North Carolina picks prosperity through pro-growth tax reform

Both houses of the North Carolina legislature are currently considering competing bills that lower taxes by $1 billion or more over the next five years, move the state to a pro-growth flat rate income tax system, and slash tax rates on businesses and North Carolina families. Both proposals have incredible potential to supercharge economic growth in North Carolina, leading to higher job creation and higher income growth across the income spectrum. ALEC’s Rich States, Poor States Economic Outlook Index measures a state’s future growth prospects given the state’s current public policy environment. The 6th Edition of Rich States, Poor States ranked North Carolina’s 2013 economic outlook as 22nd overall. We have recalculated the results of the 6th Edition index to measure the effect of these proposals on North Carolina’s economic outlook and the results are staggering. Under the final phase-in of the House plan, North Carolina’s economic  outlook would improve to at least 5th best overall, and under the Senate plan, the state would advance to at least 2nd overall after final phase-in.

The differences between the House and Senate plans currently being considered have been detailed by  North Carolina legislature in a lengthy and comprehensive chart,  but the bills generally follow a similar format:

• Flatten, lower, and simplify the income tax rate by eliminating and capping credits;
• Lower the rate or eliminate the corporate income tax (Senate bill opts for elimination);
• Eliminate the estate tax;
• Move to single sales factor apportionment for the corporate income tax;
• Expand the sales tax, in an effort to move the state towards a consumption tax model.

Both plans involve various phase-in periods for rate lowering and cut total taxation substantially over a five year period. The House plan cuts taxes by $1 billion over five years, while the Senate plan cuts $1.4 billion over that same five year period.

All of these moves are stellar reforms for a state looking to move to the front of the national pack in terms of 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 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. The details of the recent House and Senate proposals allow us to reformulate the index to see how North Carolina’s public policy would have stacked up had the state passed the reforms and totally phased-in all changes before the January 1^st, 2013 deadline for reforms to be considered in the Rich States, Poor States 6th Edition.

To evaluate this tax reform proposal, we modified four areas of our index, all of which raise North Carolina’s Economic Outlook Ranking:

• Personal income tax rate which will fall under both proposals (House: 5.9 percent rate and Senate: 5.25 percent rate),
• Corporate income tax rate which will fall or be eliminated under the proposals (House: 5.4 percent rate and Senate: elimination),
• Personal income progressively which will fall under both proposals as the state moves to a flat personal income tax, and
• The total and immediate elimination of the state estate tax under both proposals.

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.

Once these tax proposals and assumptions are plugged into the Rich States, Poor States Economic Outlook model, a clear picture emerges regarding the impact of these proposals. Under the House plan, North Carolina moves from 22nd to 5th. Under the Senate plan, the state moves from 22nd to 2nd. The importance of these results cannot be overstated. As Tax Myths Debunked and the 6^th Edition of Rich States, Poor States detail, the Rich States, Poor States index has a strong correlation with state economic health, including future income growth and job creation.

The human impact of these reforms should be obvious: Additional dollars in citizens’ pockets, more opportunities for North Carolinians hit hardest by the recession to get better jobs, more opportunities for citizens to get into the driver’s seat of their own economic destiny 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. North Carolinians are to be commended for picking prosperity.