The new GOP leadership in North Carolina’s General Assembly will be facing many challenges this upcoming legislative session, the projected $3.2 billion budget gap being foremost among them. Facing that daunting task, along with a still struggling economy, the soon-to-be majority leaders have signaled they don’t think now is the right time to tackle any significant reform of North Carolina’s tax structure.
According to Sen. Phil Berger (R-Rockingham), who will likely become the Senate president pro tempore when state lawmakers convene this January, “I’m not sure reforming the tax system is something that is appropriate at this time, simply because of the unsettled state of the economy. The people of North Carolina elected us, I believe, to get the state’s fiscal house in order.”
Berger is right to table any major tax reforms for the time being. The General Assembly last attempted to address significant tax reform in 2009 as the Democratic leadership unveiled their “21st Century Tax Rate Reduction and Modernization Plan” in the Senate Finance Committee. The tax overhaul didn’t make it into the final budget, but generated much discussion.
The 2009 plan was just the latest in a string of several such tax reform plans to be crafted over the last decade, none of which ended up being adopted. Each reform plan is based on the same underlying concept: broaden the tax base and lower the rates.
By that they mean subjecting more income and economic activity to taxation while lowering the rate applied. More specifically, the 2009 reform package focused largely on the three primary sources of state tax revenue: personal income, corporate and sales taxes.
With the personal income tax, the plan would broaden the base by limiting the number of exemptions and deductions filers can claim, meaning more of the individual’s income would be subject to the state tax. This would then be offset by lowering the tax rates applied to the larger base of income. The 2009 plan also included the creation of a “zero tax bracket.” That is, not taxing the first $10,000 of income for married couples filing joint tax returns.
On the corporate tax, the reform package would have lowered North Carolina’s 6.9 percent corporate tax, highest in the Southeast, down to 4.5 percent over two years. The plan also would have eliminated several targeted tax breaks and subsidy programs in order to broaden the base and make the changes close to budget-neutral.
Perhaps the most discussed aspect of the 2009 plan was extending the state sales tax to dozens of services not currently subject to the tax, while lowering the sales tax rate. Much of the debate surrounding this option involved the fact that a growing share of household spending is now devoted to purchasing services, and the state sales tax should reflect the changing economy in order to provide a more stable source of revenue for the state.
Politically, such reform continues to prove to be too difficult in spite of the repeated recommendations from tax reform committees. This is largely because well-funded special interest groups exist to protect most of the exemptions and credits that would be eliminated by reform – and countless service sectors deploying lobbyists to fight to keep the sales tax from being applied to their industry.
The concept of reforming the state tax structure to broaden the base and lower the rate is laudable because it moves us toward a more neutral system with fewer favors and privileges being granted and thus fewer distortions of our economic decisions.
But raising the prospect of tax reform at this time may be biting off a bit too much to chew given the current economic situation and budget problems. Fix the budget, reign in spending, then reform the state tax structure to create one that is more conducive to economic growth.