By Dr. Michael Walden, NCSU economist

Editor’s note: is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy.

RALEIGH, N.C. – When tax reform is mentioned, people take notice, simply because taxes take a big chunk out of our income. North Carolina has been talking about tax reform for almost two decades. Indeed, I participated in a state-level tax reform commission a couple of years ago. Now, a special committee of the North Carolina General Assembly is taking up the issue again.

Is it really time to think about overhauling the state’s tax structure, and if so, what kind of changes should be made?

Two forces are driving the move to redo North Carolina’s taxes. One is that the sales tax – one of the major generators of revenue for the state – has become outdated. When it was designed as a tax on consumer spending, our purchases were of products – "goods" in economics lingo – that is, things we can touch and carry like food, clothing, furniture, appliance, etc. Consumer spending on services was non-existent.

Now, the majority of consumer spending is on services, but this spending is not subject to the state sales tax. Thus, to keep revenue from the sales tax on pace with growth in the economy, the sales tax rate has had to be increased several times over the years.

The second force is enhanced competition between states – even between countries – for good-paying jobs. Here, companies look at a state’s corporate income tax rate, and workers look at a state’s individual income tax rate. On both, North Carolina is relatively high, so the concern is that our high corporate and individual income tax rates may be deterring new businesses from settling in our state.

But what makes a tax overhaul so difficult is that different priorities for change are held by different groups. Two competing priorities seem to be dominant. One group focuses on the impact of taxes on economic growth. They want tax rates to be low and the tax base (what is taxed) to be broad.

The other group is most concerned about how any tax changes affect the distribution of tax payments by households of different income levels. In particular, this group doesn’t want tax restructuring to increase the tax rates paid by lower-income households.

It’s difficult to accommodate both groups in tax reform, and this is one reason why – despite much study and talking – remaking North Carolina’s tax system has not moved off square one. However, a new plan has been put forward that may be able to bridge the gap between those with alternative views as well as address the issues with our current system.

The new plan comes courtesy of California, where a high profile tax commission has just issued its recommendations. California has tax issues that are similar to North Carolina’s, although – fortunately for North Carolina – California’s issues are several magnitudes beyond ours!

There are two essential elements to the California plan. First, the state sales tax and state corporate income tax would be completely eliminated. The individual income tax would be retained, but with two low rates, limited itemized deductions (only mortgage interest, property taxes and charitable contributions could be taken as deductions), and a large ($45,000 for joint filers) standard deduction.

Second, to replace the sales tax and corporate income tax, a new "net receipts" tax would be imposed on all businesses. A tax rate (the plan recommends 4 percent) would be paid on the difference between a business’s receipts and its non-labor expenses. Some call this a "value-added" tax because the value created by the business and its workers is what is taxed.

The California plan aims to be "revenue neutral," meaning it would initially neither increase nor decrease tax revenues. However, over time the new system would expect to keep tax revenues more in line with economic growth and also be less "bouncy" with the business cycle. This means tax revenues would be more even over both the good times and bad times in the economy.

It’s thought supporters of economic growth would like the plan because of elimination of the corporate income and sales taxes, low rates and limited deductions on the individual income taxes and the broad base and low rate on the new net receipts tax. Those who monitor taxes paid by lower income households would presumably like elimination of the sales tax and the very large standard deduction for the individual income tax.

It will be interesting to see if North Carolina considers something along the lines of the California tax proposals. It’s said that changing the tax structure is extreme political heavy lifting. Should we – and will we – muscle our way to a new way of deriving public revenues for our state? You decide!

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