Tax Reform Sets the Stage for N.C. Economic Growth | Eastern North Carolina Now

    Publisher's note: The author of this post is Dr. Roy Cordato, who is Vice President of the John Locke Foundation. This post was featured at the Carolina Journal, John Hood Publisher.

    RALEIGH  -  For decades North Carolina's tax system has needed a major overhaul. A model of hodgepodge tax policy, it has featured high rates for most taxpayers and special exemptions for the few. It has penalized economic growth and discouraged job creation.

    The process of fixing the system began with this year's sweeping state tax reform. The changes made, particularly to personal and corporate income tax rates, set the stage for long-term economic growth. The reform process was thoughtful and, in large part, ignored complaints from special-interest groups that typically plague such efforts.

    Lawmakers debated several possible approaches, all with the same goals  -  reducing the tax system's bias against productivity and job creation. The plan would reduce favoritism, simplify the code, reduce tax rates, and lighten the overall tax burden.

    Sweeping changes target two areas: personal and corporate income taxes. The reform plan lowered tax rates and broadened the tax base. Changes to the sales tax were less wide-ranging, leaving current rates in place and expanding the base to include some services. The reform also eliminated the estate tax.

    Overall, North Carolinians' taxes are cut by about $4.75 billion over five years, assuming the state meets certain revenue triggers and implements the plan fully. That works out to no more than 4 percent of expected General Fund revenue during the period, and probably less if the economy grows as a result.

    North Carolina's personal income tax has had a graduated rate starting at 6 percent and climbing to 7.75 percent, the highest top rate in the Southeast. Tax reform ushers in a single 5.75 percent rate, with large personal exemptions and most loopholes and deductions eliminated. Exceptions include deductions for charitable giving and mortgage interest and property taxes.

    The 6.9 percent corporate tax, also the highest in the Southeast, will be lowered first to 6 percent and then to 5 percent in 2015. Assuming the state meets revenue targets, the rate will drop to 4 percent in 2016 and 3 percent in 2017. Unlike the current tax, which combines a high overall rate with special breaks for favored businesses, new rates will apply to businesses across the board. Giveaways embedded in the current system are eliminated.

    These changes lay the groundwork for future economic growth. Income taxes penalize productive activity  -  work, investment, entrepreneurship. The higher the rate, the greater the penalty. Furthermore, progressive rates compound the effect by penalizing people for earning higher incomes. Flattening and dramatically lowering rates will ameliorate these problems.

    Principles of government transparency and economic growth both suggest that the corporate tax should eventually be abolished. While people think "corporations" pay the tax, it's actually paid by workers, consumers, and shareholders. Furthermore, it adds a layer of taxation on investment that is already double-taxed by the personal income tax system. By lowering the rate, these negative impacts are reduced. The reduction will be dramatic if revenue triggers enable the rate to fall to 3 percent.

    Future reform efforts should focus on the personal income tax base. The current system double-taxes all returns to investment. It does this by taxing income that is invested, which automatically reduces the returns to that investment (interest, dividends, capital gains) by the same rate. Then those returns are reduced a second time when they are taxed as earnings.

    This year's reforms did not address this problem. Lawmakers can address the issue by exempting either the investment's principal or its interest from the tax base, as is done with Individual Retirement Accounts. A good first step would be either to eliminate the tax on capital gains or apply a lower rate, as is the case in federal law.

    By cutting taxes overall, lawmakers have transferred resources from government control to consumers and entrepreneurs in the private sector. This is always more efficient and, therefore, growth-enhancing.

    North Carolina's legislature deserves praise. It has helped level the playing field for taxpayers and eliminated roadblocks to prosperity. In doing so, it has set the stage for sound, long-term economic growth.