MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

YOU DECIDE: Is North Carolina ready for a tax revolution?

By Dr. Mike Walden
North Carolina Cooperative Extension Service

It wasn't exactly on par with the Boston Tea Party or the Declaration of Independence, but if the thinking of a recent gathering of prominent North Carolinians gains acceptance, there could be a revolution in the way North Carolina raises tax revenue.

The occasion was a meeting sponsored by North Carolina State University's Institute for Emerging Issues and the Z. Smith Reynolds Foundation, led by former Gov. Jim Hunt and Tom Ross, the foundation's executive director. Leaders, mostly from the private sector, participated, and I was honored to attend as a presenter and panelist.

The gathering's purpose was not to discuss ways to increase taxes, or to decrease them, for that matter. Instead, the task was to examine the structure of North Carolina's taxes and determine whether this structure makes sense for the 21st century.

In fact, there are several concerns about North Carolina taxes as we move from the manufacturing age into the technology era. One concern has to do with what is taxed: economists call this the “ tax base .” For example, the sales tax, a major source of revenue for both state and local governments, is applied only to sales of products, or “hard goods” such as furniture, clothing, appliances, etc. Spending on services is exempt.

This made sense in the 1930s when our current sales tax was developed. But it doesn't make sense today when the majority of consumer spending is on services, and services' share keeps getting bigger. Over time, this situation has forced legislators to increase the sales tax rate on the ever-smaller sales tax base.

Another concern surrounds the progressivity of the state income tax. A progressive income tax means the tax rate on income rises as the taxpayer's income increases. So a richer taxpayer not only pays more dollars in taxes than a poorer taxpayer, but he or she also pays a higher percentage of income for the tax.

Advocates of the progressive income tax say it's needed because higher-income people can afford to pay more, and also because a dollar's value to them is worth much less than to a lower-income taxpayer.

While these assertions may be true, the progressive tax presents two issues. One, the higher tax rate on richer households may deter them from living in North Carolina, where the upper income tax rate is among the nation's highest. Second, the progressive rate system may cause tax revenues to be more volatile over time, rising in the good times when more people are pushed into higher tax brackets, but falling when the economy sinks into a recession.

Regarding local taxes, the conferees learned about an issue with the property tax, which is the major source of locally raised tax revenue. Long periods between property revaluations — sometimes as long as eight years — make it difficult for property tax revenues to keep up with economic growth.

After hearing presentations about North Carolina's tax issues, participants were divided into groups, each challenged with redesigning North Carolina's tax system. There was one restriction: the redesigned system had to provide the same tax revenue today — no more and no less — than the current system. A computer program that simulated North Carolina's primary taxes allowed the groups to see the impacts of their choices.

Did the groups reach any consensus? Perhaps amazingly, they did. There was agreement local property values should be reassessed more frequently, maybe even annually. There was also agreement the sales tax should be extended to services, but as a result, the sales tax rate could be dramatically lowered, to the 2 percent to 2.25 percent range. However, spending on health care services would continue to be exempt.

For the income tax, there was agreement that greater effort should be made to exempt very low income households from paying the tax, such as by significantly increasing the standard deduction. But beyond this the groups disagreed. Some wanted a “flat” rate of 5 percent, while others wanted to maintain the current progressive system.

The gathering was not designed to address all of North Carolina's tax issues, but to begin the conversation over these issues in earnest. I think the conversation will continue.

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Dr. Mike Walden is a William Neal Reynolds Professor and extension
economist in the Department of Agricultural and Resource Economics of North
Carolina State University's College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic outlook and public policy.
His You Decide column is provided every two weeks by the Department of
Communication Services. Earlier You Decide columns are available on the Web
at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at
http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html