As North Carolina embarks on revenue reform in 2013 much has been made about the need for a comprehensive approach. This is indeed important because it recognizes that each of the state’s revenue sources could be improved. But beyond that, a comprehensive approach is needed because in order to achieve key principles of a sound revenue system — adequacy, equity and stability — each revenue source has unique features that are necessary to building a sound overall tax system. Maintaining a diversity of revenue sources also is furthermore important to protect against the economic and non-economic factors that could affect a single tax source.
The personal income tax, for example, has been demonstrated to best grow with the economy and thus contribute to long-term adequacy, and because the tax is based on income, policymakers can design a system that is based on ability to pay. Meanwhile, the sales tax can potentially contribute to both adequacy and stability if designed to do so, but will always ask more from low- and moderate-income households. However, the right mix of tax sources can balance the achievement of key principles for a tax system.
Research shows that diverse revenue sources can lead to decreased revenue volatility and improved revenue growth. However, the design of the portfolio of taxes must be connected to the state’s unique economic conditions. Thus, importing the tax portfolio of another state to North Carolina ignores the unique economic context of a state’s economy—whether it be the presence of natural resources or industry composition, for example—and undermines the ability of a tax system to function in concert with that economy over time.
Today, our state’s revenue system is based on collections from the personal income tax, sales tax, corporate and franchise tax, as well as other taxes. Unlike the “three-legged revenue stool” in most states that includes property taxes, in North Carolina property taxes are collected at the local government level and do not contribute to state revenue. Instead, our state’s three-legged stool is comprised of the personal, sales and business taxes.
Cutting off one or two legs of the stool – as some have proposed through the elimination of the personal and corporate income taxes – would topple the stool, compromising our ability to fund the education of our children, infrastructure development in our communities and our overall well-being. Improving how each tax performs through reform makes better sense and will ensure that the state has a greater mix of revenue sources to meet the fiscal needs of the state. To best achieve the principles of a sound revenue system, maintaining diverse revenue sources is critical for North Carolina and the goal of being able to invest collectively in greater opportunity.