February 2014

North Carolina Adopts Major Income-Tax Reform

by Amy K. Frantz

Some states are adopting income-tax reform and lowering tax rates, if not completely moving to an income-tax free system. The most recent state to adopt significant tax reform is North Carolina.  In July of last year, Governor Pat McCrory (R) signed into law the reforms hammered out by the Republican-controlled North Carolina General Assembly.  The new tax law will lower the personal income tax to a single-rate flat tax, “eliminate the personal income exemption, but increase the standard deduction,” and cap the mortgage interest and property tax deductions, among other provisions.[1]  The tax reform also reduces the corporate-income-tax rate and provides a path for further possible reductions in the corporate-income-tax rate.  A press release from Governor McCrory highlights the personal-income-tax and corporate-income-tax changes:

Personal Income Tax:

  • Reduces and simplifies the 3-tiered state personal income tax from the current maximum rate of 7.75 percent and minimum rate of 6 percent to [a single rate of] 5.8 percent in 2014 and 5.75 percent in 2015.
  • Increases the standard deduction for all taxpayers, applied to the:
    • First $15,000 of income for those married filing jointly.
    • First $12,000 of income for heads of household.
    • First $7,500 of income for single filers.
  • ​Retains the state child tax credit and increases it for families making less than $40,000.
  • Offers a $20,000 combined maximum deduction for mortgage interest and property taxes.
  • Makes charitable contributions fully deductible.
  • Protects all Social Security income from state taxes.

Corporate Income Tax:

  • Reduces the corporate income tax from 6.9 to 6 percent in 2014 and then to 5 percent in 2015, a 29 percent rate reduction.
  • If the state meets revenue targets (i.e. if there is additional tax revenue growth due to a growing economy), the corporate income tax will drop to 4 percent in 2016 and 3 percent in 2017.[2]

John Hood, President of the John Locke Foundation located in Raleigh, North Carolina, commended the North Carolina General Assembly and Governor McCrory for the direction they took in reforming the corporate income tax and the impact on that state’s businesses:

If your goal is to foster economic growth and job creation, there’s a right way and a wrong way to cut taxes on business. Fortunately, Pat McCrory and the General Assembly made the right choice.

The wrong way is to offer tax credits or other targeted incentives to companies based on where they locate or how they spend their revenue. In order for such incentives to create net economic value, the public officials who craft them would have to possess superior knowledge to that of private entrepreneurs, investors, and managers.

This is what Nobel-winning economist Friedrich Hayek and his collaborator W.W. Bartley called the “Fatal Conceit” in a 1988 book of the same name. Central planning doesn’t fail because government officials are dumb or have bad intentions. Central planning fails because no single person or group could possibly possess all of the constantly emerging and changing pieces of information necessary to make welfare-enhancing decisions.[3]

North Carolina’s Tax Simplification and Reduction Act also eliminates the state estate tax or “death tax” and caps the state’s gas tax at 37.5 cents per gallon.[4]  Additionally the law makes some changes in the state’s sales and franchise taxes, including eliminating the back-to-school and Energy Star sales tax holidays.  “Sales taxes would be applied to service contracts and increased for manufactured and modular homes.”[5]  “Several controversial tax breaks, such as a subsidy for film production, are now scheduled to expire over the next two years.”[6]  The tax reform is “revenue neutral in 2013,” but when fully implemented will result in an “annual $450 million tax cut.”[7]

North Carolina Legislators and the Governor also adopted budget reforms this year to accompany the tax reforms. “Legislators improved state government’s balance sheet by boosting reserve funds, speeding up repayment of a $2.5 billion debt to the federal government for unemployment benefits, and imposing a debt limit that forces lawmakers to seek voter approval before they can assume new state debt.”[8]

Amy K. Frantz is Vice President of Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.

[1] Barry Smith, “N.C. Tax Reform Plan ‘Blew Other States Away,’ Analyst Says,” Carolina Journal Online, July 17, 2013, <http://www.carolinajournal.com/exclusives/display_exclusive.html?id=10340> accessed September 19, 2013.  For more on the provisions in the North Carolina tax reform legislation, see “H.B. 998, S.L. 2013-316, Tax Simplification and Reduction Act, State Impact, $ in Millions,” from the North Carolina General Assembly’s Fiscal Research Division, August 16, 2013, <http://www.ncga.state.nc.us/FiscalResearch/budget_legislation/budget_legislation_pdfs/2013/conference/2013%20Finance%20Charts%20for%20Web.pdf > accessed September 18, 2013.

[2]“Governor McCrory Signs Tax Reform Into Law,” Press Release, State of North Carolina Governor Pat McCrory, July 23, 2013, <http://www.governor.state.nc.us/newsroom/press-releases/20130723/governor-mccrory-signs-tax-reform-law> accessed September 19, 2013.

[3] John Hood, “The Right Way to Cut Taxes,” Syndicated Weekly Column, John Locke Foundation, September 20, 2013, <http://www.johnlocke.org/news_columns/jh_column.html > accessed September 18, 2013.

[4] “Governor McCrory Signs Tax Reform Into Law,” and Becki Gray and Sarah Curry, “Tar Heel Transformation,” The Locke Letter, Vol. 22, No. 3, Summer 2013, pp. 6-7.

[5] Barry Smith.

[6] John Hood, “The Right Way to Cut Taxes.”

[7] Becki Gray and Sarah Curry.

[8] John Hood, “Historic legislative session highlighted by free-market, conservative reforms,” Press Release, John Locke Foundation, July 31, 2013, <http://www.johnlocke.org/press_releases/show/715> accessed September 18, 2013.