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Carolina tax reform sets pace

020517Hood

John Hood

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Tuesday, November 21, 2017

North Carolina has already accomplished what Republicans in Washington want to pass — historic tax reform that caps or eliminates special-interest deductions, cuts tax rates, and encourages investment, business formation and job creation.

The process began in 2011, after the GOP took charge of both houses of the state legislature. With the election of Republican Gov. Pat McCrory in 2012, legislative leaders had an ally on tax reform. The ensuing 2013 tax bill initiated a reform process that has continued to reduce the tax burden by both cutting rates and increasing standard deductions.

The net effect was to save North Carolina taxpayers about $5 billion from 2013 to 2017. By 2022, the projected savings will approach $10 billion.

With regard to tax rates, the most dramatic change was on the business side of the tax system. Keep in mind that businesses are bundles of contracts among human beings — among owners, workers, customers, and vendors. When government taxes a business, it really taxes the incomes of some or all of these individuals, even if they don’t realize it.

Politicians and political activists often assume that corporate taxes, for example, just bite corporate shareholders. In the short run, investors may well bear most of the cost when corporate taxes go up. But markets soon adjust. Investors can move their money fairly easily from high-tax to low-tax jurisdictions. Customers can often do the same, particularly if they shop online or can shop around among competing products or places.

Workers are the least able to avoid business taxes, because it can be so costly to leave one job for another — particularly if it would require leaving one community for another. Thus many economists believe that workers bear most of the burden of corporate taxes in the long run.

Before 2013, North Carolina imposed a 6.9 percent tax on corporate income attributed to the state. By 2019, thanks to tax reform, that rate is scheduled to fall to 2.5 percent. That’s one of the lowest rates in the country. That will make North Carolina a more attractive place to do business — thus boosting the employment and incomes of North Carolina workers over time.

As the state implemented tax reform, its economic performance has often compared well with our peers. In virtually every category — job creation, employment gains, and income growth — North Carolina has exceeded regional averages, national averages, or both.

That doesn’t necessarily prove a causal relationship. Indeed, most of the benefits of tax reform couldn’t possibly have happened yet, given the lifecycle of business investment. But pro-growth tax policies certainly haven’t hurt. And, make no mistake, corporate tax cuts are pro-growth. According to the findings of the more than 100 peer-reviewed studies published on the issue since 1990, states with lower corporate taxes tend to experience stronger economic growth than those with higher corporate taxes.

In Washington, both the House and Senate tax plans seek to follow in North Carolina’s footsteps by dramatically reducing the tax rate on corporate income. There are many other features of the plans — some good, some not-so-good — but in fiscal terms the net effects aren’t large. The real action will be slashing the corporate rate to 20 percent, a move likely to induce substantial flows of capital into America.

There remains one big difference between Raleigh’s accomplishments and Washington’s aspirations: fiscal responsibility. While reforming and cutting taxes, North Carolina has kept a lid on spending growth. Our state budget is in the black, not deeply in the red like the federal budget.

Indeed, measured as a share of the state’s gross domestic product, the government sector in North Carolina grew slower than the national average from 2013 to 2016 while North Carolina’s private-sector economy grew faster than the national average.

Our state has set a good example. Federal politicians should follow it.

John Hood is chairman of the John Locke Foundation.

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