Tax Reform Coming to NC?

Today’s joint meeting of the Senate and House Finance Committees once again focused on reforming North Carolina’s tax code. The oft-repeated goal of the committees is to broaden the base and lower rates; in other words tax more economic activity but do so at a lower rate.

Today’s focus was on North Carolina’s personal income tax, and how the state defines income for tax purposes. Walter Nunnallee, tax professor at NCCU Law School, described how North Carolina uses “federal taxable income” as its basis for taxable income. That means that all of the federal exclusions and deductions the federal tax code uses also apply to North Carolina. But the state does have a smaller standard deduction meaning that slightly more of your income is taxable by the state than by the Feds.

The question, then, is how to broaden the income tax base? The primary way to do so would be to eliminate some of the credits and deductions. For instance, Fiscal Research head Barry Boardman identified 38 state credits and deductions that reduce state tax revenue by $1.2 billion. The largest of these exemptions was the itemized deduction for home mortgage interest, which reduced state revenue by $675 million; and others include gifts to charity, medical and dental deductible expenses and unreimbursed employee expenses.

While there appears to be significant pots of tax revenue to be gained by ending some of these exemptions, the political battle to do so would be brutal. Just imagine the outcry from homeowners and the real estate lobby if state lawmakers proposed ending the home mortgage deduction?

Every deduction, exemption and credit in the tax code was created to benefit a specific group. Powerful lobbyists are employed to protect these carve-outs, making them almost politically impossible to reverse.

If indeed the state did want to offer relief to specific groups or for specific activities, it would be much better to do it through budgetary spending rather than mucking up the tax code. Tax all similar economic activity the same, then if you want to offer relief to homeowners, for instance, send them money. This method would be much more transparent as it would be far easier to detect how much is being spent on these various items through the budget rather than the much more opaque and difficult to track method of tax deduction. Simplifying the tax code would also free up resources currently devoted to navigating the complex tax code – resources that could then be devoted to productive activity.