House offers broad tax cut
If reforming North Carolina’s tax code were easy, one of the many tax-reform efforts of the past 20 years would have succeeded. Didn’t happen.
There isn’t just one obstacle to tax reform. There are many. For starters, at the macro level there is a lack of political consensus about the goal. Is it to raise additional revenue for government? To foster economic growth? To reduce complexity? While some politicians espouse them all, these goals often conflict.
At the micro level, every special deduction or loophole has a special-interest defender. Take the example of the income-tax deduction for mortgage intereswt. It disproportionately benefits wealthy taxpayers who invest their savings in large houses rather than securities or productive capital. Most North Carolina households don’t itemize, which means they can’t claim the interest deduction, and most of the 23 percent of N.C. households who do take the deduction reduce their tax bill only slightly.
Clearly, most North Carolinians would pay lower taxes under a reform that capped or eliminated the mortgage deduction in exchange for lower tax rates. The result would be higher economic growth and no appreciable change in homeownership (the mortgage-interest deduction mostly affects the size of homes bought by wealthy households). Yet the real-estate lobby has fended off this common-sense reform for decades by skillful lobbying and public relations.
Yet another obstacle to tax reform is misinformation. Many journalists, activists and self-styled experts do an atrocious job of explaining tax issues to the public. For example, they fail to distinguish between tax deductions or exemptions that pick favorites or reward special interests (e.g., mortgage interest) and tax deductions or exemptions that are necessary to define the tax base properly so government doesn’t pick favorites (e.g., deductions for the cost of generating future income).
As the North Carolina Senate and House approached the task of reforming the state tax code, they faced these and other obstacles. The two chambers responded differently. While agreeing on the macro goals – economic growth and simplification – they disagreed at the micro level. The Senate decided not just to take on special-interest preferences in the income tax but also to broaden the sales-tax base dramatically, thus adding dozens of other interest groups to the coalition opposing its plan. The House decided to do much less to the sales-tax base, thus accepting somewhat-higher marginal tax rates on savings and investment in order to improve its chances of running the legislative gauntlet and getting a bill enacted.
Another way the two tax bills differ is how they affect households of low-to-moderate incomes. According to a tax calculator attached to the Senate plan, it has the effect of raising the overall state tax bill for many households at or below $40,000 in income, particularly those with multiple children. This effect occurs primarily because of the Senate’s expansion of sales tax to many currently untaxed goods and services, including food.
The House tax bill avoids this problem and thus produces broader net tax relief. According to a just-released analysis of the bill by the legislature’s nonpartisan fiscal staff, more than 80 percent of North Carolina households would pay less state tax under the House plan than they currently do, including all households below $40,000 in income, all singles, and all heads of households. Only a small number of married couples would see a net tax increase, ranging from $9 to $43 a year depending on income. Even for them, the benefits of simpler taxation and faster economic growth would more than offset their small cost.
Gov. Pat McCrory has already indicated his preference for the House approach, which would result in a 5.9 percent flat tax and a tax code friendlier to investment and job creation. Admittedly, the road to successful tax reform remains littered with political obstacles. Both Senate and House leaders deserve praise for daring to traverse it. Now they just need to work together to get to the destination — and North Carolina taxpayers need to root them on.
John Hood is president of the John Locke Foundation.