North Carolina’s Current Tax System

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North Carolina’s current tax system

Before exploring possible solutions that address our state’s revenue challenges, it is important to understand the underlying causes of our tax system’s problems.

Lack of Balance Among Tax Revenues

In order for states to have steady, constant revenue bases, it is important that tax revenues come from diverse sources, such as the personal income tax, corporate income tax, and the sales tax. Over time, North Carolina has come to depend heavily on the volatile personal income tax as our main source of tax revenue (See charts below. Note: Corporate Income Tax (CIT) and Personal Income Tax (PIT)).

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This system proves to be inefficient especially during a recession when fewer people are working and contributing to the tax base at the same time that demand for services increases. As a result, our government is forced to make harsh budget cuts, and sometimes raise taxes to make up for loss in personal income tax revenues.

Erosion of the Sales Tax Base

Like many states, North Carolina’s sales tax system was designed in the 1930s for an economy where most spending was on tangible things, like cars and clothing.  We now spend our money on services, most of which are not subject to the sales tax, such as car repairs, doctors visits, and live entertainment. North Carolina currently taxes less than one-fifth of all services, below average compared to other states (see below).

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This shift in spending habits is one reason why sales tax revenues are a smaller share of total state revenue.  Unfortunately, as households spend less of their budgets on taxable items, we’ve had to raise sales tax rates on the items we do tax—just to maintain sales tax revenue levels.  Continuing to rely on ever increasing sales tax rates  is not fair to producers and consumers of these products.

Solution

In order to address these problems, North Carolina must adopt a solution that is comprehensive. To reduce the dependence on the personal income tax, North Carolina should broaden the sales tax base to include more services, and lower the sales tax rate.

Effective responses to boost long-term competitiveness will likely require targeted and sustained investments of public and private resources over time. Our current systems of public finance at the state and local levels are outdated and ill suited to meeting these needs. A system that allocates adequate resources to high priority areas despite the inevitable ups and downs of the economic cycle is crucial.

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Expanding the sales tax base to include services would bring
a variety of important benefits

  • A more stable source of tax revenue, one that wouldn’t fall precipitously in a recession;
  • A fairer tax system that no longer discriminates against producers of goods;
  • Growth in revenues that better match the growth of our economy; and
  • A reduction in the sales tax rate

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