Karl Smith Tax Reform in North Carolina

1.The Current Tax System 2.The Growing Problem 3.Alternatives and Concerns 2

1.The Current Tax System –Levels and Portfolio Compared to Other States –Issue 1: Volatility –Issue 2: Sufficiency –Issue 3: Equity –Consumption Tax vs. Current Sales Tax 3

State and Local Burden 4

Tax Portfolio

Sales Tax Base Is Declining Increasing Interstate Sales Increasing Consumption of Services –Sales Tax Base is Becoming More Volatile –Sales Tax Base is Becoming More Regressive

Consumption Shifting to Services 7

Goods Consumption Increasingly Volatile 8

Issue 1: Volatility Shift in Consumption Makes Sales Tax More Volatile NC High Income Tax Reliance Leads to More Volatility –Household Income Less Stable than Household Expenditures –Deductions and Multiple Rates Make Income Tax Less Stable than Household Income 9

Issue 1: Volatility 10

Issue 1: Volatility 11

Issue 1: Volatility 12

Issue 2: Sufficiency Total Revenues are Lagging Household Income Growth Demands on the State are Increasing 13

Issue 2: Sufficiency 14

Issue 2: Sufficiency - Demographics 15

Issue 2: Sufficiency 16

Issue 3: Equity Our Current Sales Tax is Levied on Primarily on Tangible Goods –Bias Against Retailers and Manufacturers –Tangible Goods Are a Larger Portion of Consumption for Poorer Households 17

Regressivity Budget & Tax Center Data 18

Consumption Tax in Theory 19 The sales tax in principle is a tax on consumption Idealized features of a consumption tax –Taxes what citizens take out –Smoother than Income –Grows with the economy –Tracks ability to pay

Sales Tax Base Less Representation of Consumption Deadweight loss –When the consideration of taxes causes less efficient economic choices. – Ex. Buying an item on Ebay because shipping is less than tax –Ex. Waiting for a tax holiday when an item is needed today –Ex. Driving just across state lines to pay cheaper tax 20

Sales Tax Base Less Representation of Consumption As the tax rate increases deadweight loss increases exponentially –Greater numbers of inefficient choices are made –Greater severity of inefficiency –Ex. More people will drive further to avoid an 9% tax than a 1%. –More people driving times further average distance drove imply exponential increase in inefficiency 21

2.The Growing Problem –Convergence –Poverty –Skill Premium 22

Globalization and Convergence

Live By Convergence – Die by Convergence The very same economic forces have brought hardship to NC –Container Ship Revolution –Lower Global Instability –Free Trade Manufacturing begins to move to even lower priced areas 24

Low Income 25

Skill Premium 26

Labor Share 27

3.Alternatives and Concerns –Expansion of the Sales Tax Base –Consumption Tax from Income Tax –Flat Tax 28

Alternative: Sales Tax Base Expansion Expansion of the Sales Tax Base –Proposed By Recent Fiscal Modernization Committee –Interest Around the Country Concerns Include –How Far – How Fast –Should Medical Services be taxed –Should Business to Business be taxed –Difficulty in Other States

Alternative: Consumption Tax From Income Tax Consumption Tax from Income Collections –Tighter Compliance –Possibility for Redistributing Tax Burden Concerns Include –Possibility for Redistributing Tax Burden –Matching With IRS

Alternative: Flat Tax Flat Tax –Simple –Low Rates Concerns Include –Contentious –No possibility for Progressivity in the Tax Code

Summary 1.The Current Tax System –Sales Tax is less representative of consumption leading to a volatile, insufficient revenue source that leans on goods consumption 2.The Growing Problem –Difficult Time ahead for Low Skilled Labor and High Demand for State Services 3.Alternatives and Concerns –Reform is Difficult but No Reform Will Be More Difficult 32

Questions and Comments 33

Retail Sales 34

35 North Carolina Relative to US: Manufacturing Intensity

36 Manufacturing: Employment