Indy Week: Republicans propose eliminating income tax, expanding sales tax
media mentionby Will Huntsberry @willhuntsberry
Republican leaders believe North Carolina is sick and they have the cure. The most vital remedy, they believe, is tax reform.
Personal and corporate income tax make up roughly 60 percent of annual state revenues. The plan is to eliminate these taxes, or at the very least, slash them drastically.
Sen. Bob Rucho, R-Mecklenburg, who successfully headed up Republican redistricting, is the man tasked with the job.
“Tax reform is the first step in our master plan for putting North Carolina back on the road to prosperity,” Rucho says.
Changing the tax structure is a priority for two reasons. Number one, every function of government is tied to its budget. Legislators can’t create reforms if they can’t pay for them.
Restructuring the tax code will allow Republican leaders to see how much money they have. Then they can decide what to do with education, social services, transportation, etc.
Second, tax reform will cost the most political capital. Several studies have recommended updating the tax code, the most recent under former Gov. Mike Easley. But it’s a fight politicians have avoided or lost.
As Rucho points out, the tax code is based on North Carolina’s 1930s agricultural and manufacturing economy. State sales tax only applies to goods, not services, which now are the largest sector of the economy.
Expanding the sales tax to include services: That’s how Republicans plan to compensate for that 60 percent of revenue that will suddenly disappear with the elimination of the income tax. Getting your hair cut? Taxed. Visiting a lawyer? Taxed. Seeing your doctor? Taxed.
But lawyers and doctors have money and can fight the suggested tax reforms. Rucho hopes that such powerful lobbies will be placated by the elimination or drastic reduction of income tax.
Rucho is planning on the tax shake-up being revenue neutral—the state won’t lose or gain money. Additional sales tax revenues will in theory—albeit an untested one in North Carolina—be equal to the exact amount lost in income tax.
Republicans are adamant that moving toward a flat tax will spark an economic revival. “If you move towards a consumption-based sales tax, all economists will tell you that’s the best way to achieve economic growth,” says Rucho.
Not exactly.
N.C. State University economics professor Michael Walden advises not to get carried away by fantasies of an economic boom. “It’s too much to think this is an automatic elixir for North Carolina or any economy, that it’s just going to bust out jobs left and right,” he says.
“There is some evidence to suggest that if you move in this direction it could have some impact on growth. But I would argue that it would be modest and over several years.”
North Carolina legislators often point to Texas, one of nine states that levies only a sales tax, as a beacon of success. Texas had the fourth-fastest growing economy in 2011, according to the U.S. Bureau of Economic Analysis.
In November 2012, the Lone Star state had just a 6.2 percent unemployment rate, according to the U.S. Bureau of Labor Statistics. North Carolina’s rate was 9.1 percent.
However, states without income tax don’t necessarily fare better than their taxing counterparts. Bloomberg News cited a 2012 report by the Institute on Taxation and Economic Policy showing that “the nine states with the highest personal income taxes on residents outperformed or kept pace on average with the nine that don’t tax their residents’ incomes.” The criteria included economic output, unemployment and household income.
“Being low-tax doesn’t generate economic competitiveness or long-term economic viability,” Ralph Martire, executive director at the nonpartisan Center for Tax and Budget Accountability in Chicago, was quoted as saying. “There are other factors that are far more important. The state tax burden overall is marginal compared to federal tax burden.”
In its reporting about the study, Texas Monthly stated that economic output per person was better than average between 2001 and 2010 in six of the nine “high-rate” states, while six of the nine no-tax states were below average.
Median household income also dropped more in the no-tax states compared with the high-rate states, from 3.5 percent to 0.7 percent.
“With its zero income tax rate and our higher one, you could lead yourself to the conclusion that Texas has no income tax, so Texas is growing faster,” says Walden. However, he explains, it’s only a correlation, and other more important factors may be at play, such as the major industries that drive a state’s economy.
A progressive tax increases the rate on people as their income increases. But a flat sales tax, Walden says, will likely burden lower-income North Carolinians—since they spend more of their income on goods and services—than their higher-income counterparts.
Rucho’s argument is that the poor have always paid more. “Any economist will tell you that when you tax a business, the cost is directed directly to the consumer. In reality, corporations aren’t paying their taxes—it’s the consumer.”
On that count, Rucho is mostly correct, says Walden. “If a corporation is paying a tax, it will fund it by trying to pass the cost on to consumers, it will reduce dividends paid to shareholders or it will reduce wages to employees.”
Rucho and other Republicans also argue that eliminating corporate tax will entice businesses to move to North Carolina.
“It does make North Carolina more attractive,” says Walden. “But taxes are only one factor. Most studies show it lower down on the list of what’s important. At the top would be the skill level of the workforce, infrastructure and training available to the workforce.”
Walden ultimately sees little difference in economic impact between our current tax code and one that would rely nearly exclusively on sales tax. Given the number of times a tax reform fight has been passed over, Walden says he doubts there will be significant changes.
And yet top Republicans have been clear that tax reform is at the top of their agenda. They hold a supermajority in both chambers and have a Republican governor who is unlikely to veto many GOP bills.
They can prescribe whatever medicine they choose.