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Budget and Taxation
The State Tax Burden

Taxes represent the price we pay for government, so a reasonable tax burden is of benefit to the citizens who consume the services they fund. Unfortunately, the price of government in North Carolina has grown dramatically over the past two decades, and is no longer reasonable. More recently, while state lawmakers reduced taxes in the mid-1990s, they raised them even more earlier in the decade and then again in the 2001–2003 period, resulting in an overall growth in North Carolina’s state tax burden of well over $1 billion.

A Growing Tax Burden

North Carolina’s top marginal tax rates on individual (8.25 percent) and corporate (6.9 percent) income are the highest in the Southeast and among the highest (9th) in the U.S. They create a strong disincentive to work, save, and invest in our state. While previously low by national standards, North Carolina‘s combined sales tax has now risen to an average rate of 7.05 percent, 12th-highest in the nation, while our 24.2-cent per gallon gas tax in 2004 was the 11th-highest. However, because North Carolina relies more heavily on state funds for such services as schools and roads, our high ranking on state taxes is somewhat offset by a low ranking on property taxes. Still, our combined state and local tax burden of nearly 10 percent of income remains the highest in the region.

Research has demonstrated clearly that taxes have a significant economic impact by discouraging out-of-state businesses from relocating and by limiting new business starts and investment. High marginal rates on income, in particular, have been shown to reduce economic output, so North Carolina’s heavy reliance on high income tax rates is troubling. A 1997 study for the Locke Foundation by N.C. State economist Michael Walden found

Recent State Actions

Before the 1994 elections, the General Assembly had enacted or approved five major tax increases since 1983, including hikes in sales taxes, income taxes, motor fuels taxes, and excise taxes. The last two, implemented in 1990 and 1992, had a combined fiscal impact of more than $1.8 billion in 2001. Subsequent cuts beginning in 1995 saved taxpayers $1.4 billion in the same year meaning that, over the decade, the state tax burden actually rose by about $427 million. Furthermore, while tax increases in the early 1990s hiked marginal tax rates, the 1990s tax cuts focused primarily on exemptions, deductions, and credits, leaving our high marginal tax rates intact.

The situation worsened considerably from 2001 to 2003. Each of those three years, the General Assembly enacted budgets that increased the tax burden — by roughly half a billion in 2001 and then more than $1 billion annually in the following years. The increases, some permanent and some supposedly “temporary,” included higher taxes on personal income, retail sales, employers, health insurance, satellite television service, and even children’s candy. Claims that the 2003 budget bill was not a tax increase because it merely “extended” higher income and sales tax rates are misleading, because the bill included other, permanent taxes on consumers and because taxpayers would have paid less if the bill had not been enacted. That is a basic definition of a “tax hike.”

Recommendation

North Carolina policymakers should make it a goal at least to reduce taxes enough to bring our tax burden in line with that of our neighbors, which would require state or local tax cuts of approximately $1.3 billion. Of particular concern are high income tax rates. The Locke Foundation’s 2004 budget plan proposed to 1) reduce personal and corporate income taxes to a flat rate of 6 percent, saving $752 million; 2) give families $165 million in tax relief for education and health expenses; 3) repeal $574 million in “temporary” sales and income taxes, and 4) eliminate $369 million in selective exemptions, deductions, and other tax biases.

To view higher quality graphs, download Agenda 2004 [560KB Acrobat].