The Future is Now: A Plan to Modernize North Carolina’s Revenue System

April 2011

Executive Summary:

The time is now to modernize the state’s revenue system.

The purpose of the revenue system is to fund investments in the public structures— schools, courts, hospitals, colleges and universities, and infrastructure—that are critical to building and preserving a strong middle class and a 21st century economy, but North Carolina’s revenue system is failing the people of the state.

While the Great Recession directly caused the collapse in state tax revenues, it is not the reason why now, with the state’s economy growing once again, state revenues remain below pre-recession levels. Responding to the current fiscal crisis through a shortsighted, cuts-only approach—and ignoring the fundamental problems with the state’s revenue system—will do nothing for the sound long-term fiscal stewardship of the state’s public structures.

The state’s current revenue system fails to meet the three key principles for responsible tax policy – equity, adequacy and stability. North Carolina’s revenue system:

• Is inequitable because it asks more from those with the least ability to pay and asks the least from those with the greatest ability to pay,
• Is inadequate because state revenues are insufficient to meet the needs of the state’s people and fail to grow with the economy except during boom times,
• Is unstable because numerous exemptions and loopholes make revenues more volatile in the face of ups and downs in the economy.

North Carolina’s revenue system is outdated and narrow:

• North Carolina’s revenue system was built for the economy of the 1930s and no longer fits our 21st century, service-based economy.
• North Carolina’s tax code is riddled with tax exemptions, deductions and giveaways. The result of this “tax-code spending” is that while North Carolina’s tax rates are typically near or slightly below the national average, state tax

Comprehensive revenue modernization entails reform of the four pillars of North Carolina’s revenue system: the personal income tax, the sales tax, business taxes, and “tax-code spending.”

• Broaden the personal income tax by using adjusted gross income instead of federal taxable income (improve stability and equity). Adopt a more progressive rate structure, convert deductions to credits, and double the value of the state Earned Income Tax Credit (improve adequacy and equity).
• Broaden the sales tax to include services taxed by any other state in the US; reduce the state and local sales tax rates (improve equity, adequacy, and stability).
• Level the playing field in business taxes by enacting mandatory combined reporting for corporate income taxes, treating Limited Liability Companies like other businesses, and eliminating ineffective business subsidies (improve adequacy and equity).
• Enhance accountability and transparency of tax-code spending (i.e. tax expenditures) by adopting a formal evaluation of existing tax-code spending and incorporating new tax-code spending proposals into the state budget (improve equity, adequacy, and stability).

Altogether, the components of the BTC Revenue Modernization Plan would raise more than $1.3 billion in revenue in the next fiscal year, preserving many of the critical public investments threatened by inadequate state revenues next year and beyond.

If these proposals were adopted, North Carolina would have a 21st century tax structure that reflects the nature of today’s economy and produces the revenue required to meet the growing needs of a growing state, allowing continued investment on necessities that