Fiscal Commission eyes business taxes

State, local tax burden below national levels

• Presentations from the commission meeting

By Rebecca Troutman
Intergovernmental Relations Director

The State and Local Fiscal Modernization Study Commission met Feb. 20 for the first time in almost 10 months with a look back and a look forward.

Cindy Avrette of the General Assembly’s Research Division reviewed the commission’s findings and recommendations to the 2007 Legislature and subsequent reactions to those findings.

Avrette began her presentation by noting that the makeup of the commission itself was unusual, given the number of local government officials appointed to the commission, along with business, state and legislative leaders. The commission had several findings: an insufficient yet complicated local and state tax system; relatively high individual and corporate income tax rates; too few local government revenue sources; and burdensome Medicaid costs.

As a response to these findings, the commission recommended general guidelines to the General Assembly, urging its members to “avoid making changes that are inconsistent” with them. Recommendations included broadening the income and sales tax bases, lowering tax rates, reducing the number of low-income taxpayers, and finding a long-term Medicaid solution and greater revenue flexibility for local governments.

Specific to the Medicaid guideline was a commission recommendation calling for the state to “assume responsibility for the nonfederal share of Medicaid costs, excluding administrative costs. The shift in responsibility should be accompanied by a shift in funding sources or by the state identifying new funding sources.”

Avrette then reviewed the legislative action underlying the state assumption of county Medicaid costs. Likewise, the commission’s recommendation, which urged the state to “provide greater flexibility to city and county governments with respect to how they raise revenue by allowing a menu of options,” was partially enacted through the special budget provision that authorized counties to levy either a 0.4 percent land transfer tax or a quarter-cent sales tax, if approved by voters.

A commission recommendation to provide property tax relief for low-income elderly and to allow more frequent property appraisals – including annual appraisals – also met with partial legislative enactment through an increase in the homestead exclusion income level and the creation of a senior citizen circuit breaker program.

Commission recommendations directed at the state tax structure also saw incremental progress. The General Assembly let the upper income tax bracket expire and created a refundable state earned income tax credit. Instead of expanding the sales tax base to include services, the Legislature enacted additional sales tax exemptions, largely to encourage specific economic development.

Dr. Bill Fox, professor of economics and director of the Center for Business and Economic Research at the University of Tennessee, presented his national research on business taxes, noting that North Carolina relies more heavily on individual income taxes (46 percent of state tax collections vs. 34.6 percent nationally) and less on general sales taxes (24.4 percent state vs. 32.1 percent nationally). While North Carolina’s corporate income tax collections are slightly below the national average, Fox decried corporate income taxes as a poor mechanism for taxing those who benefit from governmental services because they tax only those that are profitable.

He then outlined some alternatives for taxing business, with the newer forms implemented to offset a shrinking corporate tax base, brought about by state and federal policy changes along with corporate “tax planning” strategies to minimize these taxes. To counteract “tax planning,” he suggested that the state examine combined reporting so that the entire corporate entity is considered. This combines loss and profitable entities, limits transfer pricing, and accounts for shared overhead costs and vertical integration.

Fox concluded his remarks by comparing corporate income tax with gross receipts tax, which can provide a larger base, a sizeable revenue potential and more stability.

Andrew Phillips, a senior manager in the Quantitative Economics and Statistics group of Ernst & Young, LLP, presented his firm’s analysis of total state-local business taxes.

Nationally, business taxes account for 45 percent of total taxes collected by state and local governments. Property taxes accounted for the highest proportion of business taxes at 37 percent, while general sales pulled in 22.5 percent, and corporate taxes generated 9 percent. In North Carolina, business taxes accounted for 37 percent of total state and local tax collections, as companies faced lower property and sales taxes than their national counterparts.

Property taxes for North Carolina businesses did account for the highest proportion of business taxes at 31 percent. Regionally, North Carolina businesses pay a smaller share of total state and local taxes in all southeast states, excluding Maryland. When comparing regional effective tax rates as a percentage of gross state product, North Carolina’s 3.9 percent rate tied with Virginia for the lowest effective rate.

The commission concluded its meeting with a brief discussion of future agenda items. It was the general consensus of the group to delay its next meeting until after the November elections.