CREATING. REVENUE SYSTEM that WORKS for NORTH CAROLINA. Presented by the NC Budget & Tax Center and the NC Justice Center

Transcription

1 CREATING REVENUE SYSTEM that WORKS for NORTH CAROLINA A Presented by the NC Budget & Tax Center and the NC Justice Center

2 The Fuel that Makes North Carolina Go North Carolina has a history of investing in its infrastructure and its people. Past investments in roads, ports, education and technology set up North Carolina to be a player in the global economy-just as the decisions of today's public-sector leaders will shape the opportunities available to future generations. In addition to implementing long-range projects, North Carolina's public sector must meet the day-to-day needs of the state-including schools, courts, human services, food safety and environmental protections. People in every community and businesses in every industry rely on the public sector in some way. In order to live up to these many 2

3 WHY NC'S REVENUE SYSTEM DOESN'T WORK North Carolina's revenue system was last overhauled during the Great Depression, when the state's economy was based on agriculture and manufacturing. Nearly all closed down, new hi-tech plants have opened and numerous large, multistate corporations now call the Tar Heel state home. North Carolina is a hub of medical and technological research and industry. As a result, many transactions in the state involve services or new technologies. responsibilities, the public sector needs a reliable stream of revenue. The state is not out to make a profit, but it does need to know it's bringing in enough money to meet current needs and fund investments. That's why a fair and adequate revenue system is so important for the overall well-being of the state and its people. North Carolina's current revenue system does not grow with the economy, which means resources are stretched thin and planning for the future is difficult. State legislators are considering changes to the tax code that will make it fairer and more adequate and will enable North Carolina to meet the needs of today and the promise of tomorrow. This pamphlet outlines some of the principles they should follow to get there. transactions involved tangible goods, like clothes, food, or equipment. As the state's population and economy grew, so did the number of transactions and the incomes of residents. Therefore, growth in tax revenue was automatic. North Carolina could keep up with the needs of its citizens and make major new investments, like expanding its world-class university system. Today, those investments have paid off, but they've also helped North Carolina outgrow its old tax system. While many manufacturing plants have North Carolina's tax system isn't designed for this kind of economy. Parts of the economy that should reasonably fall under the tax code do not. As a result, everything that does fall under the code is taxed at a higher rate-a situation that is unfair to most individuals and small businesses. For example, in 2003, nine multi-state companies headquartered in North Carolina made millions, even billions, of dollars in profits, but they all paid 3% or less of their profits in state income taxes. In fact, some received refunds of millions of dollars. 3

4 These companies do not fairly contribute to North Carolina's public sector, even though they benefit greatly from public investments and are in part responsible for the state's increased needs for civil courts, roads, and technology. annually since 2001 (adjusted for inflation), while corporate profits have grown by an average 12.8% annually. If North Carolina's revenue system required fair contributions from corporations and WHO PAYS IN NORTH CAROLINA? (2003) Income Bracket Average Income Percent of income paid in state and local taxes* Wealthiest 1% $970, % Middle 20% $35, % Lowest 20% $10, % SOURCE: Institute on Taxation and Economic Policy * This rate takes into account that taxpayers who itemize deduct their state income taxes from their federal income. The state's tax system is also unfair in that it lets the wealthy contribute less than low- and middle-income families do. millionaires, tax revenue would more closely follow the growth of the economy, making the system more adequate. The lower a family's income is, the more likely it is to spend almost all of its money on the basics of life-and all of those things, with the exception of food, are taxed. As a result, the lowest-paid workers in North Carolina pay 10.7% of their income in taxes, compared to only 7.1% for the wealthiest people. This lack of fairness significantly contributes to the lack of adequacy in North Carolina's revenue system. Corporate profits and the incomes of wealthy individuals are growing much faster than the wages of working families. According to the US Commerce Department, wages and salaries have only grown an average of 1.9% CREATING A FAIR AND ADEQUATE STATE TAX SYSTEM North Carolina needs a modern revenue system that follows two fundamental principles of good tax policy. First, the system must be fair, meaning those with the smallest incomes pay the smallest share of their incomes in taxes. Second, the system must be adequate, meaning revenue grows with the economy. Making sure more of the economic activity in North Carolina falls under the tax code would help to achieve both of these goals because it spreads out tax responsibility and ensures that revenue growth tracks economic growth. Personal Income Taxes The income tax is the fairest element in North Carolina's revenue system because those who make the most pay the largest share of their incomes, while those who make the least pay the smallest share. Therefore, it is imperative that the state maintain and strengthen the progressive income tax and continue to rely on it as the cornerstone of the revenue system. The amount of incomethe "base"-to which North Carolina's income tax is applied is very narrow, which is why the rates appear higher than those in many other Southern states. North Carolina is one of only a handful of states that uses federal taxable income as a 4

5 starting point for state income taxes. Federal taxable income is the amount you come to after excluding some forms of income and applying federal deductions and exemptions. This is especially beneficial to wealthy people, who tend to itemize and take multiple deductions, while many low- and middleincome families use the standard deduction only. Instead, North Carolina could use adjusted gross income, like most other states, and then subtract state deductions and exemptions. That would broaden the income tax base, making it possible to lower all rates. In addition, expanding the current system from three income brackets to six brackets would enable state lawmakers to better target tax reductions at middle- and low-income IN ORDER TO INCREASE FAIRNESS and target tax reductions at families most in need, the state legislature created a state Earned Income Tax Credit. Expanding that credit - from 3.5% to 10%, for example - would further improve fairness and help families cope with the rising costs of health care, child care, housing, gas, and other necessities of life. Twothirds of North Carolina families who get the EITC make less than $20,000 a year, so they could use the financial boost. families. The brackets should be indexed to inflation so that as inflation pushes up wages, the income range for each tax bracket also goes up. Corporate Income Taxes Big corporations take advantage of their presence in numerous states to move money around and shirk their tax 5

