Weekly Briefing

North Carolina’s Fiscal Modernization Study Commission is revived after a lengthy hiatus 

Eighteen months ago at the conclusion of the 2006 session of the North Carolina General Assembly, lawmakers passed a bill that established a special Senate-House study with an ambitious charge. The new State and Local Fiscal Modernization Study Commission was directed by state law to:

(1) Examine State and local revenue-sharing and taxing authority, and the division of responsibility for providing for infrastructure, public education, Medicaid and other needs.

(2) Examine North Carolina’s revenue- and responsibility- sharing between State and local governments compared to those in other states.

(3) Review the existing State tax code and recommend ways to modernize it.

(4) Examine the current authority of local government to levy taxes and fees and recommend any changes in such authority.

(5) Examine local governments’ ability to pay for services required by their citizens.

(6) Recommend to the Governor and the General Assembly needed changes in State and local tax structure and sharing of revenues and responsibilities.

(7) Study and recommend a permanent financing strategy leading to the elimination of county financial participation in Medicaid services

The new group was stocked with a mix of lawmakers, government officials and private citizens and staffed by a combination of legislative employees and outside consultants.  In effect, state lawmakers had created a “blue ribbon” commission and charged it with the incredibly ambitious goal of developing a new, fairer and more efficient way for state and local governments to fund themselves.

A promising start goes awry

At the outset of its efforts, the group seemed to demonstrate some good judgment and a real appreciation for the importance and complexity of its challenge. As we reported in this space at that time regarding the group’s first gathering:

“In general, speakers and members seemed to acknowledge the importance of the mission that confronts the group. It was noted, for instance, that the group would not offer a comprehensive report until May, 2008 – something that seems eminently reasonable if there is to be sufficient time to develop any truly significant recommendations for change.

 
The presentations themselves did a generally solid job of apprising Commission members of some of the key challenges that confront the state. Professor Jim Johnson of the Kenan-Flagler Business School explained the remarkable demographic changes that will confront the state as its population ages and becomes more racially and ethnically diverse. Mike Walden of N.C. State noted the importance of avoiding the trap of measuring tax “burdens” between states without accounting for the crucial societal benefits that public spending can produce. It will augur well for the group if it can sustain the serious and analytical tone of the first two days.”

After the group’s first couple of meetings, however, things started to wander off course. As some had feared, conservative legislators and business representatives (along with staff members provided by N.C. State University) began to push the commission and its various subgroups to devote inordinate time and energy to the question of “competitiveness” – as in “how can North Carolina reduce individual income and corporate tax rates so as to make itself ‘more attractive’ to those who would relocate here from out-of-state?”

Such a discussion was, of course, not only beyond the scope of the group’s original charge, but completely divorced from the reality that: a) North Carolina was already growing by leaps and bounds, and b) income tax rates alone have virtually nothing to do with whether businesses and/or wealthy individuals move to a state. 

By the time of the group’s last meeting – which took place in April of 2007 – the addition of this ill-considered issue to the commission’s work had helped produce a terribly flawed set of recommendations. Under the draft that was presented to the Commission (but never formally adopted), lawmakers would have been urged to alter the state tax code by cutting income taxes (the most progressive section of the tax code) and replacing the lost revenue by increasing the scope of the state sales tax.

Of sales and income taxes

While broadening the sales tax base so that it impacts more services can be a good idea (the sales tax base has been shrinking for years as the state’s economy has shifted from goods-based to service-based), this tactic should never be used as a means of cutting income taxes.

Rather, to the extent it’s used to provide anything in the way of rate reductions these should go toward the sales tax rate itself. A classic example of such a swap might feature, for instance, expansion of the application of the sales tax to things like legal services and entertainment combined with a slight reduction in the overall rate.

Such a move would be moderately progressive in that it would shift some of the overall sales tax burden onto transactions more likely to be used by businesses and upper income individuals. In using new sales tax revenues to subsidize income and business tax cuts, however, the commission’s draft takes a good idea and ruins it.

Last year and today

While the Commission never formally adopted a set of final recommendations, some of the ideas it was discussing last spring did find their way into the work product of the 2007 session of the General Assembly. Most notable among these was the so-called “Medicaid swap” that lawmakers enacted (in which counties were relieved of their responsibility for funding a share of the state’s growing Medicaid bill) and the decision to give counties new authority to raise local taxes. Lawmakers also cut income taxes on the rich, though it’s unclear how much influence (if any) the Commission had on that process. None of the commission’s grander schemes regarding the expansion of the sales tax and broader cuts in income and corporate taxes were seriously considered.  

This Wednesday, the Fiscal Modernization Commission will have its first meeting in 10 months. According to the tentative agenda, the focus will be on business taxes. At this point, there is no word whether the group’s reemergence amounts to a serious effort to revive its more ambitious plans to remake the state tax system or is simply a vehicle for bringing people to Raleigh to discuss some specific issues.

Whatever the objective, it’s clear that North Carolina’s real and overriding fiscal policy challenges have not changed during the last year and a half. Right now, the state’s tax system is increasingly inadequate and unfair. Not only does North Carolina find itself in a perpetual budget bind each year as revenues barely keep up with cost of providing essential services (much less improving them), but its system is increasingly regressive.

According to the best available numbers (the N.C. Budget and Tax Center expects to have an update as early as next month), the richest 1% of taxpayers pays a much lower share of their annual income in state and local taxes combined than do the middle class or the poor. Somehow, the state must figure out a way to modernize its tax system so that it: a) produces adequate revenue to keep up with the needs of a growing state with growing needs and b) does so in a way that fairly apportions the responsibility for funding government amongst various income groups.

Unfortunately, thus far, the Fiscal Modernization Study Commission has not shown any real indication that intends to tackle these tough challenges. This is unfortunate. For while time is short, it remains possible to fashion a series of progressive recommendations to the May 2008 legislative session that would modernize and update the income tax, broaden the base of the sales tax, close loopholes that allow large corporations to evade the corporate income tax, and provide additional tax breaks for taxpayers of modest means.

At a minimum, such a collection of proposals ought to be advanced and thoroughly debated by the candidates for statewide office prior to the November election and in anticipation of the 2009 General Assembly.

Let’s hope that this week’s meeting of the commission signals a sea change in just such a direction. If not, the state will be better off if the group simply closes up shop.  

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This entry was posted on Wednesday, February 20th, 2008 at 9:13 am and is filed under Weekly Briefing. You can follow any responses to this entry through the RSS 2.0 feed.