JLF’s Roy Cordato, a Ph.D. economist, has analyzed the tax reform signed into law earlier this year, and concludes the tax reform package is good news for North Carolinians.
“Throughout the process, reformers aimed to reduce the tax system’s general bias against productivity and job creation, reduce favoritism and special carve-outs, simplify the tax code, and reduce the overall burden on taxpayers,” he said. “The final version of the law made significant progress in accomplishing all of these goals.”
Lawmakers lowered personal and corporate income tax rates while broadening the tax base, expanded the sales tax base to include some services, and eliminated the estate or death tax. “The overall tax cut of $4.75 billion over five years works out to no more than 4 percent of expected state General Fund revenue during the period, and probably less if the economy grows as a result of reform,” Cordato said.
Cutting the overall tax burden will have positive effects, Cordato said. “Reducing tax revenues means transferring resources from political control to control by consumers and entrepreneurs,” he said. “This enhances economic efficiency, generating more useful output and greater economic growth and prosperity.”
From the perspective of economic growth, the two most important reforms targeted personal and corporate income taxes, Cordato said. Lawmakers replaced a graduated personal income tax system with current rates from 6 percent to 7.75 percent. The new flat rate is 5.75 percent.
“North Carolina no longer has the highest top marginal tax rate in the Southeast,” Cordato said. “That’s important because an income tax is in essence a penalty on productive activity of all kinds. The higher the rate, the greater the penalty. The old progressive rate structure also had the effect of penalizing people for earning higher incomes and becoming more productive. The new flat rate eliminates that problem.”
So what should tax reformers do next? Here’s Cordato’s recommendation.
Future reforms should focus on the income tax base, Cordato said. “This year’s reforms did not address the problem of the income tax’s penalty on all forms of investment,” he explained. “Money saved or invested is taxed first as income and then taxed a second time as earnings when the savings or investment yields interest, dividends, or capital gains.”
Lawmakers can address that issue by removing either principal or interest from the tax base, Cordato said. “The John Locke Foundation has recommended addressing this issue through new universal savings accounts, USAs, that would exempt all deposits from taxable income while taxing any withdrawals,” he said. “Another option would be to lower or eliminate the tax on capital gains.”
On the corporate income side, North Carolina leaders dropped the tax rate from 6.9 percent, highest in the Southeast, to 6 percent in 2014 and 5 percent in 2015. The rate could drop as low as 3 percent in 2017 if the state meets revenue targets.
“Unlike the current corporate income tax, which combines a high rate with special breaks for favored businesses and industries, new lower rates will apply across the board,” Cordato said. “Loopholes and giveaways embedded in the current system, based on what is essentially a crony capitalist model, are eliminated.”
Future reform should focus on abolishing the corporate income tax, Cordato said. “It’s a hidden tax, and it creates a drag on the state’s economy by placing an additional layer of taxation on investment,” he said. “Lawmakers should repeal the legislation that enables the state to tax corporate income at all. This would make it difficult for future legislatures to reinstate the tax.”
