Tax reform remains up in the air
Posted June 21, 2013
Updated June 23, 2013
Raleigh, N.C. — One of the most instructive moments in North Carolina's ongoing debate over reforming its antiquated and erratic tax system came in late May, as Sen. Bob Rucho, R-Mecklenburg, scanned the crowd in one of the Legislative Building's biggest meeting rooms.
"Members of the audience, would you just raise your hands if you're lobbyists," Rucho said, watching nearly every hand in a room packed beyond capacity go up. "Members of the committee, I just want you to remember, those are the folks that are in the process of trying to be sure that this tax system stays complicated and loopholes are maintained."
Closing loopholes carved out for certain industries or groups was among the pillars of tax reform that Republican leaders laid out before this year's legislative session began. Along with that, broad outlines of tax reform envisioned a bill that would be roughly revenue neutral – raising not much more or less than the current system – and shift more of the tax burden toward a broader sales tax that extended to services and well as physical goods. The end result would be a system that ensures a steady stream of revenue for the state and helps spark the economy.
Unlike sweeping proposals put forward earlier this year, it's unclear if the latest iterations of tax reform or the compromise bill being negotiated between the House and the Senate will comfortably fit into that outline. The current House and Senate bills are already a series of compromises that represent nips and tucks made to accommodate those who raised their hands in response to Rucho's question and the constituencies they represent.
"If all we do is drop rates a couple of points and leave a big hole in the budget, I don't know if we call that reform," said Rollin Groseclose, chairman of the North Carolina Association of CPAs Tax Modernization Task Force.
Past tax reform efforts have stalled, failed
North Carolina has made no fewer than seven attempts at tax reform over the past few decades, all of them meeting with rejection. At least a few of those measures met a sticky end because they were seen as tax hikes in disguise, efforts to soak up more money from taxpayers under the guise of reform.
"I'm looking for a revenue-neutral tax reform," Gov. Pat McCrory said earlier this year.
Corporate and personal income tax rates needed to be lowered, the governor said, but the overall reform plan needed to leave him with enough money to operate the government.
While no tax plan floated this year runs the risk of being viewed as a tax increase, lawmakers have veered the other way. The House bill would raise $302 million less than the current system over the next two years. The current version of the Senate plan would raise $4 billion less over the next four years.
That difference has been a key point of contention between House and Senate lawmakers who are trying to negotiate a final deal.
"It appears there's a philosophical difference on the spending," Senate President Pro Tem Phil Berger said recently. "They (the House leaders) want to spend more; we want to spend less. I think that's going to be one of the big issues that we're going to have to work out."
That is not just an internal legislative debate. Outside groups have also been critical of the various tax reform proposals, saying they will force unnecessary cuts to government services.
"The sad truth is that areas that will be cut to make up this lost revenue will directly, negatively impact children," said Melea Rose-Waters, a campaigner for the liberal Mom's Rising group.
Although the tax bill is separate from the budget bill, which lays out how money will be spent, the two are inextricably linked. Lawmakers can't proceed with budget negotiations without having a firm idea of how much revenue the state will earn over the next two years.
No sale on expansion of sales taxes
Berger, R-Rockingham, could find himself not just at odds with the House but with an earlier version of his chamber's own tax plan. In a video he produced in early May, Berger pledged that the Senate's tax reform bill would eliminate tax loopholes.
"No one gets special breaks or loopholes," he said in the video. "Mechanics and lawyers are treated the same."
To follow through on that pledge, early versions of the tax plan imposed sales tax on an array of services and shifted how different categories of businesses were treated under the tax code.
That version of the tax reform bill won the praise of anti-tax maven Grover Norquist, founder of Americans for Tax Reform.
The current Senate budget plan is less aggressive on those fronts. In fact, the Senate-backed version of tax reform does not expand sales taxes at all and closes fewer loopholes than earlier reform bills did. The House plan, by contrast, expands the sales tax to some services, but only those associated with a physical purchase such as the warranty sold with a computer or the delivery fee for a refrigerator.
