Income Taxes Hold Back NC’s Economy

A similar version of this article originally appeared in the Charlotte Business Journal

“The power to tax is the power to destroy.” That is an oft-repeated paraphrase of a quote from former U.S. Chief Justice John Marshall in an 1819 court decision. Indeed taxes do destroy: incentives, productivity, businesses, and opportunity.

But taxes are a necessary evil to fund government, and we all know government isn’t going away anytime soon.

It’s no secret that North Carolina legislators will take a serious crack at reforming the state’s tax code in 2013. Which leads us to the question: What tax structure will impose the least destruction on North Carolina’s economy, and enable it to once again become competitive?

Economists have provided abundant research on the topic, and have largely formed a consensus: Income taxes are the most harmful to a state’s economic growth, while the sales tax has the least negative impact.

For instance, in a book published by the American Legislative Exchange Council titled Rich States, Poor States, former Reagan economic advisor Arthur Laffer declares: “States that wish to increase growth would best do so by eliminating or lowering their corporate and personal income tax rates.”

Included in the book is research on the 11 states that have enacted a personal income tax in the last 50 years. The findings? Without exception, all of the states’ economies now have a smaller share of the nation’s economy than they possessed in the years prior to the enactment of an income tax.

The list of expert analysis confirming this thesis is abundant. To pick just one example, University of Colorado economist Barry Paulson ran a regression analysis of state economic performance and concluded that “the analysis underscores the negative impact of income taxes on economic growth in the states” and that states relying on income taxes for revenue experienced slower economic growth than states relying on other taxes for revenue.

In a 2001 paper, Ohio University economist Richard Vedder compared the economic performance of states between 1957 and 1997 and found a “strong negative relationship between income taxes and economic growth,” and “sales taxes are clearly less harmful than income taxes.”

And for those who insist that corporations must “pay their fair share” of taxes? You may want to consider where that tax burden actually falls.

Upon examining a regression analysis of state data from 1977 to 2005 for a recent paper, a Federal Reserve economist concluded, “In the case of the state corporate income tax, labor bears a significant burden from the tax in the form of lower wages.”

Moreover, in this highly globalized world, North Carolina not only needs to worry about competing with neighboring states for domestic businesses, but also competing for investments from foreign-based companies. Foreign direct investment (FDI) constitutes a significant and growing share of the U.S. economy.

State lawmakers should take note of this finding from a 2001 paper written by University of Michigan economists: “[F]or foreign investors, the corporate tax rate is the most relevant tax in their investment decision.” The economists conclude: “We find FDI to be quite sensitive to states’ corporate tax rates.”

Still other research finds that states relying more heavily on its sales tax experience less volatile revenue collections. For instance, Laffer found that: “Revenue generated from sales taxes is the least affected by the boom and bust cycle – in fact sales tax revenue changes by only half as much as revenue from personal and corporate income taxes do.”

It is no coincidence that North Carolina, with its over-reliance on personal and corporate income taxes, is suffering from the fifth-highest unemployment rate in the nation, and has seen its per capita income drop below national and regional averages over the past decade. Our tax structure is set up exactly opposite to what theory and evidence tells us we should do.

Reforming the tax code by eliminating the personal and corporate income taxes would be the boldest, and wisest, moves to make North Carolina competitive once again. Imagine every worker receiving a raise in take-home pay, and businesses small and large no longer burdened with punishing tax bills.

To replace the lost revenue, North Carolina could expand the sales tax to include services, and would likely need to raise the rate slightly. The modern economy is much more service-oriented, and this new tax code would better reflect that reality.

The bottom line: Such a reform would promote job and income growth, and provide a more stable source of revenue to state government.

Tax reform is likely coming to North Carolina. Here’s hoping lawmakers listen to sound theory and evidence and implement a tax structure that promotes economic growth, rather than continues to destroy opportunity.

Brian Balfour is Director of Policy at the Civitas Institute in Raleigh (www.nccivitas.org)

This article was posted in Budget & Taxes by Brian Balfour on October 5, 2012 at 3:28 PM.

© 2011 The Civitas Institute. Visit us on the web at www.nccivitas.org.
This article can be found at http://www.nccivitas.org/2012/income-taxes-hold-back-ncs-economy/

Comments on this article

  • 1

    Richard, Morganton, NC
    Richard, Morganton, NC Oct 10, 2012 at 8:36

    Look at the Fair Tax, whick is a consumstion tax. Elinimate all taxes and tax what is consumed (minus food) and the system will work.

  • 2

    Gerard Falzon
    Gerard Falzon Oct 10, 2012 at 8:40

    Great essay! I totally agree. Additionally, we could:
    1. tax higher education which would further broaden the base and lessen the impact on those with no income (retired, elderly).

    2. How do you think that this would impact those who consume a lot such as hospital care, drugs? Would it be overly burdensome?

  • 3

    Mary
    Mary Oct 10, 2012 at 9:11

    Hopefully, this will be one of the first things on the agenda in 2013. We need change to happen quickly. As a way to present it to the general public, consider educating them about states that currently have no income tax and how well they are doing relative to their neighboring states. Additionally, though perhaps obvious to legislators, let people know we can model our tax structure after those already successful (so people don’t give in to fear, fear of the unknown, as though we are re-inventing the wheel).

    It’d be interesting to see how many people figure out that if states are stronger economically without income tax, perhaps a nation could also be so?

  • 4

    Jeff
    Jeff Oct 10, 2012 at 9:20

    Sooner the better! I could use a raise!

  • 5

    SteveP
    SteveP Oct 10, 2012 at 10:18

    Just like some political campaigns and charities do, a Flat Tax where everyone paid the same amount over a predetermined amount, say $20,000 would likely really boost NC taxes, while ensuring “parity”. The more people made, they would only have to pay the same percentage, but there would be less incentive to do weird things to avoid income taxes. I believe the net result might astonish – just like it did in Russia.

  • 6

    Ron Margiotta
    Ron Margiotta Oct 10, 2012 at 14:46

    Nowhere do you mention reduction of Govt.expenditures,could then better determine $’s needed to accomodate our Govt. This should be done in conjunction w/ a revision of the tax structure.
    Ron

  • 7

    Brian Balfour
    Brian Balfour Oct 10, 2012 at 16:18

    Ron,
    I agree we also need to address government expenditures.
    I tackled that issue in this series: http://www.nccivitas.org/2012/a-blueprint-for-budget-reform/

  • 8

    Joseph Salter
    Joseph Salter Oct 19, 2012 at 22:15

    Hello Brian, Excellent article. I would like call your attention to the website cafr1.com. Therein lies a wealth of information
    about how the tens of trillions of dollars that local, state, and the Federal governments make each year on investments revealed in
    their annual financial reports could be used to finance operations,
    thus allowing the elimination of all income taxes. Please research
    this site and let me know what you think.

    Best regards,
    Joseph

2 Trackbacks on this article

Leave a Reply

Sorry, due to spammers you must have Javascript enabled to make comments.