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New sales taxes highlight NC’s “worst of all worlds” fiscal policy

wb-shift [1]The state is raising taxes on average people while bringing in fewer dollars to fund essential public structures and services

Here’s one thing you can say for the conservative elected leaders running North Carolina state government these days: they don’t lack for audacity. Whereas some politicians might hesitate or display at least a small measure of hesitancy or sheepishness about implementing tax changes that dramatically shift the responsibility for funding our public structures and services away from the rich and onto the backs of the poor and middle class, North Carolina’s leaders are in “full steam ahead” mode.

In an era in which the one-percenters are already rapidly leaving the rest of society further and further in their rear view mirrors, Governor McCrory and the leaders of the General Assembly have enacted policies to, in effect, turbocharge their Ferraris, Mercedes and Teslas.

The latest act in this sobering drama is the new package of sales tax hikes that go into effect today.

As Colin Campbell of Raleigh’s News & Observer reported this past weekend [2]:

New sales taxes will take effect across North Carolina on Tuesday, adding to the cost of services including car repairs and appliance installations. The legislature approved the additional sales taxes last year, part of a Republican led shift to lower income taxes by expanding the number of services subject to sales taxes. Part of the additional sales tax revenue will be distributed to poorer counties. About $84.8 million in new revenue will be divided among 79 counties for schools, community colleges and economic development projects. Most of the businesses affected are already charging sales tax on such things as parts and other equipment. But until now, the labor cost has been tax free.”

You got that? Leaders are raising regressive sales taxes in order to partially make up for the hit to state revenues brought on by the repeated cuts to state personal and corporate income taxes.

Abetting the Great Tax Shift

The new sales tax hikes are, in other words, the most recent development in what critics have aptly labeled “the Great Tax Shift.” [3]

Rather than building a fair and sustainable revenue system that asks all to pay their just share and assures that the tax base will grow with the economy, leaders are doubling down on their commitment to the state’s already upside-down tax system.

And make no mistake; the current system is upside-down. As the experts at the Institute on Taxation and Economic Policy reported last year [4] even before the latest regressive cuts went into effect, the richest North Carolinians were already paying much less of their income in state and local taxes than the middle class and the poor (see the chart below).

North Carolina State & Local Taxes in 2015

wb301-chart [5]

The changes taking effect in the current budget year (combined with the previous ill-conceived repeal of the state Earned Income Tax Credit) only make matters worse. As Budget and Tax Center Policy Analyst Cedric Johnson reported last summer [6]:

In North Carolina the wealthier someone is the lower share of his or her income goes toward state and local taxes compared to everyone else. The tax changes reflected in the new [2016-17] budget exacerbate this disparity. On average, North Carolinians making $20,000 a year or less will see their overall state taxes go up slightly by $7. Those making between $34,000 and $57,000, on average, will receive a tax cut of $44, which equates to $3.67 per month. The top 1 percent, those making at least $423,000 a year, will on average receive a tax cut of nearly $2,000.”

Not filling the hole

To make matters even more absurd, not only is the Great Tax Shift unfair, it isn’t even making up for the loss in revenue attributable to the income tax cuts. When adjusted for inflation, North Carolina’s current state budget is significantly smaller than it was prior to the Great Recession of the last decade.

What’s more, this was totally predictable. Again, here’s Cedric Johnson:

Proponents of this tax shift have said it will help the state’s finances, on the assumption that revenue from sales taxes is more stable during business cycle fluctuations than income tax revenue. In fact, a graduated income tax—where rates rise along with income—has been proven to be the most reliable revenue source available to states because it displays more robust growth in the long run than sales, property, or excise taxes.

This is borne out by tracking done by the General Assembly’s Fiscal Research Division. Between 1997 and 2013, FRD found that neither revenue source fully kept up with growth in the state’s economy, but that the personal income tax provided significantly more robust resources as it outpaced sales tax revenues. The sales tax, however, tends to be a more stable revenue source during economic downturns because people still must buy things such as basic necessities, even as their incomes fall. Accordingly, having both a graduated income tax and a sales tax allows states to better weather economic downturns and realize gains when the economy is recovering and thriving.”

The truth about taxing services and raising more revenue

As with so many of the tax changes enacted and promoted by conservatives in recent years, the new expansion of the sales tax is especially pernicious and misleading in its present form because there are actually some kernels of truth in the proponents’ arguments that tend to confuse the issue.

It is correct, for example, that taxing services can be a good idea. The proponents of expanding the sales tax to services are right in that it generally makes sense to move in such a direction. Not only does this broaden the base of the sales tax in our increasingly service-based economy, it can, if done properly, enhance fairness and progressivity by taxing things that wealthy people tend to buy more of.

As tax fairness advocates have argued for years, however, the best way to do this is in a “revenue neutral” manner. This means the state should expand the “base” of the sales tax to include lots of previously untaxed services but, at the same time, lower the rate at which all sales are taxed. This would produce the twin benefits of making the sales tax fairer and less susceptible to swings in the economy.

The idea is to keep the sales tax as a key part of the state revenue system, but to avoid making it an overwhelmingly dominant component as it is in states like Florida [7] and Tennessee [8]. Unfortunately, the Florida/Tennessee model appears to be precisely what the state’s conservative leaders have in mind.

As noted above, under the sales tax expansion taking effect today, officials have opted for a more regressive path by keeping the rate the same (currently a minimum of 6.75%) and expanding it to several services that tend to be paid by lower and middle income taxpayers. The fact that lawmakers have also jacked up all sorts of basic state government fees only exacerbates the problem.

The bottom line: North Carolina needs more fairly generated revenue

None of this is to imply in any way that North Carolina doesn’t desperately need more revenue. As countless stories documenting the shortfalls in public and higher education, the courts, prisons, environmental protection and other areas have made clear in recent years, numerous public structures and services are suffering from chronic underinvestment. In such an environment, the new revenues raised through the expanded sales tax are certainly welcome. That said, North Carolinians should be under no illusion that the changes represent a positive development in state fiscal policy. They are, in fact, just the latest in a long series of destructive and/or poorly implemented fiscal policy shifts that have rendered North Carolina a badly diminished and increasingly divided state.