Reform Taxes — But Don’t Burden Business

by John Hood

In a free society, the only purpose of taxation is to raise revenues to fund the government. This should be done while minimizing the damage taxes do to growth and freedom. North Carolina’s tax system is far from this ideal. Its high marginal tax rates on total personal income and corporate income penalize investment, entrepreneurship, and work effort – the engines of economic growth and job creation.

I agree with Sen. Bob Rucho and those who support his tax-reform concept that the primary source of revenue for state government should be taxes on consumption, not on total income, because the latter includes money that is saved and invested for future (taxable) consumption. Most serious proposals for tax reform – such as the Flat Tax and the Fair Tax – define their tax base as total household consumption. But they differ in such administrative details as timing, information, enforcement, and who bears the cost of collecting and remitting taxes.

It is in program design and administration that I find myself in disagreement with Rucho’s plan, which combines a higher sales tax with a new $4 billion tax on business. Instead, I have long favored a form of consumption taxation called the USA Tax, for Unlimited Savings Allowance. It allows households to subtract their net savings and charitable giving from their net income, and pay a simple flat-rate tax on the remainder – which is, by definition, the amount they spend on retail goods and services during the year. The USA Tax would replace North Carolina’s current state taxes on personal income, corporate income, retail sales, and estates. And it would do so without creating new administrative burdens for businesses acting as unpaid tax collectors for government. Indeed, it would significantly alleviate those burdens, while resolving the tax discrepancy between online vendors and brick-and-mortar retailers.

Here’s how the USA Tax would work:

Step 1: All households liable for income taxes in North Carolina would be allowed to open one or more USA Accounts with any participating financial institution. At the end of each tax year, both account-holders and the state Department of Revenue would receive a simple inflow-outflow statement (similar to the current IRS Forms 5498 and 1099-R) reporting how much money was put into or taken out of each USA account during the tax year.

Step 2: To file their state taxes, households would begin with federal Adjusted Gross Income.

Step 3: They would deduct 40 percent of their federal personal exemptions.

Step 4: They would deduct net savings or add net withdrawals from their USA accounts.

Step 5: They would deduct deposits into 529 plans, ESAs, or other investment in education.

Step 6: They would deduct any contributions made to qualified charities.

Step 7: They would then pay a flat tax rate on the remaining consumed-income tax base.

Accounting for some dynamic effects, we are currently proposing a revenue-neutral tax rate of 8.5 percent. According to an independent analysis by Suffolk University’s Beacon Hill Institute, a North Carolina USA Tax at 8.5 percent would create 80,000 jobs in its first year of implementation, with thousands of additional jobs created in subsequent years. If full replacement of current income, sales, and estate taxes proves impossible initially, we propose a “Plan B” that would retain the state sales tax, albeit at a lower rate of 4.5 percent, and replace current taxes on personal income, corporate income, and estates with an USA Tax rate of 6 percent. This Plan B would create 10,000 jobs in its first year and thousands more in additional years.

John Hood is President and Chairman of the John Locke Foundation and a panelist on NC SPIN.