RALEIGH — Republican lawmakers outlined a proposal Wednesday to revamp the state’s tax system, offering a slew of reforms that would radically shift the tax burden in North Carolina.
The proposal would eliminate personal and corporate income taxes in exchange for higher state sales taxes levied against groceries, medical expenses and other currently tax-free services.
Senate leader Phil Berger said the moves are necessary to modernize the state’s tax code and kick-start a struggling economy. He pointed to the state’s tax rates, saying the current 6.9 percent corporate tax rate and 7.75 percent personal tax rate for the highest earners are among the highest the region.
“It is important for us in terms of our competitive posture with other states,” the Republican from Eden told reporters. “It is important for us in terms of making sure there is a fair allocation of the cost of government.”
But critics caution that the proposals represent a fundamental change in who pays the state’s tax burden, and economists said that low-income people would feel the brunt. “For this particular proposal, the responsibility would shift from rich households and prosperous corporations to poor households and smaller businesses,” Dave Ribar, a professor at UNC-Greensboro, concluded in his analysis of the proposal.
The effort to overhaul the tax code is expected to consume the 2013 legislative session when it begins in two weeks. Republicans and Democrats agree the tax system needs to change, but who should pay what share of the tax burden remains hotly contested. A handful of legislative efforts in previous years to change the system all failed, but the GOP – which took the supermajority in the legislature and the governor’s office – is promising action this year.
But restructuring the tax system is a not-so-simple math problem that will force Republicans to raise taxes and fees on economic activities that people engage in every day. It would also involve eliminating well-established tax exemptions for special interest groups.
It costs roughly $12 billion to eliminate the corporate and personal income taxes and business franchise taxes, as the GOP proposes. The money accounts for more than half the state’s $20 billion annual budget.
Proposed tax hikes
To offset the cuts, Senate Republicans are considering:
• Eliminating all 318 existing tax breaks in the state’s tax code, which account for $9 billion in revenue. The breaks cover everything from motor vehicle taxes to prescription drugs and insulin to sales taxes paid by nonprofits.
• Generating $12.9 billion in new revenue by increasing the 6.75 percent combined sales tax rate levied in most of the state to an 8.05 percent combined state and local tax rate.
The higher rate would apply to all goods and services – including those currently exempt from taxes, such as lottery tickets, haircuts, dentist visits, housekeeping and lawyers’ fees.
One major increase would be the sales tax on groceries. It currently sits at 2 percent but would increase to 8 percent.
Together, the sale tax changes would provide $12.9 billion.
• Levying a 1.05 percent tax on businesses, indexed to either net worth or gross receipts. Republicans are calling this a “license fee” that would produce $4 billion.
• Increasing the tax on all commercial and residential real estate sales, from the current 0.2 percent rate to 1 percent, generating $400 million.
Senate Republican leaders cautioned that the proposals being considered are a “concept” – not a plan. And it would be implemented over the course of several years.
But it serves as a starting point for negotiations with House Republicans and Gov. Pat McCrory, both of whom support the effort but remain ambiguous on the details. A McCrory spokesman said the governor is still reviewing the proposals.
Even with the details still emerging, the criticism of the plan is mounting. The N.C. Budget Center, a liberal think tank, conducted a simulation analysis that suggested more than half of taxpayers, particularly the middle and lower class, would see their overall tax burden rise, while the most wealthy would get a significant cut.
“We think reform is needed,” said Alexandra Sirota, an analyst at the center. “We know that eliminations of personal and corporate income tax would be devastating for N.C. because it would eliminate key revenue sources and again shift the load to a majority while some get a tax break.”
Sen. Bob Rucho, a Charlotte Republican leading the tax overhaul, countered the argument by saying corporations would pass along savings to consumers if they paid lower taxes. Rucho compared North Carolina’s economy to a “dying patient” to emphasize how tax changes are needed to lure new businesses and lower the burden on existing companies. He believes such moves would allow them to add more jobs and improve the state’s overall economic picture.
But he acknowledged there are no guarantees that businesses would lower the cost of their products or relocate to the state. The Republican proposals announced Wednesday also included no protections for low-income workers who pay a larger proportion of their income towards sales tax.
“The expansion of the sales tax might increase the burden on low-income taxpayers, so finding a way to hold them harmless would be key,” said Roby Sawyers, an N.C. State University professor and expert on North Carolina’s tax system.
Another key is how such reforms will play politically, Sawyers said. He expects to see taxes reduced but the elimination of both the corporate and income tax may prove too difficult. “The hard part is politically selling that to North Carolina citizens,” he said.
Rucho acknowledges lawmakers will need to convince the public that such reforms are necessary.
“I guess to get it through politically, people have to say we need to do it,” he said.