Raleigh, N.C. — As Sen. Bob Rucho sees it, taxes have a lot in common with the cholesterol floating about his body – some kinds are good, others are bad.
The Mecklenburg County Republican likens corporate income taxes to artery clogging LDL cholesterol, gumming up the works and preventing the free circulation and creation of wealth.
Rucho, one of the legislature's leading voices on tax policy, argues the state needs to raise more revenue with taxes akin to HDL cholesterol, which helps keeps the arteries of commerce clear and cash flowing through the economy.
"If you want to achieve economic growth, you want to pick the best taxes that will allow you to grow your economy," Rucho said.
North Carolina's stubbornly high 9.6 percent unemployment rate, he says, can at least be partially blamed on a tax code designed for the 1930s manufacturing economy and tweaked with so many loopholes, exceptions and interpretations it is unnavigable to all but the savviest accountants and lawyers.
Of course, not everyone agrees with Rucho's diagnosis or backs the emerging Republican prescription for what ails the tax code. Relying too much on the sales tax without an income tax will hurt low- to moderate-income families, more liberal tax mavens say.
But beginning in January, Republicans will control the governor's mansion and both the state House and state Senate, something that hasn't happened since the 19th century. If tax reform comes about in 2013, it will be the GOP blueprint that North Carolina will follow.
Others have written prescriptions for fixing an out-of-date tax code and spark economic growth, although few were ever followed. There have been no fewer than seven major tax reform efforts over the past 30 years, Rucho and others at the General Assembly say. Each ended with recommendations filed away in binders, waiting to be dusted off the next time the call went out to fix the system.
GOP leaders insist this time they'll succeed.
Tax reform on McCrory's agenda
"My initial goal is to update a tax system that is 60 years old," Gov.-elect Pat McCrory said during the last debate of the campaign. "At a minimum, I'd like to at least have our income tax and our corporate tax be competitive with our neighboring states of South Carolina and Virginia."
To do that, North Carolina's corporate tax rate would have to fall to 5 percent from 6.9 percent in order to match South Carolina. The top individual income tax rates would have to drop from 7.75 percent to just below 5.75 percent to match Virginia.
While both of those would be big cuts, they would fall fall short of the ultimate goals set out by McCrory and other Republicans, who have said they would like to entirely do away with both taxes if they can manage it.
McCrory takes office on Jan. 5 and, at first blush, it seems he and legislative leaders will have a lot in common.
"I would think he would be involved with everything the legislature is trying to do," said Rep. Julia Howard, R-Craven, one of the top finance leaders in the House.
Howard said Rucho and his Senate colleagues have done the majority of planning for changes to the tax code, while House leaders have pushed forward with changes to the unemployment system, an equally thorny problem.
But just because Republicans control both chambers of the legislature and the executive mansion doesn't mean their solutions will match up. There are still questions of timing, who will take the lead and what exactly will be part of any reform effort.
Republican lawmakers, for example, have been meeting on tax issues since they first gained legislative majorities two years ago and have reviewed dozens of presentations on the plan. McCrory, who has not been an elected official since he left his post as mayor of Charlotte four years ago, is busy sifting through potential staff for his administration and examining the inner workings of state government.
"He will be critical to this conversation," Rucho said of McCrory. As governor, McCrory will be in a position to use the bully pulpit to sell GOP tax reform ideas.
The rough outlines of the Republican plan are clear enough: Lower and eliminate corporate and individual income taxes; replace that revenue through a flatter, simpler tax for businesses; and broaden the sales tax base by taxing more items. All remaining taxes would become simpler by eliminating loopholes and exemptions.
"Services is where the main thrust of our economy is going and right now we're not taxing services at this time," Howard said.
She argues that relying more on sales taxes would mean a steadier income stream for the state, which has seen large dips and swells in income tax collections over the past decade.
For average taxpayers, that would mean paying taxes on service like hair cuts, legal fees and yard work that have previously gone untaxed. Service businesses that have never been in the position of having to collect tax before would have to begin to do so.
In some respect, liberal tax mavens such as the North Carolina Budget & Tax Center's Alexandra Sirota can find common ground with the Republicans. Sirota and her colleagues, for example, have argued for expanding the state's sales tax base.
However, she and others argue that relying too much on sale tax versus income taxes could mean low- and moderate-income people end up paying more in taxes every year. In a recent study, the center found that in replacing half the revenue from the income tax with additional sales taxes "the top 1 percent of North Carolinians would see a net reduction in their contributions of 4.6 percent."
But those earning less than $31,000 per year would end up seeing their total tax contribution to the state rise by as much as 5.6 percent.
"There's very little evidence that cuts to personal income tax really creates the kind of job creation that we need," said Sirota, the center's director.
While objections like Sirota's will certainly come up, Republicans seem more focused on keeping the effort "revenue neutral," meaning that the new tax system would collect just as much as the old one under the same conditions – not more.