These shifts away from key tax reform tenets prompted Rucho to resign his post as Senate Finance Committee co-chairman two weeks ago. Although Berger refused to accept Rucho's resignation, the Mecklenburg Republican has not wielded a gavel since.
"It is a huge disappointment that the governor and the speaker of the House did not provide the leadership or have the political backbone to fight the special-interest groups, who favor loopholes over a fair tax system," Rucho wrote in his resignation letter.
The question of whether lawmakers are truly on track to produce a tax reform bill versus one that merely cuts taxes has been bandied about the legislature all week.
"That's probably a valid question in terms of the Senate proposal," House Speaker Thom Tillis said late Wednesday, flinging a barb at the the other chamber.
As for Berger, he doesn't seem phased by critics and even one of his top lieutenants challenging the new track upon which tax reform is running.
Asked what he could not live without in a tax bill, Berger said, "comprehensive tax reform."
What does that mean?
"We'll see when we get it," Berger quipped back.
Pressed for a more detailed answer, Berger said that any of the measures put forward by the House or Senate this year could be considered tax reform in some way.
"I think reform is something that includes reduction of the obligation on individuals and businesses. Reform also includes modifications in how you structure your taxing authority," he said. "Under that definition, each of the bills that have been introduced can be defined as tax reform. So, it's just a matter of us working out the details."
Others never saw the early, more sweeping version of the Senate bill as a possibility. That measure would have eliminated the corporate income tax, cut the personal income tax nearly in half and broadened the sales tax base to any service that is taxed anywhere else in the country.
"What we're getting is a pretty significant tax bill that's a pretty big deal," 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.
If the final bill looks anything like the current House and Senate measures, Shackelford said, it will still represent a major shift in tax policy.
"If you want to put it up against what the Senate was originally proposing, then it might look pale," he said. "If you were hoping to have that radical policy, you might be disappointed. But it never seemed to me all that likely you could get a consensus behind all the special interests that were going to be affected by really radical policy changes, whatever they were."
Negotiating the details
Much of official Raleigh took a break on Friday for the funeral of former Gov. Jim Holshouser, a Republican renowned for his ability to work with Democrats during a period of divided government. Today's divisions are among a House, Senate and governor's office all controlled by Republicans.
While there is broad agreement as to what needs to be done, finding common ground on how to do it may be hard as lawmakers try to bring the legislative session to a close during swelter of early summer.
"We are trying to change the mix in a way we believe will stimulate economic activity," Tillis said, "but we need to do it at a pace that we can actually absorb."
They are also at odds over specific features of the plan. The Senate plan would do away with the income tax deduction for mortgage interest, while House lawmakers merely cap the amount of interest that can be claimed against your income.
Meanwhile, outside groups continue to pressure lawmakers.
Real estate groups have taken to the airwaves and the Internet to combat the mortgage interest change, saying that would hurt middle-income families. Pretty much any tax loophole that might be closed or tightened has a group pushing against the provision. Movie theater owners, for example, are pushing against a House provision that would raise the effective sales tax on movie tickets.
Americans for Prosperity, a conservative group that has pledged to vocally back lawmakers who craft what its members consider tax reform, has been urging lawmakers in person and on the radio to pass the bill as currently drafted by the Senate.
AFP State Director Dallas Woodhouse said the most important feature of tax reform would be lowering both corporate and personal income tax rates. The fact that the Senate plan puts tighter restrictions on the amount of revenue that would be raised in the coming years is a plus, he said.
"The most important thing for conservative members of the General Assembly to do is to believe what they said they believe," Woodhouse said.
McCrory, Berger, Tillis and their Republican colleagues all campaigned on a platform that said cutting taxes would spur economic growth and hiring. A growing economy should, in turn, raise more revenue for the state, even if tax rates are lower.
"The revenue issue should take care of itself," Woodhouse said.
Liberal groups, meanwhile, point to studies that contradict that conservative logic and say severe cuts to revenue will necessarily lead to severe cuts on spending for education and health care programs.
"Moving forward with the Senate tax plan will leave North Carolina unable to maintain its most important investments, which are the very building blocks of a strong economy and strong future," said Alexandra Forter Sirota, director of the North Carolina Budget & Tax Center.