North Carolina excels in tax reform

Since Republican lawmakers won majorities in both houses of the General Assembly in 2010, they’ve been reforming North Carolina’s tax system. They’ve broadened the bases of state taxes, reduced tax rates, diminished or eliminated special-interest tax breaks, and simplified the code.

As a result, virtually all North Carolinians are keeping more of what they earn to use as they wish. Our state has become a more attractive place to work, live, invest, and create jobs. The leaders of other states, motivated to compete with us, have reformed and reduced their own taxes, often emulating North Carolina’s practice of tethering scheduled rate reductions to revenue triggers in order to avoid any unforeseen budget problems.

The latest tax-climate study from the nonprofit Tax Foundation serves as an instructive record of North Carolina’s progress. The study examines five major categories of taxation: personal income taxes, corporate income taxes, sales taxes, property taxes, and payroll taxes (which fund each state’s unemployment-insurance system).

Before 2010, the Tax Foundation typically ranked our tax system as among the worst in the South for investment and growth, and far below the national average. By 2014, the conservative-led legislature had slashed sales and income taxes and initiated other reforms. North Carolina ranked 31st that year.

As the General Assembly continued to modify the system — with a particular focus on reducing marginal tax rates on personal and corporate income — the state soared in the Tax Foundation rankings. Last year, North Carolina had the 10th-best tax system in the country.

In the newest ranking, we improved to 9th. Only Wyoming, South Dakota, Alaska, Florida, Montana, New Hampshire, Nevada, and Utah ranked higher.

Most of these states either don’t tax personal income, don’t tax corporate income, or don’t tax retail sales. Utah is the exception. It has all five major forms of taxation, but fares well in the rankings because it applies relatively low rates to relatively broad tax bases.

So does North Carolina — but thanks to tax reforms already scheduled through the end of the decade, we are poised to eliminate entirely our tax on corporate income. This is an excellent idea. Corporations aren’t people. They’re bundles of contracts among people. So when government taxes corporate income, what it really does is reduce the incomes of shareholders (by reducing investment returns), employees (by reducing their wages), or customers (by increasing the prices they pay).

This is a foolish way to tax individuals. It was invented by Congress more than a century ago as a clever way to get around the federal constitution’s prohibition against personal income taxes. Lawmakers figured that corporate shares were owned primarily by the wealthy, and that taxing corporate income was essentially a back-door tax on their personal incomes.

After the 16th Amendment was ratified in 1913, Congress gained the legal power to tax personal incomes directly — and immediately did so. It should have repealed the corporate tax. State governments should have done the same. Alas, they didn’t.

So we ended up with multiple layers of taxation, especially on investment, and a less-transparent system that obscured who was really bearing the burden of the corporate-tax regime. Employees and customers had no idea that the corporate tax cost them money. And contrary to the progressives’ original goal, everyone ended up paying more — not just the wealthy. Millions of people own shares of corporate stock, directly or indirectly as savers and pensioners.

North Carolina is in the midst of rectifying this oversight. When our corporate tax phases out over the next six years, that will leave us an even more attractive place for companies to do business, making North Carolinians better off through higher wages, lower prices, and more access to goods and services.

It is likely that these tangible benefits will also be reflected in a higher ranking on the Tax Foundation index. That’s not the purpose of enacting tax reform, of course. It is merely an indicator of how much North Carolina’s business climate is improving.

John Hood is a John Locke Foundation board member. His latest books, Mountain Folk and Forest Folk, combine epic fantasy with early American history.