John Locke Update / Research Brief

Federal Tax Reform Wisely Follows the North Carolina Model

posted on in Economic Growth & Development, Fiscal Insight, Spending & Taxes
Featured Image

Even as major questions and specific details still have to be worked out, the Republican tax plan may sound familiar. It moves toward simplification, just as North Carolina’s successful tax reform of 2013 did, with fewer and lower rates, a larger “zero-tax bracket” through the standard deduction, and fewer exemptions and deductions.

Of course, spending restraint made the tax reform in North Carolina possible, and the same kind of restraint would be needed in Washington. The Senate’s budget resolution claims $5 trillion in deficit reduction over the next 10 years to make room for the $1.5 trillion tax cut, but nobody is going to confuse the federal government and North Carolina on long-term budget solvency.

The Congressional Budget Office (CBO) anticipates economic benefits of the proposed tax and budget plan will provide $1.2 trillion in greater tax collections and lower spending. A lower deficit, in turn, means slower growth in the national debt and lower interest payments on that debt. Other than the unrealistic, but reasonable, assumption that the economy will not fall into recession through 2027 (after all nobody expects the Spanish Inquisition or the next recession) is there evidence to support CBO’s economic assumptions?

UCLA economist Youssef Benzarti estimates the cost of federal tax filing has increased over the past 30 years and now takes 1.2 percent of the economy, or $230 billion a year. That would be at least $2.3 trillion over the next ten years back into people’s lives.

It is still early to assess the full impact of North Carolina’s reforms, but there are some indications that tax reform and spending restraint have provided an economic boost for the state. Median household income in North Carolina grew faster than all but three other states in 2016. Adjusted for inflation, it is the highest since the previous peak in 1995 and is closer to the national average than any time since 2000.

A lower corporate tax rate in North Carolina reduced the cost of business formation, investment, and growth. A low, flat personal income tax rate made taxes easier to file and a larger standard deduction spared more people from paying an income tax at all.  That let them keep a little more money with less withheld each paycheck instead of waiting for a refund check after filing.

Congress plans to keep the century-old charitable deduction and the mortgage interest deduction, just as North Carolina did. These deductions encourage charitable giving and borrowing to pay for bigger homes. The state and local tax (SALT) deduction, on the other hand, encourages higher state and local income taxes and might not survive. Whichever itemized deductions remain will be used far less frequently because of the large standard deduction, something North Carolina has also demonstrated.

If Congress can stick to the outline from late September, the federal tax code will be simpler and fairer that it has been in more than 30 years. Lower spending is needed to make the reforms sustainable. North Carolina has shown how to do both.

Joe Coletti is a senior fellow at the John Locke Foundation focused on fiscal policy issues. He previously headed the North Carolina Government Efficiency and Reform initiative within the Office of State Budget and Management, which led to… ...

Donate Today

About John Locke Foundation

We are North Carolina’s Most Trusted and Influential Source of Common Sense. The John Locke Foundation was created in 1990 as an independent, nonprofit think tank that would work “for truth, for freedom, and for the future of North Carolina.” The Foundation is named for John Locke (1632-1704), an English philosopher whose writings inspired Thomas Jefferson and the other Founders.

The John Locke Foundation is a 501(c)(3) research institute and is funded solely from voluntary contributions from individuals, corporations, and charitable foundations.