Tax reform a broader job-creation benefit
Taxes aren't the first thing on a business owner's mind, economist Brent Lane told the legislature's Revenue Laws Study Committee in November. They are, however, part of the bigger puzzle needed to help North Carolina's economy grow, said Lane, who is the director of University of North Carolina's Center for Competitive Economies.
While North Carolina has continued to get plaudits for its work in economic development, job creation hasn't kept up with the number of people looking for work here. In 2000, there were roughly 140,000 fewer jobs and that bodies in the workforce, Lane said. In 2011, that gap was close to 440,000. At the same time, the wages of Tar Heel workers have fallen in comparison with the national average.
Those are figures that Republicans rely heavily upon when making the case for tax reform. While the tax code's impact on individuals is a consideration, Republicans are very focused in how tweaks to the tax code can encourage businesses to grow. Doing so, McCrory, Rucho and others argue, will reap more revenue for the state and create more jobs.
For much of the past decade, Lane said, the state has focused on economic development incentives to lure companies here or encourage them to grow, but those incentives reach relatively few companies. The state, he said, would be better off tweaking its tax policy to make sure all companies benefited equally.
"We need to start thinking about the decisions you (the legislature) make as affecting the business climate for all businesses in this state, and one excellent example of that is tax policy," he said. "Tax policy affects every business, every type of business, every form of legal business in this state."
While economic incentives might lure big companies, they do little to help small businesses, which have the potential to grow more quickly than large companies do, he said.
"What they (business owners) strongly emphasize is however this legislature contemplates reforming and modernizing our tax code, make sure it ends up achieving simplicity and consistency," Lane said.
Indeed, talk to anyone involved in prior tax reform studies or the current efforts, and closing loopholes and tax breaks for specific businesses and individual taxpayers often comes up. Those breaks, they say, make the tax code hard to navigate.
Even closing all the loopholes and tax breaks wouldn't make up for the all the revenue lost by cutting or eliminating corporate income taxes. So, in addition to getting rid of exemptions, lawmakers are looking at "broadening the base" to which sales taxes apply. Currently, most services go untaxed, as do many business-to-business transactions.
"If we're going to have a broaden base, people need to be sure of the fact we're not just trying to raise more money that doesn't come from economic growth," Rucho said. Prior tax reform efforts in North Carolina and even in other states have failed because they were aimed not just at changing the tax code, but getting more money for the government out of the economy. In other words, they weren't "revenue neutral." North Carolinians, Rucho said, need to be convinced that tax reform isn't just another money grab.
"I've never seen any government put a tax on and get rid of another," said Rick Armstrong, executive director of the North Carolina Association of Launderers and Cleaners. "They say that, they pay lip service to it, but it doesn't happen."
Dry cleaners don't pay sales tax on the solvents, detergents, hangers and other materials they use to clean clothes. That break, Armstrong said, helps dry cleaners survive on relatively low profit margins for each garment cleaned. Armstrong said it's hard to envision a system that cuts out enough cost elsewhere to make up for the loss of that exemption.
Rucho said that skepticism is understandable.
"If I say, 'I'm from the government, and I'm here to help you,' you'd be crazy to believe me," he said. That's why lawmakers are so focused on the idea of making tax reform revenue neutral, he said. "Otherwise, you're going to say, 'Bob, this sounds like just another way to get more money out of my pocket.'"
Some benefit from current system
In many respects, the worries reflected by the dry cleaners and the concern expressed by the Budget and Tax Center's Sirota is the same: A revamped tax system could shift more of the tax burden to those who benefit from the current list of exemptions and rebates.
Businesses, Sirota said, do benefit from public infrastructure like roads and public goods like schools that educate the workforce. All of which, she said, calls into question Rucho's cholesterol analogy. Corporate and income taxes ensure those who are benefiting from the economy and public works are paying toward those public goods, she said.
"It overlooks some pretty fundamental aspects of both the sales tax and the income taxes," Sirota said. We need diverse sources of revenue. We need businesses paying because they do gain benefits from the things that taxes pay for."
Rucho argues that those businesses could pay something similar to annual franchise tax under his plan. Ultimately, he said, the goods and services produced by a business are taxed. By lowering other taxes such as income levies, he said, people would have more money to buy those goods and services, which in turn would mean more revenue for the state.
Rucho and Howard also said a new tax on real estate transactions – likely to be unpopular with home builders, real estate agents and others in related industries – could help make up for some of the loss of income tax revenue.
Setting aside the details of the various tax reform plans, Rucho and others will say that some remake of North Carolina's tax system is overdue. Funding for education and social service programs has swung wildly over the past 10 years as revenues have bounced up and down. The swings have made state budgets impossible to plan, making tax reform a necessity.
"I don't think we've got any choice about it," Rucho said.