Policy & Progress article: State Revenues Can Fuel North Carolina's Resurgence

A fairer system that requires equitable contributions can fund critical state investments

August 2012
By Alexandra Forter Sirota

 “Taxes are the price we pay for a civilized society.”
-- Oliver Wendell Holmes, Jr., US Supreme Court Justice, in a 1904 speech


North Carolina established its tax system in the early part of the 20th century, ushering in many of the economic advancements that transformed an agrarian and largely poor Southern state into a globally competitive place that’s great for businesses and is nationally recognized for its high quality of life.

Today, North Carolina is struggling as its middle class experiences an erosion of job opportunities and income. But it should not be surprising that this slow decline in economic security and opportunity coincides with a dramatic decrease in the state investments that built the middle class.

A rise in anti-tax sentiment made this damaging divestment possible. It appears we have forgotten what taxes get us as a society.


The Value of Taxes

Taxes made statewide public education possible and enabled North Carolina to expand access to quality education to all children regardless of their race or ethnicity in the post-Civil Rights era. Taxes also built the transportation infrastructure that established North Carolina’s early reputation as the “good roads state” and encouraged the development of research and development centers clustered around public universities—also created with tax dollars—across the state.

In addition to continuing to support and build upon these early investments, today’s taxes enable North Carolina to provide training for unemployed workers, services for businesses seeking to expand, and assistance for those who are elderly or who have disabilities. They help keep our food and water safe, protect our environment, and preserve the state’s nature and culture.

However, North Carolina’s tax system has struggled in recent years. The inadequacies and lack of fairness in the system have resulted in diminished state revenues and harmful budget cuts.

Sure, the recession was tough, but it’s not the main reason why state revenues have fallen. North Carolina is actually collecting a smaller share of state personal income than it did before the recession.

Why? Because the tax system we have today was built for the economy of the 1930s and thus is outdated and because the people whose incomes have grown the most are being asked to pay the least. This unfairness in the tax system and inability of revenue to grow over the long term fuels the budget crises that primarily hurt those who are paying their fair share—North Carolina’s working families.


Restoring Fairness

Currently, North Carolina requires low-income families to pay a greater share of their incomes in taxes than wealthy families do.

In order to be fair, a tax system should ask North Carolinians to contribute based on their ability to pay. This is important for economic, moral and social reasons.

The pure economics of collecting taxes from those who can least afford it, or who have seen the least growth in their incomes over time, creates fiscal challenges because revenue is less likely to grow with the size and needs of the population. From a moral perspective, the current system leaves low-income families with fewer dollars for basic needs such as food and shelter. And finally, when the public perceives a tax system as unfair, it is more difficult to build widespread support for the critical role that taxes play in investing in communities.

To achieve a more equitable tax system that can support the investments necessary to grow our economy and expand opportunity, North Carolina must reform its current tax system. In short, North Carolina needs to maintain and enhance the progressive income tax, reconfigure the sales tax so it’s broader but also less burdensome on low-income families, and make sure corporations are paying their fair share.


Needed Reforms

Income Tax Reform – The personal income tax is the state’s largest source of revenue. It is also the best able to grow with the economy over the long term. It is critical that the income tax base upon which the rate is applied – taxable personal income – is broad enough to capture economic activity.

Equally important is preserving our progressive rate structure so that those earning the most are contributing according to their means. We also need to make the income tax more progressive by allowing fewer costly exceptions that disproportionately benefit high-income individuals and profitable businesses.

Finally, strengthening the state’s Earned Income Tax Credit contributes to a stronger economy by putting money in the hands of low-income families, who are more likely to spend those funds on goods and services locally than higher-income families are, further fueling North Carolina’s economic recovery from recession.

Sales Tax Reform – Right now, North Carolina’s sales tax exempts most services from taxation. As North Carolina has shifted from an agriculture- and manufacturing-based economy to a service- and technology-based economy, the sales tax has become less and less effective at capturing a share of North Carolina’s economic activity for public reinvestment. By adding most services to the sales tax, the state can actually lower the sales-tax rate and still raise needed revenue. While expanding the sales tax base alone will disproportionately impact low-income families, who spend a greater share of their incomes on the goods they need to survive than do wealthier families, the negative impact of expansion can be offset by increasing the state Earned Income Tax Credit.

Corporate Tax Reform – There are numerous multi-state and multi-national companies in North Carolina that make millions in profits from business transacted here in North Carolina, but pay very little in taxes toward the maintenance and expansion of the public structures that make their businesses profitable. North Carolina’s tax laws enable these corporations to avoid paying taxes by shifting profits earned in North Carolina to their subsidiaries in other states that have no corporate income tax.

That would end with “mandatory combined reporting.” This much-needed reform would require each parent corporation and its subsidiaries to “combine” for state tax purposes and file a joint tax return, making it far less possible for these companies to shield their North Carolina profits from fair and equal taxation.


Investing in North Carolina’s Future

Increasing fairness in the tax system will also increase revenue, enabling North Carolina to make needed investments in critical public structures that provide the foundation to community well-being, economic opportunity and business success.

When a state has the funds available to make proven investments in education, skills training, well-being and competitiveness, the returns are great. Investments made with tax revenues contribute to greater economic opportunity and higher educational attainment, and they support the expansion and attraction of businesses. The mortar in the foundation of economic opportunity is our collective investment in our communities through taxes.

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