Are North Carolina’s falling tax rates responsible for the state’s economic growth? Or is the state not bringing in enough revenue to adequately fund public schools?
Has the legislature relieved working families of an undue tax burden? Or have Republicans kowtowed to corporations and millionaires?
Ahead of the contested 2018 elections, both Republicans and Democrats are trying to make their cases about North Carolina tax policy.
The GOP-controlled state legislature has spent half a decade slashing tax rates for individuals and corporations. It’s not over yet: Tax rates for both individuals and companies will be falling again for 2019.
While other states that have tried this (like Kansas) have struggled to fund basic services, overall state government revenue has actually increased in North Carolina. As conservatives see it, this is a huge success.
But Gov. Roy Cooper and other Democrats are arguing that lowering taxes is preventing the state from spending more money on public education and other priorities.
Here’s a just-the-facts explanation of what’s happened.
How North Carolina brings in money.
Though some states1 have no personal income tax, North Carolina brings in the bulk of its revenue through this mechanism.
Every state has its own funding mixture for state government. In exchange for higher personal income taxes, North Carolina has a sales tax rate and property tax rate on the lower end of the spectrum nationally.
Here’s the same info in a slightly different format, from the General Assembly’s nonpartisan Fiscal Research Division.
And then for the flipside, here’s where the money goes.
Since 2013, personal income tax rates have fallen dramatically.
With the General Assembly Democratic control, North Carolinians paid a personal income tax rate that varied based on income but ranged between 6% and 8.25% between the tax years 2001 and 2012.
That changed after Republicans took power starting after the 2010 elections. The party passed a series of tax reforms that collapsed the tax brackets, reduced the personal income tax rate and expanded sales taxes.
A major compromise between then-Gov. Pat McCrory, Senate President Pro Tem Phil Berger and then-House Speaker Thom Tillis got the ball rolling. The resulting 2013 law took reduced the tax rate to 5.75% over two years2
Starting in the 2014 tax year, the tax rate became 5.8% for income across the board.
That inched down to 5.75% for 2015 and it remained there for 2016.
The General Assembly has used the last two long session budget bills to reduce the personal income tax rate further.
The 2015 budget bill took the next step, lowering the tax rate to 5.499% starting in 2017, where it remains this year.
In 2019, the personal income tax rate will fall again to 5.25%, thanks to the 2017 appropriations act.
Because wealthier people pay more money in taxes, tax rate reductions disproportionately help them. A 1% rate difference on somebody with $250,000 in taxable income is a larger dollar amount than a 1% rate difference on $50,000 in taxable income. This is the main way some Democrats and Gov. Roy Cooper have criticized the tax reduction plan.
Republicans note that a greater percentage of North Carolinians pay no tax at all, and tax breaks mean a lot to middle-income people.
Corporate tax rates have plummeted, too.
In 2002, the corporate income tax rate in North Carolina fell to 7.5%, and over the next few years gradually inched down to 6.9%.
Similar to the personal income tax rate, the General Assembly gradually reduced that rate in three separate actions.
In the 2013 compromise, the tax rate was cut to 5%. It then went to 4% in the 2015 budget and 3% in 2017.
The legislature has used total state government revenue triggers to lower the corporate tax rate — only reducing taxes if a similar amount of revenue is brought in.
Since that is still happening, the corporate tax rate is expected to hit 2.5% next year.
This gives North Carolina one of the lowest corporate income tax rates nationally.
The North Carolina GOP has frequently cited the lower corporate tax rate as a reason why the state’s economy is booming and companies are deciding to move and expand here.
Gov. Cooper, however, says it’s because of the state’s educated workforce — something he says lowering taxes puts in jeopardy by not spending more on public schools and universities.
Sales tax rates fell, but now apply to more things.
These broader tax rate reductions were only workable by overhauling the sales tax structure.
Interestingly, in July 2011, the state sales tax rate actually decreased, from 5.75% to 4.75%. That’s where the rate has stayed since then.
But starting in 2016, the tax overhaul expanded sales tax collections to categories like personal services, car repairs that in the past hadn’t been taxed.
Overall sales tax collections have risen, from $5.9 billion in the 2011-12 year to $8.1 billion in 2016-17.
The actual sales tax you pay varies widely by county, since county boards of commissioners are able to levy different taxes with public support. See a county-by-county listing here.
The lowest-income people don’t generally pay income taxes but they do pay sales taxes on everything they buy. The argument here is that the tax plan is regressive because it shifts more of the tax burden to poor people in this manner.
What’s been the effect on revenue?
The biggest danger in lowering tax rates is that government will have to make draconian cuts to services people rely on. That’s what happened in Kansas, and led that state’s legislature to bump taxes back up.
So far, this has not happened in North Carolina.
North Carolina’s legislature has made this happen by phasing in tax reductions over multiple years and only promising corporate tax rate cuts if revenue targets are met.
There is some concern that the tax rate cuts won’t be sustainable. Projections last year from the state legislature’s Fiscal Research Division indicated that the state could face shortfalls in the coming years.
Of course, this assumes a pretty steady 4% increase in the growth of government, which General Assembly leaders push back on.
Revenue projections have consistently fallen short of actual state government income for the past few years, to the tune of hundreds of millions of dollars.
A constitutional amendment is likely coming next.
Senate Bill 75 would create an amendment to the state constitution capping North Carolina’s personal income tax rate at 5.5%.
That’s roughly equal to this year’s tax rate, and above the 5.25% it’s headed to next year.
The bill passed the N.C. Senate last year and is cruising through House committees currently. It just passed the powerful House Finance Committee and appears headed toward ratification.
Enshrining tax rates in the constitution isn’t as crazy as it sounds. North Carolina’s constitution already has a provision limiting tax rates to 10%. The amendment would simply lower a rate that’s already in there.
Such a constitutional amendment is more of a hedge against Republicans losing power in the future than it is necessary fiscal policy. Opponents also argue that it prevents the General Assembly from using all the levers at its disposal should economic conditions change.
There is a core philosophical difference at play here.
And it raises plenty of core questions that voters will be deciding on once again this fall.
Does North Carolina want to be a high-tax, high-spending state? Is North Carolina’s government operating efficiently, or does it need more cash? How should the state think about return on investment? Does it make more sense to emphasize income taxes or sales and consumption taxes?
And to go even deeper: What’s the overall goal of state government? And whose money is it first, the people’s or the government’s?