Tax cut nirvana
There’s a similar dynamic underway in North Carolina government. Ever since Republicans took control of the General Assembly in 2010, and particularly since Pat McCrory was elected governor in 2012, public policy has experienced repeated, sweeping waves of change. State agencies have come and gone. Our systems for funding transportation and delivering education have been revolutionized. A series of regulatory reforms have transformed the way rules are developed, justified, enforced and reviewed.
Those directly involved in politics or public policy are certainly familiar with these changes — whether welcomed or disdained. But I wonder if, like the parent of the growing child, many are incapable of appreciating just how dramatic these changes have been. Perhaps a “before-and-after” exercise can help.
I’ll focus on one of the most consequential areas of policy innovation: taxes. In 2010, North Carolina had the second-highest tax burden as a share of income in the Southeast. Our state income tax levied three marginal rates. The top rate of 7.75% was the highest in our region and among the highest in the country. Moreover, it kicked in at $60,000 in taxable income for singles. Even some states with higher top rates, such as Minnesota and New Jersey, applied those rates at higher thresholds, and thus were friendlier to taxpayers who earned, say, $60,000 to $70,000 a year.
North Carolina’s corporate tax rate of 6.9% also stuck out like a sore thumb in our region, with only Louisiana and West Virginia levying higher ones. Unlike most states, North Carolina then applied a separate tax on the capital stock of firms doing business in the state, (called the franchise tax). And unlike South Carolina and several other competitors, North Carolina made no effort to reduce the double taxation of corporate income by excluding all or part of capital gains from the base of the personal income tax.
Though partisan hacks may dispute this, the preponderance of scholarly research about state economic growth suggests that tax policy plays a role. High taxes on personal and corporate income are especially harmful to competitiveness, as they discourage executives, entrepreneurs, investors and highly compensated professionals from doing their business in a state. Capital formation is the key. Households, companies, and economies that foster the creation and maintenance of capital assets are able to generate more income over time. If the tax code hits capital formation with multiple layers of high tax rates — taxes on the principal of an investment, taxes on investment returns, taxes if the investment is in corporate stock and still more taxes if the investment is passed along to heirs — then don’t be surprised if capital starts forming somewhere else.
Now consider how different the tax code looks today, after several years of rewrites and reforms. If all goes according to schedule, North Carolina will soon have a 5.5% flat tax rate on personal income and a 3% rate on corporate income. These compare favorably within the Southeast and beyond. The corporate rate will be the lowest among American states that levy such taxes. Lawmakers also abolished the death tax. Although the state sales tax has been broadened a bit to include more services, the net effect has been a tax cut for the vast majority of households.
By slicing North Carolina’s top income rate by 29% and its corporate rate by 57%, lawmakers and the McCrory administration have made the state a far more attractive place to live, work, invest and create jobs. Still, we can do better. Some would like to see state income taxation abolished altogether. Such a course will prove unwise and impossible, because attempts to replace the revenue with higher, broader sales and property taxes will provoke strong opposition from small business, the service sector and the general public.
Fortunately, there are alternatives. One next step would be to follow South Carolina’s lead and adopt an exclusion that essentially reduces the tax rate on capital gains. Another would be to follow the lead of Britain and Canada by offering taxpayers access to tax-free universal savings accounts to shield investment income from double-taxation. It’s a policy long recommended by my colleagues at the John Locke Foundation and a proposal championed by Republican presidential candidate Ted Cruz.
Still another good idea would be to whittle away at the franchise tax, which, unlike the corporate tax, hits businesses even when they aren’t making a net profit.
Just as only left-wing political hacks claim that state taxes don’t matter, only right-wing political hacks contend that taxes are the only thing that matters. Conservatives believe state governments deliver valuable services, which must be financed. But how they are financed matters a lot. When it comes to capital, we need less pain and more gains.