Guest post by John Hood
North Carolina almost made another top-10 list this year — but don’t worry, our state seems likely to make the cut in 2017.
The Tax Foundation, a nonpartisan institute based in Washington, has long published a report called the State Business Tax Climate Index. It ranks all 50 states and the District of Columbia on the level and design of their taxes on property, income, payrolls, and sales.
For much of the index’s history, North Carolina ranked poorly. We had one of the South’s highest marginal tax rates on personal income, a higher-than-average tax on corporate income, a poorly designed sales tax, and problematic taxes on alcoholic beverages (excises) and the capital stock (called a franchise tax). Thus our ranking was often in the 40s.
Not anymore. In 2011, the newly elected Republican majority in the General Assembly refused then-Gov. Beverly Perdue’s call to extend a “temporary” sales-tax hike she and Democratic lawmakers enacted in 2009. After Perdue vetoed the state budget over the dispute, GOP lawmakers overrode her. North Carolina’s sales tax burden dropped by about $1 billion a year.
Then, in 2013, newly elected Republican Gov. Pat McCrory and the General Assembly enacted one of the most significant state tax reforms in modern American history. Instead of a steeply graduated income tax that produced large swings in revenue over each business cycle and discouraged capital formation and job creation in our state, North Carolina adopted a Flat Tax, now set at just under 5.5 percent.
Economists have championed the Flat Tax for decades not just because of the single marginal rate but also because of the correspondingly reductions in inefficient tax breaks and distortions. North Carolina’s version did that, too, by capping itemized deductions, ending some loopholes, and letting others expire. McCrory and lawmakers did something similar for the state’s corporate tax — eliminating lots of loophole junk and cutting the rate from 6.9 percent in 2012 to a scheduled 3 percent next year.
On the sales tax, the General Assembly broadened its base to include some additional services sold at retail. I would have approached the problem differently — relying on the Flat Tax to tax all consumption indirectly, through exclusions of net savings from the tax base. But for the vast majority of North Carolinians, the effect of the broader sales-tax base has been more than offset by the income-tax cuts in the 2013 bill, and by subsequent cuts in the Flat Tax rate plus expansions of the standard deduction (which keeps more of your income from being taxed at all).
According to the Tax Foundation’s just-updated, somewhat-revised State Business Tax Climate Index, North Carolina ranked 41st in the nation just before the implementation of the 2013 tax reform. We now rank 11th. That’s the largest improvement in tax policy since the index was created.
Most of the states in the top 10 have either no state personal income tax (Wyoming, Nevada, South Dakota, Florida), no state sales tax (Montana, Oregon, New Hampshire), or no state income or sales tax (Alaska). But Indiana (ranking 8th) and Utah (9th) are more like North Carolina, in that they levy all the major taxes but with relatively broad bases and relatively low rates.
The full import of our tax reforms has yet to be counted in the index. It doesn’t include the final scheduled drop in our corporate tax, for example. It is quite likely that, even if our lawmakers do nothing else, our state will crack the top 10 next year.
Tax policy is far from the only factor that shapes economic performance, as I have pointed out many times. Some states that rank poorly on the Tax Foundation index, such as California, still produce lots of goods, services, and jobs. Geography, natural resources, and trade patterns matter a lot, too. But when it comes to the factors that governors and legislatures directly control, North Carolina is getting a lot right, on taxes and regulations in particular.
Let’s protect those gains — and improve on them next year.
The preceding post first appeared in the Richmond County Jail Journal on October 5, 2016. Mr. Hood is chairman of the John Locke Foundation and appears on the talk show “NC SPIN.” You can follow him @JohnHoodNC.