Taxes are always part of discussions about government and public policy, and taxes were clearly a hot topic in the recent session of the North Carolina General Assembly. Debates occurred about taxing services, lowering income tax rates, implementing incentives for business and energy expenditures, and dividing public revenues between urban and rural counties. Legislation was passed for some of these items, but I can assure you there will be more discussion and debate in future sessions.
There are two reasons why taxes are often on the minds of our elected officials. One is because the amount of tax revenues collected by the state determines how much can be spent.
North Carolina – like 48 other states – has a balanced budget requirement. Unlike the federal government, which can borrow to make up a shortfall between spending and revenues, spending from North Carolina’s General Fund budget cannot exceed revenues to that fund. So taxes determine revenues, and revenues determine spending.
The second reason is broader. Forces beyond North Carolina’s control are changing the economic landscape and are affecting taxes. People now spend more on services than they do on products, yet the sales tax is still predominantly a tax on products. Online buying is growing by leaps and bounds, but not all is captured by the sales tax. How people earn and live is changing in ways not anticipated by the current rules of the income tax. Even the lines between production and consumption may soon be blurred if “3D manufacturing” eventually allows households to make appliances, furniture, electronics and maybe even vehicles at their homes.
Any tax system must answer three questions: What is taxed (the tax base), what adjustments to the tax base should be allowed and what tax rate or rates should be applied to the resulting taxable base (tax base after subtracting adjustments).
There are obviously many, many answers – indeed, perhaps an infinite number — to these questions. Here, for discussion purposes only, I outline two alternative tax systems for North Carolina. One is based on taxing income, while the other is built on taxing only consumption (spending).
Income is the most comprehensive measure of economic activity for a household and includes earnings from work and returns from investments. For tax purposes, I would include income from retirement funds only to the extent those monies had not been taxed earlier – such as when they were invested.
Two adjustments would be made to a household’s income. The first is a child expenditure deduction, following the idea that children are an investment in the future and thus a long-run benefit for the economy. The child expenditure would be large, based on government estimates for the annual cost of raising a child. The latest average is approximately $17,000 per child.
The second adjustment would be direct income support for lower-income households. A qualifying household would receive some, all or even more than their income tax withholdings in \order to put their total money resources at some set higher level. For example, a household with money earnings of only $5,000 might receive a supplement of $10,000, one earning $12,000 might get $8,000, and a household making $20,000 might receive $5,000. The levels of support would be scaled to always leave an incentive for the household to achieve higher earnings on their own.
This income tax system could be implemented as one tax, with part of the revenues going to the state and part going to the household’s home county or city. I estimate one rate of 11.3 percent would collect the same total revenue for our state and local governments as today’s more complex system. Local governments would be free to adjust the rate for their portion of the tax.
Although there is one rate, the child deduction (which is the same for households of all income levels) and the income supplement for low-income households actually make the system “progressive” – meaning higher-income households pay a higher effective rate than lower-income households.
The second tax system would have the same adjustments but would tax consumption (income minus money invested) following the idea that investments stimulate economic growth.
A tax rate of 14.9 percent would be needed to generate today’s revenue totals for state and local governments.
Under both systems the state corporate income tax would be replaced with a state property tax. The notion is that public costs imposed by businesses relate mainly to the business’s physical presence – costs such as public safety and worker education. Income earned by the corporation and passed to North Carolina residents would be directly taxed by the income or consumption tax.
These are just ideas to be batted around and debated — because, I think, like me, you will decide tax issues are not going away.
Mike Walden is a William Neal Reynolds Distinguished Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of North Carolina State University’s College of Agriculture and Life Sciences.