North Carolina is one of the state’s best prepared to deal with the budget challenges from the new coronavirus outbreak. It also represents the gold standard for state tax reform, and the connection between these two should not be lost. The Tar Heel state has successfully reduced tax rates, while controlling the growth of spending and funding the priorities of state government.
“Sensible tax cuts and honest, conservative budgets,” were the foundation of North Carolina’s successful tax reform. As an example, many states are wondering what the economic impact will be as a result of the COVID-19 (coronavirus), but North Carolina is prepared as a result of their prudent tax and budget policies, which has created a $1.2 billion rainy-day fund, over $600 million in Medicaid reserves, $3.9 billion in the Unemployment Trust Fund, and $2.2 billion in the state’s General Fund unreserved credit balance as of the end of February.
Since 2011, North Carolina’s legislature has pursued an economic policy agenda of reducing tax rates, regulations, and controlling the growth of spending. In the process, North Carolina “began changing the way the state budgeted its dollars, funded its roads, delivered education, and administered public assistance.” This has not been an easy process, legislators managed to overcome a $3 billion budget shortfall for the 2011-2012 fiscal year without renewing a temporary one-cent sales tax that generated $1 billion in revenue.
With a friendly governor in 2013, the North Carolina legislature began to enact comprehensive tax reform. The tax reform not only lowered individual and corporate income tax rates, but also reduced other business taxes, repealed the estate tax, and broadened the sales tax to more services. Before the reforms, North Carolina had some of the highest tax rates in its region. Since North Carolina has transformed its progressive income tax with rates from 6.0 to 7.75 percent in 2013 to a flat 5.25 percent tax in 2020. The standard deduction for a married couple filing jointly has increased from $6,000 to $20,750. Lawmakers also cut the corporate income tax rate from 6.9 percent in 2013 to 2.5 percent in 2020, the lowest rate among states with a corporate income tax.
The lower rates made it possible for legislators to eliminate targeted tax exemptions and credits, which helped shrink the revenue impact of the tax reforms. Broadening the sales tax base also helped. Unlike Kansas and Oklahoma, North Carolina legislators started with small tax cuts and used revenue triggers to reduce rates further.
Perhaps most important, the legislature kept the growth of government spending to the combined rates of inflation and population growth, which means spending per person adjusted for inflation did not increase. Tax and spending are two sides of the same coin and controlling spending is crucial for any successful tax rate reduction. Tax rate reduction does lead to economic growth and new revenues over time, but state tax cuts will often not “pay for themselves.” Restraining spending, utilizing conservative revenue forecasts, and other sound budgeting principles were vital to the success of North Carolina’s tax reform.
As a result of tax reform North Carolina is a leading economic competitor in the region and nationally. In addition, taxpayers have been able to keep close to $15 billion of their hard-earned income since 2011. Whether it is an economic downturn, a natural disaster, or today’s COVID-19, North Carolina is fiscally prepared. North Carolina proves that a state can lower tax rates, control the growth of spending, and provide for the priorities of government.
Prudence is vital for any tax reform. A legislator from North Carolina correctly described tax reform as an “evolution, not a revolution.” Iowa can learn from the North Carolina model that lowering tax rates, combined with conservative budgets, promotes economic growth and savings for taxpayers.