North Carolina Gets Sweeping Tax Reform

Published on August 19, 2013 in News Stories

 

 

Carolina Journal-Barry Smith, Associate Editor.

Gov. Pat McCrory on July 23 signed a new tax reform package into law, lauding legislators for their leadership in overcoming obstacles to make the change a reality.

“As an outsider, I’ve watched as committee after committee after committee, commission after commission after commission, governor after governor after governor, legislators after legislators after legislators, yes, Democrats and Republicans and Democrats and then again Republicans say, ‘We must reform our tax system in North Carolina,’” McCrory said. “Well, we’ve done it.”

The tax reform package ranks as the most significant plan in the United States likely to be approved in 2013, said an analyst who studies tax reform proposals across the country.

Patrick Gleason, director of state affairs at Americans for Tax Reform, spoke to the reduction in the top marginal income tax rate from 7.75 percent now to 5.75 percent in 2015.

“North Carolina, with a 25 percent reduction in the top rate, pretty much blew the other states away,” Gleason said. Gleason and Elizabeth Malm, an economist with the nonpartisan Tax Foundation, said that North Carolina ranks at the top of the nation in magnitude of tax reforms this year.

Malm said the changes would make North Carolina’s tax code friendlier for business, jumping the Tar Heel State from 44th to 17th in the Tax Foundation’s State Business Tax Climate Index.

That index takes into account personal and corporate income taxes, along with sales, unemployment insurance, and property taxes.

The compromise tax reform package passed both legislative chambers in mid-July.

“This is the biggest one we’ve seen this year,” Malm said, referring to the amount of money that would stay in taxpayers’ pockets instead of going to the state as a result of the proposal.

“Even though [the plan appears] modest, it looks like it’s [more than] $700 million in tax cuts,” Malm said. Kansas, which approved a tax reform package last year, is the only other state that came close, Malm said.

“I think North Carolina is the big one in the South,” Malm said. Malm thought it was “a pretty big deal” that the North Carolina reform plan goes from the current three-tiered marginal rate to one flat rate.

The plan will eliminate the personal income exemption while increasing the standard deduction. The standard deduction will be $15,000 for married taxpayers filing jointly, $12,000 for heads of household, and $7,500 for single taxpayers and married taxpayers filing separately.

Unlimited itemized deductions for charitable contributions will be allowed, while mortgage interest and property tax deductions would be capped at $20,000.

The corporate income tax rate would decrease from the current 6.9 percent to 6 percent in 2014 and 5 percent in 2015. The rate would decrease by 1 percentage point in each of the two succeeding years if certain tax collection triggers are met.

The corporate income tax rate would decrease to 4 percent in 2016 if during the 2014-15 fiscal year General Fund tax collections exceeded $20.2 billion. It would decrease to 3 percent in 2017 if during the 2015-16 fiscal year General Fund tax collections exceeded $20.975 billion.

Such a “fiscal trigger,” modeled on the federal Gramm-Rudman spending reforms of the 1980s, was recommended in early July to policymakers by John Locke Foundation President John Hood.

The corporate income tax triggers alleviate a concern raised by McCrory, who said he wanted to protect the integrity of the budget and make sure that the tax code would raise enough revenue to pay for essential state services. The triggers also would protect lawmakers and the governor in case the state experienced a recession.

In addition, the plan simplifies tax collection by shifting many purchases that are taxed in other ways into the sales tax base. It also repeals some exemptions. For instance, live entertainment and movies, service contracts (warranties), manufactured and modular home sales, electricity, piped natural gas, and some previously untaxed bakery items and newspapers would be taxed at the state retail sales tax rate. The special taxes or exemptions that had covered those purchases were repealed.

The plan also ends the back-to- school and Energy Star sales tax holidays. Sales tax refunds for nonprofit organizations would be capped at $45 million, which the N.C. Center for Nonprofits said is unlikely to affect major nonprofits, including large hospital networks, in the immediate future. The center continues to oppose the cap, saying it could be lowered or eliminated in a later tax bill.

The state gasoline tax would be capped at 37.5 cents per gallon for two years. The estate tax would be repealed.

Gleason said the improved business tax climate could pay dividends in improving the state’s economy.

“Small businesses and large companies across North Carolina are going to see a significant increase in their job-creating capacity,” Gleason said. “It’s a big step in the right direction. This final deal represents a huge improvement over the current tax code.”

At the signing ceremony, McCrory cited two reasons tax reform happened now when it remained such an elusive objective. “The first reason is, people are hurting out there,” McCrory said. “The pain has arrived in North Carolina.”

The second reason, McCrory said, is leadership. “Leadership right here and right here,” McCrory said, motioning toward legislative leaders assembled at the Executive Mansion with the governor.

He said legislative leaders were willing to compromise. “You carried the water to the finish line,” McCrory said of the GOP legislative leadership.

McCrory said that tax reform, with its decreased personal income tax rate, would benefit teachers, who didn’t get a raise in the budget. “Tax reform will give teachers a 1 percent increase in their take-home pay,” he said, noting that it would also put money back into the pockets of other North Carolina workers.

He said tax reform was part of an overall strategy to increase job creation in the state. Other things include education improvements as well as government efficiency.

During legislative debate, Republican supporters acknowledged that the plan was the first step in what they hope will be a series of additional tax reforms.

“Does it do everything that we really want it to? No,” said Sen. Bob Rucho, R-Mecklenburg. Rucho, co- chairman of the Senate Finance Committee, said he hoped that the bill was the first step toward a tax code that would have a 0 percent personal income tax rate. Rucho proposed a reform package earlier in the session that phased out personal income taxes and had support in the Senate. It was not adopted by the House or backed by McCrory.

Democrats weren’t as happy about the proposal. “I really don’t see it as broad-based tax reform,” Sen. Floyd McKissick, D-Durham, said.Sen. Josh Stein, D-Wake, also criticized the package for cutting revenues instead of leaving them level.

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