North Carolina House Bill 3 would be the first step in the process of amending the Constitution of North Carolina to provide that the top marginal income tax rate could not exceed 5.5 percent.
The Miriam-Webster Dictionary definition of “Constitution” in pertinent part provides: “the basic principles and laws of a nation-state or social group that determine the powers and duties of the government and guarantee certain rights to the people in it.”
Constitutions are meant to be lasting and hence are hard to change. Ordinary statutes only require the majority consent of both chambers in order to make a change. Our constitution, on the other hand, intending to be more permanent, requires the approval of three-fifths of each chamber of the legislature and the amendment must be ratified by the citizens during an election.
Tax law is a byproduct of numerous considerations; the perceived needs of the state (which change in accordance with the philosophy of those elected), the fiscal climate in which the state finds itself in, unforeseen events such as natural disasters, and broad based economic conditions.
Starting with the era in which the Republicans gained control of the legislature, following the 2010 election, there has been a decided bias towards lowering income tax rates and expanding the base of the sales tax.
While a mix of taxes is a prudent methodology for any state government, the shift from income taxes to sales taxes (coupled with the repeal of the North Carolina estate tax) reflects a philosophy of shifting the tax burden to individuals and entities that are less prosperous.
The sales tax is a form of consumption tax. The retailer either shifts the cost to the consumer (and hence prices go up) or the retailer absorbs the cost of the tax. For those citizens for whom consumption equals their incomes (poorer people) they are paying a greater percentage of their income into the sales tax system. For those retailers who, for whatever reason, cannot pass the tax onto their customers, the sales tax cost becomes a sort of gross receipts tax, which is owed to the state (and counties) regardless of whether the retailer has a profit or loss.
This is not to say that the sales tax is a bad form of taxation. It does have the benefit of causing everyone to contribute to the state. In addition, sales tax collections tend to me more stable than income tax collections. This is because everyone has to consume some goods, even in a recession, whereas income tax collections tend to more closely track the economic fortunes of the citizens of the state.
However, the benefit to the state, from the steadier stream of income, is the flip side of the hardship to the citizens. Simply put, the income tax is a more sensitive barometer of the fortunes of the taxpayer. If a person is unemployed or a business is losing money, they will owe little, if any, income tax, whereas the individual will still be obligated to pay a sales tax on most of their purchases, regardless of their economic circumstances.
The push away from income taxes is accompanied with the allegation that lowering income taxes improves the “business climate” of the state. If this was true, the state of Kansas should be enjoying an economic boom. Kansas has reduced its top income tax rate in stages from 6.45 percent to 3.9 percent. Revenue has predictably fallen and the state is now expanding the base of its sales tax. Nevertheless, the Kansas economy is relatively stagnant.
California, on the other hand, has a top marginal income tax rate of 12.3 percent, and yet its economy, at least as of 2015, was one of the fastest growing economies in the country.
These examples are not definitive in any direction. The fact is, the health of the economy of a state is a product of numerous factors: the education level of its citizens, the condition of the state’s infrastructure, the climate, the cost of living (particularly real estate and energy), the macroeconomic forces at the national level, and yes, the tax and regulatory environment.
So while this legislature may be pushing for a constitutional amendment, that would force the state to use sales taxes as its basic variable with respect to tax collections under the guise of improving the “business climate”, the only certainty we have is that the tax burden will be shifted down the economic scale.
In addition to the harm caused by shifting the tax burden to citizens who are less fortunate, by engrafting this philosophy into our Constitution, the General Assembly is saying “we know what is best for years to come.” There is a reason the terms of the legislature last for two years. It is so the members of the legislature will be sensitive to public opinion. The current legislature should not seek to tie the hands of future legislators. We simply do not know what economic or natural shocks this state will have to absorb in the future, nor do we know what the needs of the state will be.
This is terrible public policy, and it reflects the hubris of the current members of the General Assembly. If put to the voters in a constitutional referendum, this proposal should be soundly rejected.
Richard Nordan is a Raleigh tax and estate attorney.