North Carolina residents could receive a larger personal income tax exemption if the General Assembly’s 2016 short session follows the lead of state Sen. Bob Rucho, R-Mecklenburg, who has led the Senate’s tax reform efforts since Republicans took control of that body.
“During the short session one of my goals would be to increase the zero bracket, which is the standard deduction, and that could be from $15,500 to $17,500,” said Rucho, who has announced he will retire at the end of the current session. “That is treating every income level the same in the sense that that same $17,500 would be state tax-free, but it is extremely beneficial to the middle class.”
The General Assembly raised the exemption for 2016 from $15,000 to $15,500 for a married couple filing jointly, and from $7,500 to $7,750 for single taxpayers.
Allowing workers to keep more of their earnings by increasing the standard deduction “would be very beneficial” for the middle class, and blunt the “unfounded criticisms of the liberals telling us we’re doing this just for the rich,” Rucho said.
Rucho is optimistic that North Carolina will continue moving away from taxing income and toward a consumption-based tax system.
As part of that shift, the General Assembly approved new sales taxes on a variety of repair and installation services that will take effect March 1, and the personal income tax rate is scheduled to drop from 5.75 percent to 5.499 percent in 2017.
“It’s a slow process moving from an income tax-based revenue stream to a consumption-based sales tax on goods and services,” Rucho said.
The income tax is “detrimental to investment, savings, and entrepreneurship, and economic growth overall,” he said.
A consumption tax is “fairest because you only pay tax on what you spend,” Rucho said. “Any type of spending you do is your choice, not [the] government’s choice.” With an income tax, the government decides how much money it will take in taxes, Rucho said.
“Consumption taxes make much more sense for economic growth” than income taxes, said Roy Cordato, vice president for research and resident scholar at the John Locke Foundation. “There’s a different way to go to accomplish the same goal” Rucho seeks.
Cordato was instrumental in developing a consumption-based system known as the Unlimited Savings Account Tax plan, or USA Tax.
That plan would maintain the framework of the income tax system, but remove from the tax base all savings, investment, and capital gains, so that only purchases, or consumption, would be taxed. Cordato said that model avoids sales tax pitfalls.
“A purely sales-tax-based system will require high rates, which will encourage people to buy items both from out of state and online,” Cordato said.
There are “lots of political problems associated with expanding the sales tax base to professionals like doctors, accountants, lawyers, and so on,” Cordato said. “They’ve got 1,000 special interest battles to fight if they keep” adding more taxpayers to the sales tax base.
Business-to-business sales would have to be removed from the sales tax base or else a consumption system based on sales tax would be “riddled with problems of double taxation,” Cordato said.
Still, Rucho said tax reforms implemented under Republican leadership since 2013 are paying off. The state had a $445 million surplus at the end of the 2014-15 budget year, and was $70 million ahead of tax revenue projections from July through October of the 2015-16 budget year.
“That is good and bad,” Rucho said. “The fact that the economy is doing what we expected it to do is good. The fact that there are members of the General Assembly that believe that every dollar should be spent, that’s something that’s going to be a battle.”
Achieving budget surpluses and continuing to move toward a consumption-based tax system “is going to require fiscal discipline,” Rucho said.
While some lawmakers may chafe at voting to expand sales taxes on services, Rucho said there would be “a commensurate reduction” of the personal income tax, “so it’s not like there’s a tax increase despite the critics who will say that.”
“We have gotten good, ongoing dialogue with the General Assembly about tax policy in general, and with Sen. Rucho’s office in particular,” said State Budget Director Lee Roberts. “But it would be premature to talk about any particular proposal.”
While he praised Rucho for being “as knowledgeable and thoughtful about tax policy as anyone in the General Assembly,” Roberts said raising the standard deduction is not as simple as it might sound.
“You can’t opine on one aspect of tax reform without understanding how it fits into the broader whole,” Roberts said. “There are a lot of merits to raising the standard deduction, but there’s a process associated with that too. So we need to look at tax reform in the short session as a whole, and see what makes sense.”
He said the McCrory administration supports decreasing dependence on income taxes, “and you’re seen significant progress in that regard already.” It makes sense to move away from income taxes because they are more volatile, and more likely to be affected by ups and downs in the economy, he said.
Senate Minority Leader Dan Blue, D-Wake, and House Minority Leader Larry Hall, D-Durham, did not respond to requests for comment.
“There are a lot of economists that believe a consumption-based system is far better for economic growth. There’s some political downside to taking that approach, but overall I think it’s something that the state ought to explore,” said Brandon Arnold, executive vice president of the National Taxpayers Union.
“It’s difficult sometimes to raise sales taxes, which is often the way people go about it, but I think it’s a plausible way of increasing growth,” Arnold said.
House Rules Committee Chairman David Lewis, R-Harnett, said “we’re absolutely moving in that direction.”
He said the one area of caution “is to make sure that we do not disproportionately hurt the lower-income earners.” The way to do that is by expanding the standard deduction, and ensuring that those who earn less than certain incomes would pay no taxes.
“We believe that what someone truly consumes is what should be taxed,” Lewis said.
Savings, investments, education expenses, and charitable giving would not be taxed in his preferred version of a consumption tax, which he called “a logical step” as the economy becomes more reliant on a service-based society.
“I just believe it’s the will of the Senate and the House Republican caucuses to get to the point where hard work, and advancing yourself in life is not penalized” by taking taxes on earned income, Lewis said.
Savings and investment are “an important part of building a strong society,” Lewis said. Consumption “is the true way to tax to least inhibit people from wanting to advance up on the income spectrum.”
Dan E. Way (@danway_carolina) is an associate editor of Carolina Journal.