WRAL Investigates

Closing tax 'loopholes' could be painful for all

Posted December 14, 2012
Updated December 17, 2012

— It was one of the few lines that got nods from both Republicans and Democrats on the campaign trail this year.

"We should also look to close tax loopholes," Gov.-elect Pat McCrory said during the primary when The Associated Press asked him about plans for sparking the state's economy. "Republicans and Democrats need to put politics and special interests aside and work together for the creation of a more fair and modern tax code which rewards productivity, innovation and creates jobs."

That pitch would have been at home in the stump speeches of Democrats and Republicans alike.

So, who are all these freeloading loophole users? Are we talking about big corporations and wealthy individuals with slick accountants?

To some extent, yes. Few of will us will take advantage of tax breaks on flight simulators or worry about levies on commercial logging equipment.

But if you're looking for those who take advantage of some of the costliest exemptions in the state tax code and could end up paying more under any reform effort, take a long, hard look in the mirror, North Carolina.

Every two years, the Department of Revenue publishes a list of "tax expenditures, which are discounts, exemptions and alterations from the income, sales and other taxes people and companies would normally pay.

All those breaks ad up to $9 billion. That's equal to roughly half of what North Carolina spends in state-raised revenue every year. It's a tempting rhetorical target, considering collecting even half that money would allow the state to lower tax rates, sock away savings for a rainy day and have a cushion for when tax reform takes hold in earnest.

But the five costliest exemptions on that list are not handouts to industry. Rather, they are deductions taken by nearly anyone who files a tax form and some who don't:

  • Standard and itemized income tax deductions (total value: $2.3 billion)
  • Personal exemption on income tax ($2.2 billion)
  • Sales tax on groceries for home consumption ($662.1 million)
  • Sales tax on prescription drugs and insulin ($464.7 million)
  • Income tax exemption on certain government retirement income ($428.8 million)

Added up, that's $5 billion in tax breaks that pretty much every man, woman and child in the state take advantage of on a fairly regular basis.

tax reform Closing tax loopholes could cost you

"I'd hate to run for office on the platform that I'm going to do away with charitable giving as a deduction, and too bad if you got sick this year, we're taking away that deduction," said Douglas Shackelford, Meade H. Willis Distinguished Professor of Taxation at the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill.

You'll find a similar list of popular benefits, such as the mortgage interest tax deduction, in the federal tax code and similar types of rhetoric coming from would-be federal lawmakers.

Just as Congress is wrestling to reform an unwieldy federal tax code, state lawmakers are trying to navigate the political and economic pitfalls that come along with making North Carolina's tax code simpler.

Part of the problem with any tax reform effort – and there have been at least seven in North Carolina over the past 25 years – is the reality of doing away with "tax expenditures" requires the slaughter of sacred cows. Many of those deductions, credits and exemptions developed as a way to make the tax code more equitable and take into account different groups of people's ability to pay.

"If you've got five kids, maybe you're in a different position than someone who doesn't have any kids. If you're married, maybe you're in a different position than if you're taking care of an elderly parent or if you're blind," Shackelford said. "It's all an attempt, rough as it may be, to try to get some fairness."

In other cases, breaks are relatively new, crafted by the people now in charge of tax reform. For example, a business income tax deduction created in 2011 will allow small businesses to deduct $50,000 in income from their liability. The Department of Revenue estimated this break will costs the state $131.6 million a year, but other estimates are three to four times higher. Its exact value probably won't be known until next April or May, when final tax returns for 2012 roll in.

Another problem for those seeking to eliminate exemptions, particularly sales-tax exemptions, is "cascading."

This effect occurs when the raw materials used in production are taxed. For example, packaging bought by manufacturers is exempt from sales tax. The logic is that the end-consumer will ultimately pay sales tax on the cost of that item, and if a manufacturer pays sales tax on a cardboard box, that extra cost merely gets passed on to a consumer. Eliminating exemptions for such business-to-business transactions could increase the price of consumer goods.

"If I could figure out to get rid of sales tax for all business-to-business transactions, I'd win a Nobel Prize," said Sen. Bob Rucho, R-Mecklenburg, who is one of the lawmakers leading this year's tax reform push.

Rucho said any successful tax reform plan would likely apply sales taxes to more items, including services that are not taxed now and some transactions that currently enjoy exemptions. He acknowledged that stamping out those loopholes would likely provoke push-back from those industries which would have to begin collecting taxes.

"This could turn into the lobbyist full-employment act," Rucho joked.

Clearly, just eliminating the smaller, quirkier breaks won't get the state very far. Charging excise tax on the sacramental wine bought be churches, for example, would recoup less than $100,000 per year. Revoking a $250 annual credit for firefighters would claw back only $300,000. Outdoor historical dramas Bread, wine, oysters: NC's odd tax loopholes

But the more money a particular exemption brings in, the harder an industry can be expected to fight for it. Consider the list of items are tax exempt if they are sold to farmers:

  • horses and mules
  • farm machinery, related parts and lubricants
  • fertilizer and seeds
  • fuel used for farm purposes
  • electricity sold to run farm equipment
  • containers and storage facilities
  • feed, litter and medication
  • pesticides
  • tobacco farming items

Taken together, those breaks add up to nearly $250 million in tax-exempt sales every year.

"The farming community would like to be supportive of whatever is proposed," said Peter Daniel, the assistant to the president of the North Carolina Farm Bureau. "But the issue becomes, the farm economy is fairly fragile."

