Tax reforms passed by the General Assembly in 2013 are being credited for helping North Carolina make a substantial one-year jump in economic competitiveness.
The Tax Foundation, a nonpartisan, pro-business Washington think tank, said in a report released Tuesday that it ranked North Carolina 16th in tax business climate for its 2015 index, up from 44th in 2014. It is the group’s 11th annual report.
The ranking is based in five tax categories: corporate, individual income, sales, unemployment insurance and property.
“A state’s ranking can rise or fall significantly based not just on its own actions, but on the changes or reforms made by other states,” the group said.
The group said North Carolina made the largest ever one-year ranking upswing. However, it was not an unexpected jump since the group projected in October 2013 that tax reforms would “transform one of the worst tax codes in the country into one of the best.”
“While other states might reform one or two elements of their tax code, North Carolina leapt over 28 states by passing reforms on corporate, individual and sales taxes,” Scott Drenkard, the group’s economist and manager of state projects, said in a statement. “This level of reform – both in scope and craftsmanship – is rare.”
Reforms included: reducing the individual income tax from a top rate of 7.75 percent to a flat rate of 5.75 percent by 2015; a higher standard deduction for all taxpayers; a reduction in the corporate tax rate from 6.9 percent to 5 percent by 2015; and repeal of the estate tax.
If the corporate tax rate does drop to 5 percent, it would go from the highest to the lowest in the Southeast. The rate could drop as low as 3 percent in 2017 if the state meets revenue targets that depend significantly on tax revenue increasing in a growing economy.
Gov. Pat McCrory and Sen. Phil Berger, R-Rockingham and Senate majority leader, touted the higher ranking as more proof that their controversial reforms are bolstering the state’s economy.
Some Republican legislators say the lower corporate tax rate should over time make North Carolina more attractive to businesses wanting to open or expand operations. That, in turn, could allow the state to reduce its participation and dependence on large economic incentive packages over time.
However, the legislature’s chief economist said in an Oct. 14 report that state revenues were $62 million below expectations during the first quarter of fiscal 2014-15 compared with a year ago. By comparison, the state budget is $21.1 billion for the fiscal year.
Critics of the tax reforms said they benefit the highest wage earners at the expense of shrinking revenue that could be used for higher teacher pay and infrastructure improvements, according to The Associated Press. There was a $450 million gap between revenues and planned spending in fiscal 2013-14.
According to analysts, the corporate income tax touches a subset of businesses, namely C corporations, which tend to be larger, multi-state companies with publicly traded shares. Analysts estimate the tax reduction could cost the state about $350 million in annual revenue.
“The Tax Foundation ranking is based on the structure of state tax codes, not changes in revenue collections due to differences in economic growth,” said John Hood, president of the right-leaning John Locke Foundation. “So the entire improvement in North Carolina’s ranking is attributable to the 2013 tax reform legislation.
“To the extent that state policy influences job creation and income growth, states with less burdensome tax codes do seem to prosper more than states with higher tax rates.”
That said, Hood said it is “simply too early to judge the economic effects of the 2013 tax reform.”
“North Carolina’s improvement in the business tax climate will likely pay significant dividends over the coming years, somewhat because of stronger business recruitment, but mostly because of higher rates of in-state investment and entrepreneurship. That’s where most new jobs and gains in living standards will come from.”
Hood said North Carolina could climb into the ranking’s top 10 if the state is able to allow the corporate tax rate to continue to decline. “Reducing the double-taxation of investment returns, such as dividends and capital gains, would help,” he said.