A North Carolina tax system for the 21st century

A big reason for the long state budget session was disagreement over taxes. Debates about cutting tax rates, expanding the sales tax base and distributing tax revenues to counties consumed many hours of discussion on Jones Street.

Recent General Assembly sessions have moved the tax system away from taxing income to taxing sales. The rates on individual and corporate income have been lowered, and the sales tax base has been expanded to include some services.

Some say shifting from income to sales taxes increases the tax burden on lower-income households. Selected services have been added to the sales tax base while leaving others untaxed, prompting claims of favoritism. Cutting corporate taxes questions whether businesses are providing adequate support for public services.

A tax system must answer three questions: what is taxed (the tax base), what adjustments are made to the tax base (resulting in the taxable base) and the rates applied to the taxable base.

I propose North Carolina institute a tax system that is simple, transparent, family and business friendly, and adaptable to the unpredictable economic changes in the decades ahead. Here are the essential features:

Tax base

I recommend two alternative tax bases. Income is the most comprehensive measure of economic activity and includes earnings from work and returns from businesses and other investments. Income from retirement plans not previously taxed would only be included in the tax base.

If it is considered important to support investing for the future – rather than spending now – then consumption (income minus monies invested) would be used as the tax base. No distinction would be made between spending on products or on services – both would be part of consumption. Also, it would not matter how the spending is done. In-store and on-line buying would both be a part of consumption.

To emphasize, I recommend policymakers select only one of the taxes bases – not both.

Adjustments

Two adjustments would be made to the income or consumption tax base. First is a child expenditure deduction, following the idea that children are an investment in the future and a long-run benefit for the economy. I would set the deduction at the federal government’s estimate of the annual cost of raising a child, which today is approximately $17,000 per child.

Second, to assist lower-income households, I would reinstitute a state Earned Income Tax Credit for households earning under 80 percent of the median household earnings. I would structure the EITC so that a household always has an incentive to earn more. For example, a household with $5,000 of money earnings might receive a supplement of $10,000; one earning $12,000 would get $8,000; and a household making $20,000 might receive $5,000.

Tax Rates

To either the taxable income base or the taxable consumption base, one rate would be applied. To raise the same amount of revenue for the state General Fund as well as for locally (county and municipal) raised revenue – with one exception noted below – the income tax rate would be 11.3 percent and the consumption tax rate would be 14.9 percent (again, only one of the systems and rates would be used).

Each system would be implemented as one tax, with a portion of the revenues allocated to the state and a part going to the household’s home city and county. Local governments would be free to adjust the rate for their allocation of the tax revenue. With the generous child deduction and EITC, each system would be very progressive, despite using one tax rate.

Income from corporations distributed to North Carolina households would be captured by both systems, so there would be no separate corporate income tax. However, all businesses impose public costs related mainly to their physical presence – costs like public safety and worker training. So a new state property tax would be levied on businesses – piggy-backing on the local property tax – with the revenues added to the General Fund.

Many futurists see big economic disruptions in coming decades. How we make products, deliver services, earn income and spend will change in ways we can’t now anticipate. We need a tax system adaptable to these changes so adequate revenues will continue to flow to public purposes. The alternative tax systems proposed here do that and – significantly – provide important support for child-rearing and income assistance.

This story was originally published October 9, 2015 at 5:27 PM with the headline "A North Carolina tax system for the 21st century."