Resolving the Tax-Reform Impasse | Eastern North Carolina Now

    Publisher's note: This article appeared on John Hood's daily column in the Carolina Journal, which, because of Author / Publisher Hood, is linked to the John Locke Foundation.

    RALEIGH  -  Although news accounts and political chatter continue to emphasize the differences between the North Carolina House and Senate on tax reform, the latest Senate proposal took major strides toward the House position on a number of points. In reality, the two chambers are now fairly close to an agreement on state tax policy over the next two fiscal years.

    Both plans expand the base of the state sales tax. Both plans expand the base of the state income tax, convert it to a Flat Tax, and reduce the marginal rate, to 5.9 percent in the House and now 5.75 percent in the Senate. Both plans reduce the state's corporate-income tax over the next two fiscal years, to 6.35 percent in the House and 5 percent in the Senate.

    While the short-term fiscal impact of the new Senate plan remains larger than that of the House plan, the difference is hardly unbridgeable. In the first full year of implementation, FY 2014-15, the House plan would have a fiscal impact of $353 million, or 1.6 percent of projected General Fund revenue for that year. The Senate plan would have a fiscal impact of $492 million, or 2.3 percent.

    The real impasse lies beyond the current budget biennium. In 2015-16, 2016-17, and 2017-18, the Senate tax plan calls for a continued, rapid reduction of the corporate income tax, with the goal of eliminating the tax entirely in 2018-19. As argued in a previous column, I think this is a great idea that would help to make North Carolina one of the country's most attractive places to create, expand, or invest in new businesses. The Senate's larger corporate-tax reduction is the main reason why the long-term fiscal impact of its tax plan is significantly higher than that of the House plan - $963 million (about 3.9 percent of baseline revenue) vs. $571 million (2.3 percent) in FY 2017-18.

    While pro-growth tax reform is a core conservative principle, so is prudent budgeting. Some North Carolina conservatives, while supportive of tax reduction to promote private investment and growth, are also worried about the future fiscal risks associated with rapid growth of Medicaid spending, unwise federal policies such as energy regulation and Obamacare, and the puny size of North Carolina's rainy-day fund, which is designed to keep future governors and legislatures from having to raise taxes to meet expenses in the midst of recession.

    These concerns, not an unwillingness to support pro-growth tax reform, explain why some House leaders and administration officials are not yet sold on the full Senate tax plan. What we have here is tension between two conservative principles of fiscal policy. Both positions have validity. But resolving this tension is absolutely essential for boosting economic growth in North Carolina - not to mention the political stature of those negotiating the deal. Failing to come to resolution would be the worst possible outcome for all sides.

    Fortunately, there is a path to resolution. It starts with remembering another good conservative idea: fiscal triggers. From the Gramm-Rudman federal reform of 1985 to state tax and expenditure limitations, conservatives have long argued that binding constraints on future fiscal decisions are a valuable tool to keep special-interest lobbying or short-term political considerations from knocking government budgets out of alignment. Such policies typically set fiscal targets that trigger some automatic policy response in the future, such as spending cuts, budget savings, or tax rebates.

    North Carolina lawmakers should apply a similar idea to tax reform. The House-Senate compromise bill could include the phase-out of the corporate income tax by 2018 but also an annual fiscal trigger for each installment of the tax cut after 2015. One possible trigger could be annual General Fund revenue growth. If revenue growth doesn't meet the baseline projection in, say, 2015, then the scheduled reduction in corporate tax would be deferred until 2016. Alternatively, lawmakers could use a minimum deposit in the state's rainy-day reserve as the fiscal trigger. If adverse revenue and budget conditions prevent the legislature from making the minimum rainy-day deposit in, say, 2016, then the scheduled tax cut would be deferred until 2017.

    These adjustments would be automatic, and could never result in a higher tax rate than the previous year. They would effect only the pace of tax reduction in future years, about which our knowledge today is inherently limited.

    Such a compromise would give the Senate what it wants: a clear, legislated goal of significant tax reduction. It would also give the House and McCrory administration what they want: prudent budgeting in case unforeseen external events create unforeseen budget gaps.

    Sound like a deal?