Any tax reform efforts that pile more costs on farmers, Daniel said, could drive some out of the business.
Farmers are different from manufacturers, he said, because they can't just raise the price they charge for a product. Commodity prices are set on trading markets, so an extra tax comes out of the farmer's bottom line.

The Farm Bureau is one of the most influential lobbies at the General Assembly.

Similarly, virtually any tax loophole slated to be closed is likely to have its own defender. Automobile dealers, for example, have opposed efforts to fully apply sales taxes to car sales. The film industry professionals in Wilmington and Winston-Salem say credits for productions are needed to lure big Hollywood pictures to the state.

But making sure that everyone is treated as fairly as possible is key to the tax reform effort, Rucho said. Creating loopholes for one industry will cause others to ask for their own exemption.

"Everybody should be treated the same," he said.

If reform goes forward, that could end up meaning everyone pays a little more in sales tax. The question for many will be if the larger tax reform effort can offset those increases.

23 Comments

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  • driverkid3 Dec 19, 9:34 a.m.

    bill0, try this: cut ALL benefits to illegal aliens, cut child tax credits, do an investigation on those getting benefits and make doubly sure they are not gaming the system. There are some out there that game the system EVERY DAY and laughingly BRAG about it. Close some of these state offices that are duplications, cut the salaries by 15% at least of the governor and other top ranking officials. Do this untill we get back on an even keel.

  • Rebelyell55 Dec 18, 8:58 a.m.

    It will be painful for all but those elected officals and excutive group in state. They're the ones who'll use you tax dollars to cover their expense.

  • niall Dec 18, 8:53 a.m.

    "Here's a wild idea. How about anyone who proposes spending cuts needs to spell out exactly what is going to be cut?"

    First, a 10% cut across the board, sparing nobody's sacred cows. Second, goodbye to subsidies for businesses, farmers and anybody else. Third, put all departments on a zero-based budgeting and make them justify their cost every year.

    That's where I'd start. Of course, neither Democrats or Republicans are remotely serious about making the hard choices required to fix the special-interest-seasoned legal spaghetti that we call a tax code, so expect it to get worse not better until it all collapses under its own weight.

  • offthegrid7165 Dec 18, 8:38 a.m.

    Why don't we simply have 100 or 200 students in each class while we are at it? Imagine how much money that will save the state. westernwake1

    Indeed. All the major colleges across the nation already do that... and they are making a killing! Touch of sarcasm there.... but nevertheless true. Of course, this will not work in public school for a number of reasons.... I can remember growing up in NC and attending grade, middle, and HS with 30+ students in class... and can tell you hands down... we performed as well as today's kids.. and of course, that was with extra activities and holding down various jobs to help out mom and dad. The last two generations have poor understanding of responsibility and have developed an attitude of entitlement.

  • westernwake1 Dec 17, 7:55 p.m.

    "Nonsense.

    There's lots of opportunity to cut spending. Increase class size 2 kids. I think the last debate about this indicated this was a 500 MILLION dollar savings in the state. Show me any statistic that conclusively demonstrates that 2 more kids in a class does meaningful harm and I'll buy you lunch" - RKBA

    There are already a significant number of studies that prove conclusively that smaller class sizes improve education and outcomes. The majority of the work shows that educational outcomes degrade as the class size grows to be more than 17 to 19 students. Most classes in Wake County are already at 25 to 29 students per class. Yeah, you can always add two more students and save $500 Million. Why don't we simply have 100 or 200 students in each class while we are at it? Imagine how much money that will save the state.

  • Danny22 Dec 17, 7:38 p.m.

    When we get through with all the new obamacare taxes and other new taxes, we'll be lucky to have enough left for food to feed our families. Obama has been so busy giving out free stuff that he has forgotten that somebody has to pay the bills and interest on the loans.

  • oleguy Dec 17, 6:40 p.m.

    Well I did buy a flat screen, Digital, but am using a antenna, and I was running an old 166 with 4 meg of ram till about 4 years ago,,, But we can cut spending in the Govt,,,

  • RKBA Dec 17, 6:04 p.m.

    "So, if you say "cut spending", pretty much the only way to do that in a significant way is to cut funding for schools or stop taking care of sick, old people. "

    Nonsense.

    There's lots of opportunity to cut spending. Increase class size 2 kids. I think the last debate about this indicated this was a 500 MILLION dollar savings in the state. Show me any statistic that conclusively demonstrates that 2 more kids in a class does meaningful harm and I'll buy you lunch.

    Stop putting flowers in the median. Stop putting signs that say "bridge freezes before road" in front of EVERY bloody bridge in the state.... and on and on and on.... there's a LOT of opportunity to stop spending. Not trying is a cop out.

  • Big John Dec 17, 5:53 p.m.

    "So, if you say cut spending, pretty much the only way to do that in a significant way is to cut funding for schools or stop taking care of sick, old people."

    If you don't think there is a tremendous amount of waste in both education and the medicare/medicaid system, I challenge you to do a little digging on that one. And saying that you shouldn't bother with the rest because it's a small amount is just the kind of mentality that got us where we are. Chipping away at the waste in every area, regardless of the amount, is the right way to restore proper government spending. Small habits lead to big ones and right now there is so much waste in government it needs to be flipped upside down until it's fixed.

  • Pirate01 Dec 17, 4:04 p.m.

    They are not "loopholes" they are laws!!!

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