets of the corporation, and
    • 5.9% on corporate dividends or capital gains paid out to shareholders.

    So the best way to improve the House tax reform would be to add investment incentives for the 2015 tax year and beyond. JLF's proposed tax-deferred USA accounts would be one such vehicle. Another would be to mirror the federal code and several other states by taxing dividends and capital gains at a lower marginal rate than wage income. Still another would be to reduce further the corporate or franchise tax. House leaders could clearly signal their intention to address the issue as quickly as additional budget savings or revenue growth will allow.

    Now that both legislative chambers have outlined their approaches to tax reform, bargaining can begin. The two sides really aren't that far apart philosophically. They differ on practical considerations. For taxpayers, the only truly impractical outcome here would be for legislators not to come to agreement. North Carolinians need the higher household incomes and greater job opportunities that tax reform will bring.

    I think their needs are about to be met.
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