When North Carolina Governor Roy Cooper (D) signed the new state budget on a mid-November afternoon, a move that surprised many when it was announced two days prior, he became the nation’s third Democratic governor to enact an income tax cut in 2021. The other two income tax cutting Democrats are Wisconsin Governor Tony Evers, who also signed off on an income tax cut as part of a new state budget, and Louisiana Governor John Bel Edwards, whose proposal to reduce the state’s top income tax rate from 6% to 4.75% was approved by Pelican State voters on November 13.
The new budget enacted by Governor Cooper and the Republican-controlled North Carolina General Assembly cuts the state’s flat personal income tax rate from 5.25% to 4.99% on the first day of 2022, dropping once again to 3.99% on July 1, 2027. The standard deduction is raised from $21,500 to $25,500 for married couples and from $10,750 to $12,750 for individuals.
This personal income tax cut will provide relief to individuals, families, and the hundreds of thousands of small businesses that file under the individual income tax system in North Carolina. Meanwhile the new budget’s elimination by 2031 of the state’s corporate income tax, currently at 2.5%, will provide relief to larger employers and make the Tar Heel State one of only three that does not levy a corporate income tax or a business gross receipts tax.
“This budget continues the Republican-led legislature’s decade-long commitment to low taxes and responsible spending,” Senate Majority Leader Phil Berger (R) said. “The multibillion-dollar surpluses these policies helped create are evidence that they’re working, and it means we can cut taxes even more.”
North Carolina’s new budget further builds upon what has been a dramatic overhaul of the state tax code that has been nearly a decade in the making. As recently as 2013, North Carolina’s personal and corporate income taxes, with top rates at 7.75% and 6.9% respectively, were the highest in the southeast. Now those same rates are among the most competitive in the nation. The remarkable improvement in North Carolina’s business tax climate that transpired over the past decade is the result of multiple rounds of tax reform. These tax revisions have been shepherded through to enactment by Senate Leader Phil Berger, who has led the North Carolina Senate since Republicans took over in 2010, Speaker Tim Moore (R) and his predecessor, now U.S. Senator Thom Tillis (R).
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North Carolina was already the only state in the southeast that would have a combined federal and state corporate income tax below 30% even after the imposition of the corporate rate hike proposed by President Joe Biden, which has since been jettisoned from the latest spending package due to opposition from Senator Kyrsten Sinema (D-Ariz.). The new budget enacted by Governor Roy Cooper will increase North Carolina’s tax advantage over other states and countries.
A Democratic governor agreeing to eliminate a corporate tax will strike many as counterintuitive in a year when a Democratic president has called for a corporate tax hike. Governor Cooper’s move, however, marks a break with Biden and a return to the approach taken by former President Barack Obama, who acknowledged the benefit of reducing corporate tax rates.
In addition to making North Carolina a more profitable place to do business and invest, the elimination of the state’s corporate income tax is also good news for North Carolina workers. That’s because, as economists across the political and ideological spectrum agree, a significant share of the cost of corporate taxation is borne by workers, not just shareholders.
During the Obama administration key federal agencies made adjustments in methodology to account for the fact that some portion of the corporate tax burden is borne by workers in the form of lower wages. In an October 2013 study the Congressional Joint Committee on Taxation (JCT) announced that moving forward it would report the effect that corporate taxes and corporate tax adjustments have on both labor and capital. Prior to 2013, JCT models assumed the cost of corporate taxation was borne entirely by the owners of capital (stocks, bonds, mutual funds, IRAs, etc.)
That move by the JCT followed similar model adjustments by the Treasury Department and Congressional Budget Office to account for the share of corporate taxes borne by workers. Stephen Entin, an economist at the non-partisan Tax Foundation, estimates that workers bear nearly 70% of the corporate income tax burden.
“Over the last few decades, economists have used empirical studies to estimate the degree to which the corporate tax falls on labor and capital, in part by noting an inverse correlation between corporate taxes and wages and employment,” Entin writes. “These studies appear to show that labor bears between 50% and 100% of the burden of the corporate income tax, with 70% or higher the most likely outcome.”
Professor Mihir A. Desai published a Harvard Business Review article in 2012 finding that corporate tax increases go “straight on the back” of the American worker by reducing real wages:
“Because capital is mobile, high tax rates divert investment away from the U.S. corporate sector and toward housing, noncorporate business sectors, and foreign countries,” Desai writes. “American workers need that capital to become more productive. When it’s invested elsewhere, real wages decline, and if product prices are set globally, there is no place for the corporate tax to land but straight on the back of the least-mobile factor in this setting: the American worker.”
A University of Oxford and University of Warwick paper also released in 2012 found a $1 increase in the corporate tax reduces wages by 92 cents in the long term. This report studied more than 55,000 businesses across nine European countries from 1996-2003.
In 2015, economists Kevin Hassett and Aparna Mathur published a study finding that a 1% hike in corporate tax rate leads to a 0.5% drop in wages. That study looked at 66 countries over a quarter-century.
“We find, controlling for other macroeconomic variables, that wages are significantly responsive to corporate taxation,” Hassett & Mathur write. “Higher corporate tax rates depress wages.”
Going farther back, a 2006 Congressional Budget Office study by William Randolph found that 74% of the corporate tax burden is borne by domestic labor. The left-of-center Tax Policy Center, meanwhile, projects that 20% of the corporate income tax burden is borne by labor. It’s clear that economists across the ideological and political spectrum are in agreement that the burden of the corporate income tax is borne, in part, by workers. The disagreement is only over the degree to which the burden is borne by workers versus capital.
Policy arguments aside, enacting income tax relief with bipartisan support, it appears, also makes for great politics. The three income tax cutting Democratic governors boast higher approval ratings in their states than the President. In North Carolina, for example, though Roy Cooper and Joe Biden have both seen their approval ratings dip, the most recent polling has Governor Cooper’s approval rating nine points higher than the President’s, coming in at 43% to Biden’s 34%.
Legislators are already preparing income tax reducing legislation to file for 2022 sessions. While acrimony and party line votes will be the name of the game in Washington for the next year, income tax reform proposals — as we have seen with occupational licensing reform, criminal justice reform, expansion of school choice, and other policing Initiatives — will continue to garner bipartisan support in state capitals.
President Biden and congressional Democrats have decided to pursue a new tax and spending bill larger than the entire New Deal and they aim to pass it with only Democratic votes. They’re seeking to do this following an election in which voters increased the number of Republicans in the U.S. House of Representatives and put the GOP in charge of more state governments. Governors Cooper, Evers, and Edwards, meanwhile, offer a glimpse of the more moderate, bipartisan path that President Joe Biden could’ve taken, but chose not to.
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