6 responsibilities, giving them an unfair advantage over local businesses. When they don't pay their taxes, the rest of us pay more and public services suffer. The state could address this problem by instituting combined reporting, which requires each multi-state corporation to add together the profits of all of its subsidiaries, regardless of location, into one report. This prevents the corporation from shuffling around money to avoid paying taxes. The non-partisan Multistate Tax Commission found that corporate tax shelters cost North Carolina an estimated $300 million in fiscal year Combined reporting would capture as much as $100 million of that. Otherwise, the money goes into the pockets of shareholders around the world. The NC General Assembly should also eliminate many, if not all, of its specialized tax credits for businesses. The state loses out on almost $1 billion in revenue because of these loopholes, which are created to promote everything from job creation to chicken carcass recycling. There's no way to know if these credits actually achieve their intended goals because the state never conducts performance evaluations of credits. Sales Taxes About half of all transactions in North Carolina involve services, which are not subject to taxes. As a result, everything that is taxed is taxed at a higher rate. In addition, wealthy people tend to consume more services than other families. Therefore, the current sales tax set-up lets wealthy people pay a lower overall sales-tax rate, while middle- and lower-income workers must pay more than their fair share. By including services in the sales tax, the revenue system would capture much more of the state's economic activity, and the tax rate could be cut significantly. This would result in an overall tax reduction for many working families, and it would mean greater revenue for counties, which can put that money toward the specific needs of their communities. Lawmakers should also reexamine some of the sales tax caps that are now in place. For example, there is a $300 cap on the 3% car tax. That means the person buying a $10,000 used pickup pays the same tax as someone buying a brand-new $50,000 Lexus. For the Lexus buyer, that's a $1,200 tax break. Caps that target luxury items like high-priced cars and boats need to be eliminated. In addition, sales tax exclusions - like the one for machinery purchased for use in manufacturing - should be examined to determine if they benefit North Carolina as a whole. Property Taxes The property tax is strictly a local revenue source in North Carolina, but it accounts for one-quarter of all state and local taxes. It's gone largely untouched since it was established in 1777, and it continues to provide a relatively fair and highly stable revenue source for local governments. However, the property tax does need to be modernized as part of any comprehensive tax reform effort in the state. Currently, North Carolina only mandates that counties revaluate property once every eight years. This forces counties to raise their property tax rates frequently in order to simply maintain revenue growth consistent with population and inflation growth. In addition, properties that have recently been sold are subject to a much greater tax than other properties with similar resale values. Requiring more frequent revaluations and annual indexing of property values would help to make property tax revenue more stable. The property tax is a slightly regressive tax because lower-income State and Local Tax Recommendations These recommendations in and should be implemented INCOME TAX Maintain primary reliance Have a minimum of five them for inflation Broaden the base of inco applied Lower all rates, but subs rates Enhance refundability of taxpayers SALES TAX Expand to cover more pe Eliminate ineffective cap Lower the rate CORPORATE INCOME TA Eliminate ineffective exe Adopt combined reportin loopholes PROPERTY TAX Require more frequent re indexing of property valu Create refundable circuit income homeowners and taxpayers are likely to devote greater shares of their incomes to housing costs than higher-income taxpayers. In order to mitigate the impact of this tax on low-income taxpayers, North Carolina should follow the lead of many other states and provide targeted propertytax reductions. This can 6

7 Reform teract with one another simultaneously. on progressive income tax income brackets and index me to which the rates are tantially lower the bottom credits for low-income rsonal services and exemptions X ptions and credits g strategy for eliminating valuations or annual es -breaker credit for lowrenters be done through a state income tax rebate that kicks in when a homeowner's property tax bill exceeds a certain percentage of his income. A similar credit for lowincome renters can help to offset property taxes that landlords pass on to tenants. A COMPREHENSIVE APPROACH North Carolina's state legislators have been hesitant to tackle the politically charged challenge of making structural changes to the tax system. Instead, they've addressed the resulting budget shortfalls using stop-gap measures, including fee increases, sales and excise tax hikes and budget cuts. All of these hit low- and middleincome families hardest. But beyond that, these piecemeal changes create the perception that the legislature regularly raises taxes, causing resentment and frustration among taxpayers. Legislators and taxpayers must understand that reforming the revenue system is essential to the state's future. However, they should approach reform in a comprehensive manner by addressing all the areas of the state and local tax system. By giving this process careful consideration, state leaders have the opportunity to design a revenue system that will fuel North Carolina's growth and ensure prosperity for future generations. 7

8 NORTH CAROLINA JUSTICE CENTER Opportunity and Prosperity for All 224 S. Dawson Street P.O. Box Raleigh, NC / voice 919/ fax COPYRIGHT 2007 NO PORTION OF THIS DOCUMENT MAY BE REPRODUCED WITHOUT PERMISSION.