North Carolina needs lower sales tax rate and more efficient, just system

July 11, 2010

Click here to view and here to listen to Dr. Roy Cordato discussing this Spotlight report.

RALEIGH — North Carolina needs to lower its sales tax rate, end taxation of some items, and remove inefficient, unjust distortions in the current tax. That’s the prescription for true sales tax reform offered in a new John Locke Foundation Spotlight report.

“The General Assembly formed a special tax reform committee in 2009, but that group has focused mainly on expanding the existing sales tax to cover more services,” said report author Dr. Roy Cordato, JLF Vice President for Research and Resident Scholar. “For those concerned that the size and scope of state government are already too large, that approach to tax reform should be alarming. It is a recipe for increasing taxes in the long run and expanding an already bloated state government.”

Lawmakers have talked about lowering the sales tax rate while broadening the tax base.
Their discussion of lower rates can be misleading, said Cordato, a Ph.D. economist.

“It is fair to speculate that any rate cut would simply add a spoonful of sugar, politically speaking, to help the base-broadening medicine go down with the electorate,” he said. “The reality is that a broader sales tax base would help politicians trying to raise revenue in the future.”

Rather than looking for ways to take more money away from North Carolina taxpayers, true reformers should take another approach, Cordato said. “Appropriate reform would involve changes to the sales tax base, broadening that base in some areas and narrowing it in others.”

The sales tax should conform to three basic principles, Cordato said. “First, the sales tax base should be neutral and not constructed so that it penalizes some purchases and rewards others,” he said. “Second, the tax should conform with principles of justice that are rooted in a respect for liberty and freedom of choice. Third, the system should avoid hidden taxes.”

North Carolina’s sales tax violates all three principles, Cordato said. “The existing tax base is overly broad,” he said. “Because business-to-business sales are taxed, customers end up getting double-taxed. For example, a person buying a bottle of shampoo from a drug store pays the tax on the shampoo, plus the hidden tax built into the price of the shampoo. That hidden tax consists of the taxes the store owner paid for the cash register, store shelving, credit card equipment, and other items.”

The sales tax penalizes consumer goods that require a larger-than-average number of business-to-business purchases, Cordato said. Most services already face a hidden sales tax.

“All goods that go into providing services already are subject to North Carolina’s sales tax,” Cordato said. “The price for lawn service includes the sales tax on the lawn mower. The price of a haircut includes the sales tax on the hair clippers.”

Many goods and services are taxed at “extraordinary” rates, Cordato said. “Violating the principles of neutrality and justice, North Carolina taxes a number of items at higher rates: movies and other entertainment, alcoholic beverages, tobacco products, hotel rooms, and rental cars.”

“In a free society, the purpose of a tax system is simply to raise money for government operations,” Cordato added. “It should not be used to punish activities disfavored by politicians or to reward activities politicians consider virtuous. The tax system should be neutral with respect to people’s freely made choices.”

Implications for North Carolina’s sales tax are straightforward, Cordato said. “Both goods and services should be taxed — but taxed only once,” he said. “That taxation should be obvious to the taxpayer. Sales taxes on all business-to-business purchases should be abolished. That means many goods taxed now should be removed from the base. Lawmakers also should scrap extra sales taxes on alcohol, tobacco, and other products.”

Regardless of changes to the sales tax base, North Carolina needs a lower tax rate, Cordato said. “This state’s combined average state and local rate of 7.98 percent is nearly identical to Tennessee’s rate of 8 percent, which is the highest rate in the Southeast,” he said. “But we should remember that Tennessee has no income tax. North Carolina’s rate is a full percentage point higher than any other Southeastern state. This includes Florida, another state with no income tax.”

An overly high rate violates the principle of tax justice, Cordato said. “A punitive sales tax rate imposes a penalty on living and doing business in this state,” he said. “It flies in the face of the North Carolina Constitution’s guarantee of citizens’ right to enjoy the fruits of their own labor — their income.”

Lawmakers should keep these ideas in mind when they revisit tax reform, Cordato said. “Rather than look for the best way to raise more money in the future, legislators should pursue a tax system that is neutral, just, and avoids hidden taxes.”

Dr. Roy Cordato’s Spotlight report, “Reforming the Sales Tax: Keep in mind liberty, prosperity, and sound principles of taxation,” is available at the JLF Web site. For more information, please contact Cordato at (919) 828-3876 or [email protected]. To arrange an interview, contact Mitch Kokai at (919) 306-8736 or [email protected].