John Locke Update / Research Brief

The Franchise Tax: North Carolina’s Version of the Warren/Sanders Wealth Tax

posted on in Fiscal Insight, Spending & Taxes

The Democratic party’s most radically progressive candidates, Bernie Sanders and Elizabeth Warren, have promised to impose a tax on wealth. To be clear, wealth is distinct from income. Wealth is accumulated income in the form of savings and investments and real assets like real estate, antique or art collections, plant and equipment for a business, and even one’s home. So, a tax on wealth is a tax on the value of what is obtained when income, which for individuals has already been taxed, is spent on wealth-enhancing assets.

Warren and Sanders are proposing a wealth tax as a way to “soak the rich” to pay for an array of socialist-type programs like tuition-free college education, the Green New Deal, and the misnamed Medicare For All. Collectively these programs would require many tens-of-trillions of dollars in new government revenues. The only way to even approach getting that money is to tax what people have, in addition to what they earn.

At the federal level, the United States does not have a wealth tax, and many argue that such a tax would be unconstitutional. On the other hand, North Carolina and 15 other states have a wealth tax that goes by a rather obscure and non-descriptive sounding name of “franchise tax.” Of course, North Carolina’s franchise tax targets a different base than the wealth tax being proposed by Warren or Sanders.  It is imposed on businesses, rather than individuals.  But that doesn’t change the fact that, in principle, it is a tax on wealth and a rather significant one at that. According to the Tax Foundation, if North Carolina abandoned its franchise tax, it would move from 33rd in the nation to 16th in their state rankings for property and wealth taxes. (See this Carolina Journal article for a more expansive look at the workings of the tax itself.)

North Carolina’s wealth tax targets the “net worth” of businesses organized as C corporations and S corporations. Net worth is defined simply as assets minus liabilities, that is, how much the company has minus how much it owes. This is the classic definition of wealth. The rate of taxation for C corporations is $1.50 per $1,000 of net value with a floor of $200 that no corporation (no matter how small) can escape. For S corporations, it is $200 on the first million dollars in net value and then $1.50 for each thousand after that. (See NCDOR for additional information.) The tax is capped at $150,000 or $1,000,000 in valuation.

While the target base is different from the wealth tax proposed by the radical progressives in the Democratic Party, North Carolina’s franchise tax faces the same criticisms.

From an ethical perspective, the tax is, at best, morally suspect unless one adopts the notion proclaimed by progressives like Warren and Sanders that it is not possible to treat businesses or the wealthy unjustly through the tax code. But if we start with the idea of tax fairness within the construct of a free society based on equal treatment under the law, North Carolina’s franchise tax unjustly punishes companies for using their profits to grow their businesses. If a company builds a new plant or purchases equipment and therefore enhances its value, it is penalized. And from a justice perspective, the state doesn’t just penalize the company once when its capital stock is initially enhanced, but year after year, as those original purchases continue to be part of the company’s base of wealth. In other words, the same stock of wealth is hit over and over again. In a free society, it is difficult to see how such a punitive approach to taxation can be justified morally.

From an economics perspective, the tax discourages growth by penalizing capital accumulation. Taxing a company’s wealth is the equivalent of taxing its capacity to grow as a business. It restrains its ability to satisfy its customers and to provide employment opportunities. Wealth, whether it’s held by individuals in the form of savings and investments or companies in the form of real capital, is what generates future income. If you tax wealth, either at the individual level or the business level, you simultaneously tax and therefore reduce the incomes that flow from that wealth. And because all income flows from an economy’s existing stock of wealth, all wealth taxes, whether on individuals (as proposed by Sanders and Warren) or on businesses (as exists in North Carolina), reduces the incomes of workers and employers alike.

Ultimately, there is a dilemma that many politicians in our state must confront. You cannot, as a matter of principle, be both against wealth taxes at the federal level as proposed by Bernie Sanders and Elizabeth Warren and a supporter of the franchise tax.

In June 2019 Roy Cordato retired from his full time position as Senior Economist and Resident Scholar at the John Locke Foundation and currently holds the position of Senior Economist Emeritus at the Foundation. From January 2001 to March 2017,… ...

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