State should press the sales tax into services.


The state tax system hasn't changed much since the 1930s, and some say it needs an overhaul. It worked well enough for the manufacturing economy of the 20th century, but services dominate the state's economy now. The Institute for Emerging Issues, a Raleigh-based think tank chaired by former Gov. Jim Hunt, hopes to have recommendations ready when a new governor takes office in 2009. Roland Stephen is assistant director for research and policy.


BNC: North Carolina has a $2.4 billion surplus, yet you say we're in trouble.

Stephen: That was made up largely of nonrecurring funds. About 45% of our revenue is from the income tax, and the income tax is volatile. In good years, when people are paying on their capital gains, getting bonuses or those sorts of things, that yields a windfall, and you ought not to enter into spending commitments that assume it will continue. More fundamentally, we have a tax system that will not grow as the economy grows. But we can be sure that our spending obligations will grow as the economy grows. In fact, they're likely to outstrip it.

What are the top expenditures?

Education is the biggest, but Medicaid will grow faster. Medicaid pays for long-term care of the elderly if they are below a certain income level. That represents about a third of Medicaid dollars. Medicaid also pays a lot for people who are on disability, and that's a big-ticket item. So, as our population gets older and sicker, the cost of Medicaid is going to grow more rapidly than our economy.

What else is wrong with our income tax?

The top rate is high compared with other states--in particular, other Southeastern states. Do people leave North Carolina because of it? I don't know. But it is a bad signal. In a noisy environment where CEOs and others are making investment decisions about where to locate firms, they're looking for cues about the business climate.

Where does our overall tax burden rank?

Somewhere in the middle of the pack. We have high personal-income taxes, but we have low property taxes.

How can we fix our problems?

The sales tax in North Carolina, as in many states, rests on the sale of goods. Services have not been taxed in most states, yet in the United States we're moving to a service economy. So sales tax rests on a continuously shrinking piece of the economic base.

And heavy purchasers of services, who tend to be wealthy, get a free ride?

Exactly. If I'm living a quiet life and go buy a lawn mower, I pay a sales tax on that....

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