A new loophole for businesses will cost state $336 million a year

During last year’s budget-cutting session, a break for partners in businesses of all sizes slid through with little fanfare

dkane@newsobserver.com June 3, 2012 

Deep into last year’s legislative session, House Speaker Thom Tillis and Senate leader Phil Berger announced a budget deal after weeks of searing debate over education cuts and the repeal of a piece of the state’s sales tax.

But one of the juiciest pieces of the agreement drew little scrutiny or debate: a tax break for owners of businesses that will cost $336 million a year, one of the largest tax cuts in a decade.

Tillis and Berger, both Republicans, heralded the tax break as a “$50,000 exemption for small businesses – the backbone of North Carolina’s struggling economy.” But the exemption is not just for small businesses. There is no cap on the size of the business that can claim the exemption.

So the break will go to roughly 460,000 business owners of all sorts, including equity partners in law firms, doctors and dentists with thriving practices, even lobbyists who patrol the legislature. It also includes some state lawmakers who are business owners.

Each of those partners will be able to avoid state taxes on his or her first $50,000 of income – roughly $3,500 less in taxes.

For example, lawyers who are equity partners at Womble Carlyle Sandridge & Rice, the state’s largest law firm, will each receive that tax break for income they earned in North Carolina. The Winston-Salem based firm brought in $279 million in 2011, and generated profits equal to $590,000 per partner, according to The American Lawyer, a trade publication.

Laura DeVivo, a lobbyist with the firm, said it played no role in the tax break’s passage and would have no comment on it.

Partners at Moore & Van Allen, another major North Carolina law firm based in Charlotte, listed profits per partner at $855,000 in 2011, according to The American Lawyer. One of those partners is a state senator who argued against the tax break.

Annual revenue from that $336 million tax break would roughly equal the salaries and benefits of the 6,400 employees who lost their jobs last year to help balance the $20 billion state budget. Roughly 900 of those employees are teachers who were let go as the statewide school population increased by approximately 10,750 students.

Gerry Hancock is a former Democratic state senator and Raleigh lawyer who now lobbies lawmakers for school districts in high-poverty counties. He said it makes no sense to provide a tax break – particularly to those who don’t need it – while cutting teachers and other public employees who perform needed services.

“As a general proposition, tax breaks for the wealthy while we are starving public schools and public services is bad government,” he said.

No talk of cost

North Carolina’s legislators can debate spending decisions long and loudly, but decisions on whom to tax usually happen more quickly and with more cover. It’s not always easy to figure out how they get into a budget.

This one appears to have started with legislation introduced by Rep. Bryan Holloway, a Stokes County Republican. It is similar to tax break bills he had filed in earlier sessions that went nowhere.

But last year, Republicans took control of both chambers. Holloway said the new leaders were receptive to his tax break, but he had little clue how it ended up in the final budget. The House version of the budget did not include the tax break, but the legislation did include reference to an undefined “tax relief” package.

When the Senate took over the budget bill, it added the tax break, but initially included a limitation: Only partners or owners of businesses with revenue of less than $825,000 would be eligible.

It’s not clear who came up with the cap, but its intent was to make sure only small business benefited. The cap passed the Senate Finance Committee, but lawmakers dropped it before the budget bill came to a vote on the Senate floor. The bill later cleared the House.

Barry Boardman, an economist with the legislature, said lawmakers dropped the cap after he and other staffers struggled to find a way to write legislation that would put it in place. One difficulty, he said, is how combined income would be treated for someone who owns or is a partner in several businesses.

It’s unclear how much a cap would have saved. Boardman said lawmakers did not ask him or other staffers what it would cost to extend the tax break beyond small businesses.

An economic stimulus?

Discussion about the tax break still often revolves around “small business.”

House Speaker Tillis, in a recent interview, said he thought the tax break only helped small businesses. In a news release, the conservative nonprofit Americans For Prosperity recently called it a small-business tax break.

But only corporations that issue stock and pay dividends are excluded from the tax break. Such corporations are increasingly rare in North Carolina as more people set up their businesses as partnerships or limited liability corporations – in some cases to avoid paying the corporate income tax.

