State tax reform remains on track

North Carolina has one of the best-performing economies in the country. We also have one of the country’s most competitive tax codes. That’s no coincidence. Tax reform has served our state well.

According to a just-released study by the Tax Foundation, North Carolina’s overall tax system is the 13th-most competitive in the country and third-best in the southeast, after Florida (No. 5) and Tennessee (No. 8).

In all the major categories of taxation — individual income, corporate income, property, retail sales, and payroll (to fund unemployment insurance) — our state ranks in the top half by the Tax Foundation’s criteria of simplicity, neutrality, transparency, and growth-enhancement. We do particularly well in corporate taxes (3rd lowest) and payroll taxes (7th).

During the 1990s and 2000s, North Carolina fared poorly on most of these measures. To the extent our state competed effectively for people, businesses, and capital investment, it did so in spite of our tax system, not because of it.

Fiscal conservatives shouldn’t oversell the effects of tax policy. Many other factors influence economic decisions, and North Carolina has many attractive features and assets to offer prospective residents, entrepreneurs, and investors. All other things held equal, however, most empirical research on the question shows a negative association between high taxes and economic growth.

South Dakota, for example, has one of America’s lowest tax burdens. New York has its highest. Plenty of people would still rather live, work, or invest in New York than in South Dakota because of the former’s deeply developed markets, cultural amenities, and access to capital of all kinds. But South Dakota’s pro-growth tax code has helped it compete — and New York isleaking people and money to places such as Florida, Texas, and North Carolina that have assets South Dakota lacks as well as better tax systems.

“Taxes are not everything,” the Tax Foundation observes, “but they do matter, and they are within the control of policymakers. Even within a given revenue target, there are better and worse ways to raise revenue.”

In addition to the research it cites, I’ll mention a 2023 study in the Journal of Risk and Financial Management. Its authors examined 10 years of county-level data across the United States. They found that, to varying degrees, increases in income, sales, and property taxes are all associated with lower rates of employment, growth, and innovation (as measured by patents issued per resident). “The results consistently underline that taxes have detrimental effects on local economies,” they wrote, “whether urban or rural.”

Since 2011, the North Carolina General Assembly has broadened the base and lower the rates of both our personal-income tax and our sales tax. Lawmakers have also slashed our corporate-income tax by more than half and are on track to phase it out entirely by the end of the decade. By itself, the latter reform will likely vault North Carolina into the top 10 states in tax competitiveness.

Corporate taxes are especially pernicious and harmful because they warp capital flows and labor markets. Remember that corporations aren’t actually taxpayers. They are bundles of contracts among taxpayers. When corporate managers send money to state or federal treasuries to satisfy their companies’ income-tax liability, those funds must come from one of three places: 1) money otherwise paid to employees and vendors, 2) money otherwise paid to owners and shareholders, or 3) money collected from their customers as higher prices.

Studies show that the actual incidence of a hike in corporate tax is spread across all three groups, but not evenly. Consumers are often very responsive to price changes and can often buy products made in lower-tax jurisdictions. In the short run, shareholders may take the hit — but over time, managers reduce it by moving assets and establishments to lower-tax jurisdictions. That leaves the least-mobile group, workers, bearing most of the cost over time.

North Carolina can and should eliminate our corporate tax, taxing people’s consumed income transparently and proportionally through other means to fund truly necessary public services.

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