Tax reform returns to center stage

With the tumultuous election cycle behind us, lawmakers in both Washington and Raleigh will talk taxes in 2025. In the nation’s capital, the return of a Republican Congress and Trump administration will likely produce an extension of expiring tax cuts enacted back in 2017, including rate reductions and immediate expensing for the corporate-income tax.

Meanwhile, in our state capital, a GOP-led legislature will face a new Democratic governor, Josh Stein, who doesn’t share its fiscal priorities.

Let’s start there. Over the past dozen years, the General Assembly has enacted a series of tax reforms that slashed marginal rates on personal and corporate income, excluded more and more households from the income tax, and expanded the base of the state sales tax while reducing its rate — thus bestowing on North Carolina a version of the Flat Tax championed by supply siders for half a century.

Critics seethed. They argued that the net effect of these changes was to underfund state services and tilt the tax code against lower-income people. Neither argument proved persuasive. North Carolina has pursued a gradualist approach to tax reform, phasing in key changes and requiring tax revenue to meet minimum thresholds before rate cuts occur. State spending continues to keep pace with inflation and the state’s population.

As for the distribution of tax burdens, critics focus entirely on state and local levies while ignoring entirely the federal taxes that now fund well over a third of North Carolina’s state budget as well as significant shares of local budgets.

Every state taxpayer is also a federal taxpayer, so it makes little sense to look at tax burdens in isolation. As the left-leaning Institute on Taxation and Economic Policy confirms, America continues to have a progressive tax system. Those in the lowest-income quintile pay an average of about 17% of their incomes in federal, state, and local taxes. The next-highest quintile in income pays 22%, the middle quintile pays 26%, the next 27%, and the highest-income quintile 29%. Because of North Carolina’s balance of tax types, our shares do not deviate markedly from the national proportions.

Given current projections of state revenue for this fiscal year and the next, the General Assembly is unlikely to enact large-scale tax changes in 2025. That doesn’t mean the subject won’t come up. In a past session, lawmakers approved a gradual phaseout of North Carolina’s corporate-income tax. Some interest groups want to push the pause button on that in favor of reforming the state’s franchise tax or other levies.

I disagree. The double taxation of corporate income — first to the firm, then to its shareholders as dividends or capital gains — has never been a defensible feature of the system. It distorts investment decisions and dampens economic growth.

Indeed, the creators of the corporate-income tax didn’t intend to layer it on top of personal-income tax. It was a replacement for it. After Congress enacted the first permanent tax on personal incomes in 1894, the US Supreme Court subsequently ruled, correctly, that it violated the tax provisions of the federal Constitution.

Frustrated progressives then created the corporate tax in 1909 as an alternative means of taxing the personal incomes of the wealthy shareholders who then owned nearly all corporate shares. Years later, when the 16th Amendment allowed Congress to levy a personal-income tax, it failed to abolish the corporate workaround. We’ve been stuck with the deleterious effects ever since.

North Carolina is, at least, doing our part. At present, we rank 12th in the nation in the competitiveness of our tax code, according to a new Tax Foundation study. What’s the most cost-effective way to vault us into the top 10? Finish phasing out the corporate tax. At that point, I’m told by Tax Foundation economists, North Carolina will, all other things held equal, rise to 5th in tax competitiveness.

As Congress and the White House seek to extend the corporate-tax reforms of 2017, we shouldn’t abandon North Carolina’s trailblazing policy. We should finish it.

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