Taxation in North Carolina and the 2023-25 State Budget

By Nathan C. Goldman and Christina M. Lewellen, associate professors of accounting in the Poole College of Management

As the Fiscal Year 2023-25 North Carolina State Budget continues to remain in flux, one key piece that we know will be affected is state tax collections. With the state collecting over $3 billion above what they anticipated in the prior year, Republican lawmakers have pushed for lowering state taxes to achieve revenue neutrality. However, Democrat lawmakers have suggested that there are better uses for these funds, such as increasing pay for teachers and state employees (both of which are facing record-high vacancy rates in North Carolina) and enhancing public health. In this Poole Thought Leadership article, we consider the current state of taxation in North Carolina to shed light on whether lowering state taxes appears to be a reasonable path.

Current Status of North Carolina Taxation

One can point to many plausible measures for analyzing whether North Carolina’s tax collections are optimal. The 2023 state individual income tax rate is 4.75%, which is down from 4.99% in 2022. North Carolina currently has the 35^th highest state income tax rate for individuals. As part of previously passed legislation, this tax rate will decline to 4.6% in 2024, 4.5% in 2025, 4.25% in 2026, and 3.99% for the years 2026 and beyond. For corporations, the current income tax rate is 2.5% through 2024. This rate will then begin a steep drop to 0% in 2030. Even before the decline to 0%, North Carolina currently has among the lowest state corporate income tax rates, and the collections only comprise about 1.5% of the total state revenues.

The State Business Tax Climate Index, which measures how well the state’s tax system is structured from the Tax Foundation’s perspective, ranks North Carolina 10^th overall in 2023. The Tax Foundation also ranks North Carolina as the fifth best in its corporate tax rank, and it also ranks North Carolina above the median in every category considered (individual income tax (No. 17), sales tax (No. 20), property tax (No. 13), and unemployment insurance tax (No. 10)). North Carolina currently ranks 32nd in tax collections per capita. These relatively high rankings suggest that the current tax system in North Carolina is structured well when compared to other states.

North Carolina Tax Cut Proposals

We are only one budgetary cycle removed from a legislature that imposed staggered lowering of both individual and corporate income tax rates. However, with the state facing a substantial surplus, lawmakers are seizing this opportunity to further their tax reduction goals. While Governor Roy Cooper initially proposed halting the decline in tax rate reductions for wealthy individuals and corporations, the North Carolina House and Senate had other ideas. Both branches of the legislature passed budgets that would accelerate the previously enacted tax rate reductions. The House’s proposal would only be a minor change in tax rates. The House’s budget also includes provisions for increasing the standard deduction, repealing the privilege license tax, and reducing the franchise tax rate. Whereas the Senate would both accelerate the reduction in tax rates and bring the 2030 and beyond individual income tax rate to 2.49%. Both proposals reflect a substantial change and decline in tax collections from North Carolinians.

Is the Goal to Be No. 1 for State Business Tax Climate?

While ranking 10^th in the State Business Tax Climate suggests that North Carolina provides a competitive state to be operating in, a question arises of whether the legislature’s goal when imposing further taxes reductions is to become the most competitive (i.e., ranked No. 1). The current state that holds that designation is Wyoming, which offers no corporate income tax, no individual income tax, and the sixth lowest sales tax. Wyoming collects a disproportionate share of its overall tax collections from property and sales taxes. They also collect a substantial percentage of their tax collections from other taxes, including excise taxes, severance taxes, or estate and gift taxes. Even though Wyoming has the most competitive business tax climate, they still collect a substantial amount of taxes, ranking 34^th in state tax collections per capita in 2021. While there is certainly a correlation between lower taxes and a better business tax climate ranking, and lowering the tax rates on individuals and corporations will lower the collections per capita, lowering the tax rates may not affect the current No. 10 ranking for North Carolina.

North Carolina Is Already the No. 1 State for Business

In an article by CNBC, North Carolina is ranked as the No. 1 state for business in 2023. This ranking includes a variety of attributes, such as workforce, infrastructure, economy, lifestyle, cost of doing business, innovation, business friendliness, education, access to capital and cost of living. While North Carolina’s rankings for attributes related to the tax environment are strong (business friendliness No. 10, cost of doing business No. 18, economy No. 3), North Carolina is also anchored to the top based on other categories related to public spending like infrastructure (No. 16), innovation (No. 6), and education (No. 7). The No. 1 ranking for doing business also may be attributable to several large and influential companies coming to North Carolina or already here, such as Apple, Boom Supersonic, Vinfast, and Google. Many of these companies tout the business-friendly environment of North Carolina when choosing to come here. However, there are also numerous mentions of other important attributes that are directly impacted by public spending, such as the workforce, education and infrastructure.

Finding the Right Balance for State Tax Collections

A single best solution for every state’s tax system does not exist, so each state must set and determine the appropriate mix for tax collections to fund their government. For instance, a state like Florida, which levies no individual income tax, has tremendous tourism and can more effectively fund its government through sales taxes rather than income taxes. Other states have substantially lower tourism but high business activities, leading them to do the opposite. While states strive to have a business-friendly environment regarding taxes, it is important to highlight that “tax friendliness” is just one of many factors determining which state companies want to operate in. For instance, the top five states for State Business Tax Climate rankings scored rather low in CNBC’s rankings for the Top States for Business in 2023: Wyoming (No. 37), South Dakota (No. 34), Alaska (No. 50), Florida (No. 8)), and Montana (No. 35). While Governor Cooper has continuously pushed for more substantial investment in infrastructure and education, the legislature is far more interested in prioritizing tax reductions. Given the state government faces 23.1% job vacancies, partly due to the low wages that are not being increased as dramatically as workers have hoped, CNBC’s No. 1 ranking for North Carolina may not last long.

Summary

To summarize, making North Carolina a leading state in business competitiveness is a noteworthy goal that should be at the forefront of every legislator’s mind as the 2024-25 budget becomes finalized. However, business competitiveness is complex, and drastic tax cuts do not necessarily help advance this goal. With the state operating under prior years’ finances due to the budget not being passed before July 1, lawmakers must act quickly to help address spending related to the critical needs of workers and residents. Furthermore, when striving for revenue neutrality, it is important not just to consider the costs and benefits of pulling the lever that decreases tax collections versus pulling the lever that increases spending. Pro-growth spending like raising pay for teachers and governmental employees, building healthy and resilient communities, and investing in critical infrastructure can potentially have an even greater impact on North Carolina’s business competitiveness than the (lower) amount of taxation that individuals and corporations face.