On tax reform, set firm priorities

Negotiators from the North Carolina House and Senate are current hashing out a compromise budget for the fiscal year that begins in July. One of the sticking points, it seems, is how best to build on the state’s impressive record of tax reduction and reform.

Before the Republicans won their legislative majorities in 2010, North Carolina had a poorly constructed tax code that burdened households with excessive and unfair costs while discouraging job-creating investment. Our state had other attractive amenities, of course, so North Carolina was no basket case before 2010. But because we imposed relatively high marginal tax rates on personal and corporate income, we lost out on opportunities that other states happily seized.

Since 2010, state legislators have substantially reduced income and sales taxes. Our top marginal rate on personal income was once 7.75%. Now we have a single marginal rate of 4.75%, which by current law is scheduled to drop to 3.99% by the end of the decade. And fewer North Carolinians are subject to income taxes in the first place, thanks to a significant expansion of the standard deduction.

On the business side, North Carolina once imposed one of the highest corporate tax rates in the region. Now we have the lowest rate (2.5%) of any state that taxes corporate income. It’s scheduled to phase out entirely by 2030. Two years ago, lawmakers also enacted welcome changes to the calculation of the state’s franchise tax, which taxes business assets rather than their net incomes.

As for the sales tax, while lawmakers did broaden its scope to include more services sold at retail, they also make sure the state rate dropped to 4.75%, down from the 5.75% rate enacted by the last Democratic legislature.

Overall, North Carolina went from one of the worst rankings on the Tax Foundation’s Business Tax Climate Index to one of the best. As of 2023, we rank 10th in the nation.

Even if the General Assembly did nothing more, North Carolina would likely rise further up that ranking as previously scheduled tax cuts go into effect. Given another strong biennium of revenue growth, however, both the House and Senate favor additional tax relief in 2023.

So why haven’t they struck a deal yet? Because their tax-reform priorities differ. The Senate wants to accelerate the reductions in personal income tax, nudging the rate down to 4.5% in 2024 (it’s currently scheduled to drop to 4.6%) and taking the rate to 2.49% by 2030. The House agrees with the Senate about the 2024 nudge but otherwise leaves the schedule alone.

Instead, the House seeks another expansion of the standard deduction as well as a 33% cut in the franchise tax rate, to be phased in by 2030. The House package also eliminates the privilege-license tax, an archaic system that makes some professionals pay the state for the “privilege” of doing business in North Carolina.

In a new paper, the Tax Foundation’s Katherine Loughead weighed in on the issue. “North Carolina policymakers should continue making the state’s income tax rates more competitive,” she wrote, “and simultaneously prioritize for reform the areas of the tax code in which North Carolina remains an outlier, including the franchise tax and the privilege license tax.”

I agree. But I’ll be more pointed. Most states don’t levy the equivalent of franchise or privilege-license taxes. So even if their overall tax burdens are equivalent to ours in dollars collected, their cost of collecting those dollars is lower. That argues for making their reduction or elimination a higher priority than accelerating previously scheduled drops in marginal rates.

Why not just enact every tax reduction currently on the table? Because the state does, in fact, have other priorities to fund. Over the past decade, legislative leaders have pursued audacious tax reform without abandoning fiscal prudence. It’s a strategy that has served them and North Carolina well, earning our state national recognition.

They should stick with this strategy. Stick with what works.

John Hood is a John Locke Foundation board member. His latest books, Mountain Folk and Forest Folk, combine epic fantasy with early American history.