How North Carolina got in the fiscal fix it is in

How North Carolina got in the fiscal fix it is in

budget2 As state lawmakers work to prepare budget adjustments for the new fiscal year that commences July 1, it’s increasingly clear that there in no way that they can provide the kind of pay raises our long suffering teachers and state employees deserve or meet the long list of unmet needs that confront our state in a host of other areas. There just isn’t enough money in state coffers to get these jobs done.

Given this backdrop, North Carolinians would do well to remember a few basic facts about how we got into this fix.

First and foremost on this list is the fact that tax changes passed since 2013 have not only significantly reduced revenue available for public investments, but also shifted the tax load to low- and middle- income taxpayers and away from the wealthy and profitable corporations. Once all changes are fully implemented, for instance, the tax load on low income taxpayers will have increased by an average of around $30 per year while it will have decreased by around $15,000 per year for millionaires.

These tax changes mean the amount of revenue raised through the state’s three main tax revenue sources – the personal income tax, the corporate income tax and the sales tax – will have been reduced by billions of dollars. Simply put, state leaders lowered the bar of possibilities for North Carolina. As a result, even the fact that state tax revenues for the current year are now forecast to exceed initial projections by $330 million does little to help. We still have less than we would have had if not for the 2013 cuts and much less than we need to build a solid foundation for a prosperous North Carolina.

This reality is reflected in the low spending target recently agreed to by leaders in the House and Senate – a number even lower than the Governor’s modest budget proposal. There simply aren’t enough dollars to go around to fulfill even the modest election year priorities identified by state leaders – much less to boost the economy with smart public investments that prepare every child for success, support every family’s health and well-being and deliver on a vision where every community in the state can thrive.

Here’s a recap of the sequence of tax policy changes enacted in recent years. It is worth repeating that these changes will, once fully in place, produce an annual revenue loss of at least $2 billion – much needed dollars given the growing needs of the state.

In 2013, state leaders included a package of tax changes in their approved state budget that made significant changes to the state’s tax system. These changes included:

  • Replacing the graduated personal income tax (PIT) structure that was based in part on the taxpayer’s ability to pay with a flat tax and lowered tax rate. The flat PIT rate was set to be reduced to 5.75% by 2015 from a top marginal rate of 7.75% under then-current tax law.
  • Cutting the corporate income tax (CIT) rate to 5% by 2015 from 6.9%. A further reduction of the CIT rate to as low as 3% by 2017 was allowed to occur if state revenue collections met relatively low thresholds.
  • Eliminating the estate tax which only applied to the wealthiest individuals in the state with estate values that exceeded $5.25 million in 2013. For 2012, the latest tax year for which data was available at the time, only 23 tax filers were subject to the estate tax in North Carolina.
  • Eliminating state Earned Income Tax Credit (EITC), which helped North Carolinians who earn low wages keep more of what they earn. For tax year 2013, more than 927,000 North Carolinians claimed the state EITC, benefiting more than 1.2 million children. Allowing the state EITC to go away served as a tax increase for these North Carolinians.
  • Expanding the sales tax base to include services not previously included. These services included maintenance agreements, repair contracts and similar agreements or contracts by which the seller agrees to maintain or repair tangible personal property.
  • Expanding the sales tax to admission charges for entertainment activities. These activities subject to the sales tax include live performances, motion pictures or films (e.g. movie theaters), museums and guided tours, among other activities.

In 2015, state lawmakers passed additional tax changes in their approved state budget that included:

  • Further reduction of the PIT rate to 5.499% from 5.75% to be phased in beginning January 2017.
  • Further reduction of CIT rate to 4 percent from 5 percent. The rate will fall to 3 percent once revenue collection reaches a relatively low threshold. Policymakers changed the requirements for meeting this threshold to ensure that the CIT rate is further lowered.
  • Changed how profitable multi-state corporations are taxed and in doing so created an uneven playing field for small, home-grown North Carolina businesses that don’t benefit under this tax change.
  • Further expansion of the sales tax base to repair, maintenance, and installation services. These services include shoe repairs, jewelry repair, tire repairs (patches, plugs, etc.), clothing repair or alteration, carpet installation and a range of other services.

It is our state leaders’ insatiable appetite for tax cuts that has created the constrained revenue landscape and false choices that North Carolina now confronts.

It didn’t and doesn’t have to be this way.

State lawmakers should begin the process of turning the tide and creating a tax system that works for everyone by stopping the bleeding. This means halting additional scheduled income tax rate reductions and restoring the state EITC as quickly as possible. After that, a return to a graduated PIT rate structure that takes into account one’s ability to pay and a revival of the estate tax on the very wealthy would go even further to ensure that all communities can thrive and broadly shared prosperity reaches all corners of the state.

The bottom line: As the national economic recovery continues for yet another year, North Carolina’s current fiscal challenges remain almost exclusively self-inflicted. Let’s hope state leaders realize before it’s too late that the key to the box they’ve locked themselves into has been in their pocket all along.

Cedric Johnson is a Policy Analyst at the North Carolina Budget and Tax Center.