Pro-Growth Tax Reform Crosses the Finish Line in North Carolina

Just over a month ago, we chronicled the efforts of the North Carolina House and Senate to reform the states uncompetitive tax code and move towards a pro-growth tax system. At that point, the House and Senate had two competing bills and were attempting to broker a compromise that also had the approval of the North Carolina’s Governor, Pat McCrory. Last week, an agreement was reached and both the House and the Senate passed an outstanding tax reform package designed to super charge the economy. The Governor has signed that bill this afternoon, ushering in a game changing tax reform with huge growth implications for North Carolina’s citizens.

As part of our previous blog post, we scored the competing House and Senate bills using our Rich States, Poor States Economic Outlook Index. Now that the legislation has been finalized, we can score what these reforms mean for the state of North Carolina. Our analysis shows that North Carolina’s recently passed tax reform, assuming full implementation and a “static” world, would improve North Carolina’s economic outlook, from 22^nd to either 4^th or 5^th overall in Rich States, Poor States (depending on whether all corporate tax cuts are phased in).

The specifics of the bill are far ranging and have a broad effect in most areas of North Carolina’s tax system (summary available here). Some of the bills highlights include:

• Moving the income tax to one flat rate of 5.8 percent rate in 2014 and 5.75 percent in 2015.
• Lowering the corporate tax rate to 6 percent in 2014 and 5 percent in 2015. Additional revenue triggers will lower the rate to 4 percent in 2016 and 3 percent in 2017 if revenue growth targets are met.
• Eliminating the estate tax.
• Expanding the sales tax to include service contracts in an effort to move the state towards a consumption tax model.
• Eliminating multiple gross receipts franchise taxes, privilege taxes, and preferential sales tax rates.

In all, the reform bill cuts taxes more than $500 million in the first two years alone, and more than $650 million a year by the 2017-2018 fiscal year (see revenue estimates  here).

As we noted in our previous blog post, these reforms have huge implications for state economic performance.

“As we have documented extensively in our recent publication, Tax Myths Debunked, Chapter 3 of the latest Edition of Rich States, Poor States, and a recent blog post, taxes have a major impact on job growth, income growth, migration, and even tax revenue growth. Moreover, the formula for which tax policies unlock that growth is clear: low total taxation, simple and neutral tax bases, flat and low rate taxes, and taxes on consumption rather than on investment, income, and inheritances.  Taxes on productive behavior like work, investment, and entrepreneurship ensure that a state implementing those taxes get far less of those activities.”

Rich States, Poor States Economic Outlook Index tries to capture these insights from public finance research and historical experience on the effects of various tax policies on economic performance, and grade where the states stand with respect to a pro-growth public policy agenda.

We also noted some important caveats related to analyzing a legislative change such as tax reform in North Carolina in this manner.

“We did not modify the sales tax burden (which will increase under the proposals, hurting the state’s outlook ranking), remaining tax burden (which will fall under the proposals, improving the state’s outlook ranking), or recently legislated tax changes (which will consist of large tax cuts are a result of the proposals, improving the state’s outlook ranking). All three of these variables would change as a result of both laws, but because there is not sufficient data to recalculate those variables in a fair, reliable, and accurate way, they must be set aside for the purpose of this analysis. That said, the net of effect of these three omitted factors will almost certainly be to improve North Carolina still higher in the state outlook rankings than the projections that this post suggest.

We also assumed that the final rates at the end of the phase in period would take effect as of January 1, 2013 in order to rank the full final effect of the reform. In reality, these rates will phase-in slowly improving North Carolina’s rankings, though much of the reform is front-loaded into the next fiscal years. For the sake of proper comparison, these projections obviously also assume a static world in terms of state policy, meaning that the other recently enacted policy changes of states since the index was published (January 1, 2013) are ignored.”

Consistent with this methodology, our assumptions use the following variables:

• Personal income tax rate which will fall to 5.75 percent.
• Corporate income tax rate which will fall to at least 5 percent, and possibly as low as 3%, depending on the level of revenue generated.
• Personal income progressively will fall as the state moves to a flat income tax.
• The total and immediate elimination of the state estate.

After recalculating the numbers with these figures, the impact of this tax reform bill becomes clear: had these reforms been fully implemented as of January 1, 2013, North Carolina would have become the nation’s 5^th most competitive state if the corporate rate had only dropped to 5%, and would move up to 4^th nationally if the corporate rate dropped all the way to 3%. This from a current standing of 22^nd nationally in the 6^th Edition of Rich States, Poor States. In short, North Carolina moves from the middle of the pack to one of the nation’s leaders in economic competitiveness.

The human impact of these reforms cannot be overstated: More money in taxpayers’ wallets, greater opportunity for North Carolinians suffering in poverty to find gainful employment, more opportunities for citizens to become their own boss by starting their own business, and fewer North Carolina citizens pulled away from their families and home state in order to look for opportunity in states that have embraced a stronger pro-growth agenda. As reform crosses the finish line, North Carolinians are again to be commended for picking prosperity.