North Carolina Income Tax Reform and Proposals
Eleven states enacted laws to reduce income tax rates this year, in most cases associated with other structurally sound tax reforms. If North Carolina state senators get what they want, their state will be the twelfth – and possibly the largest yet.
On June 10, 2021, the North Carolina Senate passed Bill 334 with its own amendments. As amended, the bill would phase out corporate income tax, reduce the personal income tax rate, increase the standard deduction and the child deduction, and simplify the tax base for deductibles, among other changes. If passed as is, after the changes are fully implemented, North Carolina’s already competitive ranking on the State business climate index– a measure of state tax structure – would drop from 10th to 5th overall, making it the highest ranked among states that levy personal income tax.
Over the past decade, North Carolina’s tax structure has improved dramatically through a series of tax reforms that began in 2013 and were strengthened in subsequent years. To understand the importance of the reforms envisaged this year, it is important to first place them in their historical context.
North Carolina’s corporate tax rate, once the highest in the Southeast, is now the lowest in the country at 2.5%. The corporate tax base, once riddled with exemptions, is now known to be relatively neutral after the reduction in incentives. Personal income tax has been transformed into a competitive flat-rate tax, while franchise tax liability has been reduced and the sales tax base has been modernized to apply to a more wide range of consumer services. As a result, North Carolina experienced the most dramatic improvement in Index ranking that a state has never experienced, dropping from 41st to 12th in just one year.
In the years that followed, North Carolina experienced a noticeable improvement in its economic growth. Previously, North Carolina lagged behind other states, recording only 1.8% real GDP growth in the seven years leading up to reforms, well below the national average of 5.6 % at the time. In the seven years since the reforms, North Carolina’s GDP grew 9.5%, exceeding the national average of 9%.
If further reforms of corporate income tax, personal income tax and franchise tax are implemented, as foreseen in HB 334, the strong economic growth trajectory of the State is expected to continue.
Most notably, phasing out the already lowest corporate tax in the country, as HB 334 would do, would benefit North Carolina employees and consumers. Dollar for dollar, reducing and ultimately eliminating corporate income tax is one of the most growth-friendly tax policy changes North Carolina policymakers could make, not having equal to the repeal of the state’s aggressive franchise tax (capital stock). While the legal impact of corporate income tax weighs on corporations, the economic impact spills over to workers in the form of lower wages, shareholders who see a lower return on investment, and customers confronted at higher prices. The abolition of corporate tax would have the opposite effect.
Under HB 334, the state’s 2.5% corporate tax rate would be reduced by 0.5 percentage points per year, starting in 2024 and phased out by 2028. Over the course of l Fiscal 2019 North Carolina corporation tax generated $ 836 million, or less than 3%. tax revenue from the general state fund. Compared to most other sources of income, corporate tax is not only more damaging economically, but it is also notoriously volatile, which poses challenges for state forecasters to anticipate the revenues that they will expect. ‘it will generate in a given year. Reducing and ultimately eliminating dependence on such a volatile source of revenue would make government tax revenues more stable over time.
However, some House Republicans have proposed prioritizing franchise tax reform over corporate tax reform, which could prove to be even more beneficial as the tax on franchises. deductibles – discussed below – are imposed regardless of ability to pay, and in particular taxes on investments in the state.
In addition to phasing out corporate income tax, HB 334 would reduce the state’s personal income tax rate from 5.25% to 4.99%, effective January 1, 2022. This change would benefit all taxpayers, since North Carolina is one of 9 states that levy a single-rate personal income tax on income from wages and salaries. A single rate structure promotes neutrality by treating every dollar of taxable income equally, which is favorable over graduated rate structures which reduce the gain of working at the margin.
As of January 1, 2021, North Carolina’s personal income tax rate of 5.25% was lower than the highest rates in all but 13 states that levy personal income tax on income wages. However, with 10 states enacting laws this year to reduce their personal income tax rates, the state tax landscape is quickly becoming more competitive. States that do not respond risk falling behind.
In addition to reducing the personal income tax rate, HB 334 would make both the standard deduction and the deduction for children more generous. The standard deduction would increase from $ 10,750 to $ 12,750 for single filers and from $ 21,500 to $ 25,500 for joint filers, while the deduction for children would increase by $ 500 per eligible child, from $ 2,500 to $ 3,000. In addition to making the deduction more generous for those who already receive it, the bill would expand eligibility for the deduction by increasing the income threshold at which taxpayers can claim it (from $ 60,000 to $ 70,000 for tax filers. singles and $ 120,000 to $ 140,000 for married couples joint filing).
While the reduction in the personal income tax rate alone would benefit taxpayers at all income levels, the proposed increases to the standard deduction and the child deduction would remove the additional income from the base entirely. tax, providing additional relief to taxpayers at the bottom of the income scale. spectrum.
Another notable reform of HB 334 is the simplification of the state franchise tax base. Currently, North Carolina is one of 16 states to impose a franchise tax, also known as the capital tax. Unlike corporate income taxes levied on a corporation’s net income, franchise taxes are levied on a company’s wealth, generally defined as equity (with some adjustments). Capital tax is essentially a tax on investment in a state, which makes it more economically damaging than many other types of tax. By taxing companies on their net worth, capital taxes discourage investment in the state and the accumulation of assets, favoring profit taking over investment and business growth. Franchise taxes can be especially onerous for new businesses, capital-intensive businesses, and struggling businesses, as they are payable even when businesses are showing losses or barely breaking even. As a result, many businesses have to tap into their precious cash flow to pay the tax.
Under current law, North Carolina franchise tax is levied on the greater of three bases: (1) the equity of the business allocated to North Carolina; (2) 55 percent of the appraised value of all government movable and immovable property; or (3) the company’s total investment in tangible assets in the state. Under the three bases, tax is collected at a rate of $ 1.50 for every $ 1,000 of the tax base, with a minimum of $ 200 to ensure payment even by low net worth businesses. HB 334 would reduce complexity by eliminating everything except the first basic option. This change would also reduce the franchise tax liability for some businesses that own a significant amount of real and tangible personal property in North Carolina despite having low equity. A tax note for an earlier version of the bill estimates that this change will reduce the collection of franchise taxes from $ 150 million to $ 170 million per year.
In addition to these structural reforms, HB 334 would appropriate up to $ 1 billion in federal aid under the American Rescue Plan Act (ARPA) to provide grants to companies that have suffered economic harm due to of the pandemic. Eligible businesses would be eligible for grants of up to $ 18,750.
HB 334 would also allow intermediary companies to choose to be taxed at the entity level in order to circumvent the $ 10,000 federal and local tax (SALT) deduction limit that was adopted under the Tax Cuts and Jobs Act (TCJA) of 2017. Although intended to reduce taxes on unincorporated businesses, intermediary businesses were never intended to be taxed at the entity level; by definition, their business income was designed to “flow” into the owners’ personal income tax returns. An entity-level tax would introduce additional complexity and non-neutrality into the tax code, undoing some of the progress that has been made in simplifying the tax code and making it more neutral.
Overall, however, the reforms proposed by HB 334 regarding corporate tax, personal income tax, and franchise tax would further strengthen North Carolina’s position as leader. leader of a sound fiscal policy and as a State whose tax code is one of the most conducive to generating long-term economic growth.