State Sen. Dan Clodfelter, a Charlotte Democrat who has supported many tax breaks over the years, immediately understood who would be helped by the new legislation. Cutting taxes for higher-income people at a time of teacher layoffs and other cutbacks to state services strikes him as misguided.

He pointed out on the Senate floor during the tax break’s passage that he and the other roughly 175 partners at his law firm, Moore & Van Allen, would receive the tax break, and that cost alone would have kept open Mecklenburg County’s drug court, which diverts nonviolent felons with drug habits into treatment instead of prison.

“I appreciate the benefit,” he told his colleagues, “but budgets are about choices and those choices have moral implications and not just economic ones.”

Republican leaders who are aware that the tax break goes to owners of bigger businesses say they don’t have a problem with it. They cited a UNC-Chapel Hill study that pegged the annual cost at $336 million but predicted the tax break would serve as an economic stimulus that will create more than 1,100 jobs in the current fiscal year, which ends June 30, and 2,800 more jobs the following fiscal year. The tax break’s cost in the current fiscal year is estimated to be $132 million.

“It’s designed to put money back into the economy,” said state Sen. Bob Rucho, a Matthews Republican and a Finance Committee co-chairman. “It’s somebody buying a computer, somebody buying something so that money is churning around and not sitting in the government coffers.”

But the UNC study did not consider the flip side of the picture. Taking money from government, particularly last year, led to layoffs and less money spent on a variety of goods and services that government purchases from the private sector.

Some argue the government is more likely to circulate those dollars than business owners and partners who are collecting it in $3,500 chunks.

Alexandra Forter Sirota, director of the N.C. Budget & Tax Center, a nonprofit that advocates for low-income residents, said that tax break is too small to put toward hiring more people or make a major investment to make the business more productive. More likely, she said, is many recipients will park the tax break in a bank account where it will have little impact on the economy.

“It is very much subsidizing the wealth building for wealthier folks,” she said.

A welcome surprise

Beyond the legislature, it is difficult to find champions for the tax break. Representatives for doctors’ and lawyers’ associations said they didn’t ask for it and knew nothing about it until it had passed.

Gregg Thompson, the leader of the North Carolina chapter of the National Federation of Independent Business, which represents small businesses, said his group did not ask for it either, and his organization could not find members who knew enough about it to speak to a reporter. The federation had sought cuts in the personal and corporate income tax rates.

“We certainly understood the size of the (budget) deficit and we also understood that a tax cut would cost a lot at that time,” said Thompson, a former state representative from Mitchell County. “I did not know that they were going to come up with that ($3,500) break, but again, we were grateful for that for small business.”

Gov. Bev Perdue, a New Bern Democrat, vetoed the budget, a veto overridden by lawmakers, but through a spokeswoman last year generally praised Republican tax proposals. Efforts to reach her about the $336 million tax cut failed.

Perdue had sought a corporate tax cut in her budget proposal last year, an idea Republican leaders rejected because they thought it would have little economic impact. More than two-thirds of corporations pay no state income tax because it is a tax on profits.

Republican leaders say they will revisit the tax break in future years if it does not produce the projected job growth. But they are already downplaying expectations of strong economic growth.

State Sen. Eric Mansfield, a Fayetteville Democrat, will receive the tax break because he is a partner in a doctors’ practice. He said if the proposed cap had been in place, he would not have qualified.

Mansfield had filed legislation providing a tax break for small businesses that allowed them to be treated no differently than a typical corporation when it came to tax burdens. His bill defined small businesses as those with no more than $850,000 in revenue so that it would benefit “mom and pop” operations.

Legislative fiscal staff told him that cap would allow roughly 75 percent of the state’s businesses to qualify.

Mansfield, who recently lost a bid for lieutenant governor, said he doesn’t support helping wealthy business owners at a time of teacher layoffs. He filed three other bills attempting to kill tax breaks benefiting filmmakers, cigarette producers, and beer and tobacco distributors to help find money for schools in a tight budget year.

“Instead of us battling over what gets cut, maybe we should fix our tax code, and maybe we wouldn’t have to battle so much over what gets cut,” he said.

None of his bills were taken up. Legislative leaders say they aren’t planning on scrutinizing tax breaks until next year’s long session, which comes after the November election.

Kane: 919-829-4861

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