Make tax rates low, base broad, expert advises

A joint House-Senate Finance Committee began revisiting tax reform Tuesday in an effort to come to some consensus on whether North Carolina can restructure its revenue system. The committee, which may make recommendations to the 2010 short session of the General Assembly, began by listening to William Fox, director of the Center for Business and Economic Research at the University of Tennessee in Knoxville.

What Fox said was interesting even though it was along the line of what many who have studied this issue for years have recommended: Broaden the sales tax base and then cut the sales tax rate as well as the income tax rate.

But Fox's recommendation focused as well on sales taxes on business: Don't do it, he said. "It's not in the best interest of the economy," he said.

Fox noted that North Carolina has "a very narrow" sales tax base that taxes only about 30 of 165 potential sales transactions, including services. (Committee co chair Sen. David Hoyle, D-Gaston, thought this state taxes more like 40-some kinds of sales transactions.) Fox said nationally the sales tax base is shrinking -- and in response the states are raising tax rates. That's the wrong direction to pursue, he said: "Keep your bases very broad and your rates very low, and you will have the best results."

A couple of statistics caught my eye.

Nationally, state sales taxes represent nearly 31 percent of revenue. In North Carolina, however, general sales taxes represent only 23.1 percent of state revenue. That's "very light for a southeastern state," Fox said, and shows that this state relies more on the income tax,

Over the past three decades, the sales tax base as a proportion of personal income has dropped from about 53 percent in 1979 to about 38 percent now. Among the reasons for this decline are the state's decision to drop the state sales tax on food, to have an annual sales tax holiday just before the start of school, and the state's narrow use of services.

The sales tax holiday is popular, but makes little sense from the economy's point of view, Fox said: "Economists are nearly unanimous that it's a bad idea; Politicians are nearly in agreement that it's a good idea."

Some personal consumption expenditures have changed greatly over three decades. In 1979, we spent 20.3 percent of income for food and beverage but only 13.7 percent in 2007. On the other hand, we spent 47.4 percent of income on services in 1979, but by 2007 that was up to 59.7 percent. One reason: health care is a part of the services sector.

North Carolina loses perhaps as much as $300 million in sales tax revenue from e-commerce sales, Fox said. That estimate has risen a lot since last year, when it was computed at $212 million. But overall, most e-commerce sales are not business-to-consumer transactions. They are business-to-business transactions, and while the states should tax e-commerce consumer transactions, they should leave business-to-business transactions out of the revenue mix, Fox said.