Raleigh, N.C. — Lawmakers and Gov. Pat McCrory struck a deal on tax reform Monday, ending a weeks-long impasse over how to rewrite a tax code that hasn't been significantly overhauled since the 1930s.
Republicans in the House and Senate signed off on the deal during closed-door caucus meetings Monday afternoon.
"We've done something that no legislature has done since the Great Depression," House Speaker Thom Tillis said during a news conference. "Everybody's tried to take a bite of this apple, but they fell short because they lacked the courage and they lacked the commitment to getting in a room and working out their differences."
The package will reduce both personal and corporate income taxes. It also eliminates the estate tax and preserves the ability of most nonprofits to get refunds of what they pay in sales taxes.
According to an analysis by the legislature's nonpartisan staff, taxpayers at both ends of the income spectrum will pay less. For example, a married couple filing jointly with two children who make $40,000 a year will pay $80 less under this tax plan. The same couple filing jointly with two children who make $250,000 will pay $2,434 less.
Rewriting the state's tax code has been a major goal for both McCrory and Republican legislative leaders. However, even some GOP lawmakers kindly disposed toward rewriting the tax code withheld some praise from the plan.
"Is this comprehensive tax reform? No. But this is the first step towards it," said Sen. Bob Rucho, R-Mecklenburg.
Rucho wrote earlier versions of tax reform proposals that would have forced the state's income tax rate down to zero by broadening the number of items and services to which sales taxes apply. It also ended special tax breaks for a number of industries.
His version of tax reform was set aside, however, due to objections from House members and the governor's office.
In particular, McCrory has said that any tax reform plan needs to give the state enough money to operate. He called the package rolled out Monday "fiscally responsible, ensuring the appropriate revenue for state government services now and in the future."
The measure replaces the three-tier personal income tax system with a flat tax of 5.8 percent in 2014, which drops to 5.75 percent in subsequent years. Standard deductions increase to $7,500 for single filers, $12,000 for heads of households and $15,000 for married couples.
Tillis and Senate President Pro Tem Phil Berger said the bill would raise about $500 million less in revenue than the current system over the next two years. That cost would be $2 billion over five years, although Berger quibbled with the term "cost," pointing out state government spending will still grow under the tax reform plan.
Republicans say that lowering taxes will cause the economy to grow, helping more people to get employed and bringing more money into state coffers.That economic growth, they insist, will mean that the reduction in tax revenue will not be a steep as a "static" model predicts.
"Our goal is to get people back to work," McCrory said.
But critics of the plan say there's little evidence to backup that idea.
"It is very likely that as a result of this failure to pursue real, comprehensive tax reform, state sales taxes and local property taxes will go up in the future," Alexandra Forter Sirota, director of the liberal N.C. Budget & Tax Center, said in a statement. "That’s what happened in every other Southern state that has personal and corporate income taxes that can’t keep up with growing public needs."
Sen. Mike Woodard, D-Durham, also criticized the proposal for its cuts to state spending in coming years.
"What happens is, if this is not revenue neutral, our citizens lose," Woodard said. "The services we provide – education, health care – these are going to suffer under this tax proposal."
Passage expected this week
House and Senate leaders said they planned to vote on the bill Tuesday and Wednesday. Legislative leaders released three different analyses of the bill late Monday, including a comparison of the latest House and Senate tax proposals to the newly crafted compromise deal.
Among its other features:
- Deductions for mortgage interest on first homes, something that had been a point of contention between the House and the Senate, will be capped at $20,000. Despite being high relative to most single-family homes, that deduction cap still makes the North Carolina Association of Realtors unhappy.
"We see a cap on mortgage interest and property tax deductions as a major shift in tax policy that will hurt homeowners across the state and the entire real estate economy," association president Mark Zimmerman said.
- Charitable contributions will remain fully deductible.
- The child tax credit will continue and be more valuable for those making less than $40,000.
- Social Security income will remain exempt from state taxes.
- The corporate tax rate will be cut from the current 6.9 percent to 5 percent by 2015. If North Carolina meets revenue targets in the coming years, officials said, the corporate rate will drop even further, to 4 percent in 2016 and 3 percent in 2017.
- North Carolina's gas tax will be capped until June 30, 2015.
- Most nonprofits will be able to claim refunds of what they pay in state sales taxes. The compromise plan puts a cap of $45 million on the amount of refund claimed in any one year, which should allow all but the biggest nonprofit hospitals to reclaim all of the money they pay in sales taxes.
- The estate tax is repealed.
- A deduction on retirement income is eliminated.
- The state's franchise tax, a property tax on businesses, goes unchanged but will be studied for reform in future years.
- Starting in 2014, the sales tax holidays for back-to-school and Energy Star products are eliminated.
Expanding the sales tax to more items, an idea that was part of initial proposals in both the Senate and House, were not outlined in news releases initially distributed Friday. However, Tillis said the new plan will expand the sales tax base to some items that aren't currently taxed. That appears to have been a reference to things like movie tickets and utilities.
"Our tax reform plan is not just a tax cut here and there but meaningful tax reform – historic tax reform – that will spur economic development, create jobs and put more money into the pockets of hard-working North Carolinians," McCrory said.
The plan was quickly applauded by the conservative Americans for Prosperity, which has been pushing lawmakers to forge a deal for months.
"Not only does this deal significantly lower the personal and corporate income tax rates, but also it allows several tax loopholes to expire," Dallas Woodhouse, state president of the group, said in a statement. "This plan is real tax reform and good stewardship of the people’s money."
Critics of the plan point out that it abandoned earlier effort to close loopholes offered to certain industries.
"Real tax reform would focus on closing special interest loopholes and establishing a tax code that treats all of our hardworking taxpayers fairly," House Minority Leader Larry Hall said. "Instead, Gov. McCrory and the Republicans chose to make even deeper cuts to our schools just to ensure that the wealthiest individuals and corporations in North Carolina will receive huge tax breaks."
Top Republican lawmakers have said tax reform is "a process" and that they expect to make further tweaks to the tax code during future legislative sessions.
With a tax deal done, lawmakers are now free to turn their attention to the budget that spends the money taxes raised.