June 19, 2013

RALEIGH — The most likely outcome of tax reform negotiations in the North Carolina General Assembly is a plan that would lead to average annual state revenue growth of 3.2 percent to 3.9 percent. That’s a key finding in a new John Locke Foundation Spotlight report.

“Assuming that state General Fund revenue growth follows its 20-year historical average, state revenues would grow by 17 percent over the next five years under the state Senate’s tax reform plan, or by 21 percent under the House plan,” said report author and JLF President John Hood. “That means average annual growth of 3.2 percent under the Senate plan and 3.9 percent under the House plan.”

Those numbers fit with one “three truths of tax reform” spelled out in the report: Neither the House tax plan nor its Senate counterpart would prevent state government from funding core public services.

“In contrast to liberal criticism that the House and Senate plans would rob state government of necessary revenue, the reality is that the fiscal impacts of the two tax plans are relatively modest,” Hood said. “If enacted, they would leave most expected revenue growth over the next five years in the state treasury.”

The other two truths of tax reform: Tax bills under discussion now would constitute fundamental tax reform, not just broad-based tax relief for most households, and there is strong empirical support for the idea that reforming and reducing state taxes will increase job creation and economic growth.

“Whatever compromise tax bill the House, Senate, and McCrory administration are about to hammer out, expect liberal critics to hammer them on it,” Hood said. “But to most North Carolinians, the results will be clear: a simpler and more efficient tax code, lower tax burdens, and greater economic growth and prosperity in North Carolina. That’s real tax reform.”

Hood’s report challenges the notion that fundamental tax reform is inconsistent with tax cuts.

“Recognizing that any worthwhile tax reform would reduce or eliminate special tax benefits defended by powerful interest groups, conservatives have traditionally argued that tax reform should be structured as a net tax cut in order to motivate the majority of citizens who gain from reform to overcome the opposition of the minority of special interests who stand to lose a prized tax break,” Hood said.

While they have disagreed about the means, conservatives generally have agreed the goal of fundamental tax reform is to target consumption, not total income. When government taxes the amount of money saved as well as the returns on that savings, it penalizes savings in favor of current consumption, Hood said.

“Such a system discourages the formation of private capital to finance business creation or expansion, thus reducing job creation and economic growth,” he said. “Imposing a corporate income makes the situation even worse. The same stream of investment earnings is taxed both as corporate income and again as dividends or capital gains.”

Liberals take a fundamentally different approach to tax reform, Hood said. “For them, the main problem isn’t that the current tax code hampers economic growth but that it generates too little revenue for government to spend,” he said. “In other words, liberals think the current tax system lets households keep too much of their own money. Conservatives think the current tax system lets households keep too little of their own money.”

The House and Senate tax plans reduce marginal tax rates on personal income, significantly reduce or phase out taxes on corporate income, and broaden the base of North Carolina’s income and sales taxes to eliminate special tax breaks and inefficiencies, Hood said.

“In short, whether the General Assembly enacts the House tax plan, the Senate tax plan, or something in between, state lawmakers will be both cutting taxes and reforming the tax code,” he said.

Hood turns to the published record in academic and professional journals to rebut liberal claims about the impact of tax reform on the North Carolina economy. “When critics claim North Carolina’s economy will not derive significant benefits from the Senate and House tax plans currently under discussion, this claim is clearly at odds with the available evidence.”

The report lists more than a dozen journals that have published studies revealing links between economic growth and state taxation just in the past two decades. “While no one should overstate the role of state taxes, anyone who suggests that reducing and reforming state taxes won’t create at least some positive response in the private economy is ignoring a large body of empirical evidence to the contrary.”

Tax reform in North Carolina is likely to produce clear benefits, Hood said. “Either the House or Senate tax plan likely would result in thousands of new jobs created in the short run and even greater benefits for entrepreneurship, job creation, and income growth in the long run.”

John Hood’s Spotlight report, “Three Truths of Tax Reform: Senate, House plans would spur growth, create jobs,” is available at the JLF website. For more information, please contact Hood at (919) 828-3876 or [email protected]. To arrange an interview, contact Mitch Kokai at (919) 306-8736 or [email protected].