NC Budget and Tax Center

Why cutting taxes for business again makes no sense

When businesses pay their share of taxes, North Carolina is able to invest in the things that build thriving communities and a prosperous economy – things like good schools, roads, public health and a clean environment.

The Senate’s tax plan, Senate Bill 325, includes a tax cut for businesses that goes against this proven principle.  There are four reasons why this plan will move our state backwards.

  1. North Carolina’s corporate income tax rate is already the lowest in the country.

North Carolina’s corporate income tax rate, now 3 percent, is the lowest in the country among 32 states with a flat corporate income tax rate, and the states with graduated corporate income taxes all have top rates above 3 percent as well. (Four other states – Nevada, Ohio, Texas and Washington – do not have a corporate income tax; they impose a gross receipts tax – which is a tax on the total gross revenues of a company).

On January 1st of this year, North Carolina reduced the corporate income tax rate from 4 to 3 percent which will reduce revenue by $500 million when in effect for a full fiscal year.  This was an automatic reduction built into the 2013 tax changes that is happening even as enrollment costs associated with public schools and universities are increasing and health care costs for retirees are rising.  It happens as the state struggles to rebuild Eastern North Carolina communities post-Hurricane Matthew and cope with the implications of the increasing likelihood that Congress will shift more costs to states.

  1. Another corporate tax cut will not lead to meaningful economic growth, research indicates.

The proposed corporate tax cut will not provide the needed local boost to address North Carolina’s economic challenges or catalyze greater job growth where it is needed.  That is because, as research has found, the impact on corporate investment of a small cut in the corporate tax rate would not only be small but require years to fully take effect.  The consensus of that research is that even a very large, 10 percent reduction in total state and local taxes paid by businesses – much larger than the reduction in corporate income taxes alone in the Senate bill – is likely to increase economic output and jobs by only about 2 percent before accounting for any offsetting negative impact on the provision of public services that businesses rely on such as efficiently run courts and high quality public schools that help build an educated and trained workforce.

Additionally, there is no reason to believe that tax cuts going to big multistate corporations will benefit North Carolina’s economy: businesses may choose instead to use the money to finance out-of-state investments or distribute these additional dollars in the form of dividends to their shareholders who mostly live out of state. Estimates by the Institute on Taxation and Economic Policy suggest that just 18 percent of the corporate income tax rate cut would stay with residents of North Carolina.

  1. Cutting income taxes on small business won’t do much for North Carolina’s economy, either.

The Senate bill proposes an additional cut in the personal income tax rate, sometimes justified on the grounds that this will encourage job creation by small businesses that pay tax on their profits through the personal income tax rather than the corporate income tax.  But Kansas completely eliminated its personal income taxes on these businesses and the rate of small business startups actually declined in the following two years. Small businesses hire mainly based on product demand and tax cuts are unlikely to generate the dollars to justify hiring more employees.

Nor will cutting income taxes attract entrepreneurs to the state, particularly if it leads to further reductions in the quality of North Carolina schools, parks, and other building blocks of vibrant communities.  In a 2014 survey, only five percent of the founders of high-growth companies cited low taxes as a factor in where they started their businesses.

  1. Not all NC businesses benefit under tax plan, winners and losers created

North Carolina imposes a franchise tax on corporations for the privilege of engaging in business in the state. In North Carolina, this flat fee for all businesses is intended to cover basic government supports such as application filings and court costs.  The Senate bill proposes to increase the minimum franchise tax liability for the very smallest businesses organized as “Subchapter S” corporations (S-Corps) from $35 to $200 but reduce the tax for moderate-sized S-Corps worth less than $1 million.  (For income tax purposes, S-Corp profits are taxed on the personal income tax returns of their owner(s), while the remaining C-Corps are subject to the corporate income tax.)

There is no justification for taxing small S-Corps more lightly under the franchise tax than small C-Corps. The S-Corps are already being relieved of corporate income tax liabilities even though they get all the non-tax legal benefits of a C-Corp. And if the rationale for cutting taxes on S-Corps with less than $1 million of value is that it brings their taxes closer to what Limited Liability Companies (LLCs) pay – which is what Senate bill proponents assert – then the appropriate solution is to level-up both LLC and S-Corp franchise tax payments to C-Corp levels, not level the S-Corp payments down.

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