Legislature returns to tax reform


John Hood Columnist


North Carolina’s economy continues to expand at a relatively rapid pace. Over the last year, for example, our gross domestic product grew by 2.6 percent after inflation, compared to the nation’s 1.6 percent growth rate and the Southeast’s 2 percent rate.

One consequence of healthy economic growth is healthy revenue growth for the state. Through February, General Fund revenues are up 4.9 percent over last year, and currently exceed projections by $438 million. The final revenue surplus for the current fiscal year is likely to be larger than that. And projected revenue growth for the next fiscal years is solid.

Republican leaders in the legislature believe that there will be room in the state budget next year for sizable pay raises for teachers and other public employees, spending boosts in other critical areas, and tax relief. Gov. Roy Cooper agrees with this general observation, actually, although the budget plan he already submitted was heavy on the spending and light (some $70 million worth) on the tax cuts.

While lawmakers haven’t yet released their budget plan, both the Senate and House have made public their plans on taxes. As usual, the Senate’s plan is more ambitious. It would reduce state taxes by roughly $1 billion over the next two years, with a policy mix that includes rate cuts in both personal and corporate income, increases in the standard deduction, changes in the franchise tax, and the conversion of the child tax credit into a (somewhat larger) child tax deduction.

The overall effect of the Senate plan would be to reduce taxes for the vast majority of North Carolina households — income taxes paid would drop by an average of 5.1 percent — but those with low to moderate incomes would receive larger cuts, percentage-wise, than affluent households would.

The House’s tax plan is about half the size in fiscal impact and structured somewhat differently. For example, it would get rid of the sales tax on mill machinery. It does reform the franchise tax and increase the standard deduction on the personal income tax, albeit not as much as the Senate plan does.

If history is any guide, the two chambers will meet somewhere in the middle on these tax proposals. As they do so, they should prioritize those elements that do the most to make North Carolina’s tax system more competitive and coherent. For example, a retail sales tax should never have been applied to a business input such as mill machinery. That definitely needs to go.

Dropping the corporate tax rate from 3 percent to 2.5 percent by 2019 should also be a priority. It has never made sense to tax income when it is received by corporations, and then again when that income is passed along to shareholders in the form of dividends or capital gains. In the past, governors and lawmakers tried to offset North Carolina’s corporate and franchise taxes for select businesses by handing out special incentives. That was unfair, inefficient, and potentially corrupting. Cutting those rates across the board is the right approach.

Reshaping the state’s tax system has been one of the greatest accomplishments of the past six years. It has also been one of the most furiously contested by progressives, who rightly view a lower tax burden as a check on the size and scope of government (at the state level, at least, where the constitution requires a balanced budget).

As the House and Senate negotiate their way to a final budget for the 2017-19 biennium, however, they should keep in mind that there are other important accomplishments to preserve and build on. Lawmakers must continue to put significant money into state savings accounts, both to hedge against a fiscal or natural disaster in the short run and to fund benefit promises to retirees in the long run. They must also continue to advance their education reform initiatives.

There should be enough fiscal space to accommodate these needs, while also continuing to improve North Carolina’s business climate through tax reduction and reform.

John Hood is chairman of the John Locke Foundation and appears on the talk show “NC SPIN.” You can follow him @JohnHoodNC.

John Hood Columnist
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