Plan would alter taxes

RALEIGH

Democratic leaders in the N.C. Senate proposed yesterday a historic overhaul of North Carolina's tax system that would generate more than $1 billion in new revenue over the next two years.

The large package of proposed tax changes would help reduce the state's projected budget shortfall, and according to supporters, would modernize an outdated, often convoluted system that hasn't been revamped in nearly 80 years.

"We need to have a tax system that matches the economy we have in 2009, rather than the economy we had the last time we did anything like this, which was 1933," said Sen. Dan Clodfelter, D-Mecklenburg.

Overall, the plan would reduce most tax rates while simultaneously broadening the tax base.

For instance, it would reduce the sales-tax rate to 6 percent in most counties from the current rate of 6.75 percent. But it would subject many more goods and services to the sales tax.

Personal-income-tax rates would also be reduced in all income brackets. But itemized deductions would be eliminated.

Corporate income taxes would go down. At the same time, the state would eliminate many tax credits aimed at businesses -- including the type of tax credits that helped lure computer-maker Dell Inc. to Forsyth County.

And the Senate plan contains "sin taxes" on tobacco and alcohol. It calls for an increase to the cigarette tax of 15 cents a pack -- substantially lower than the $1-a-pack increase proposed by Gov. Bev Perdue. The Senate's proposed tax on alcohol would be based on the alcohol content of the beverage being purchased.

Reynolds American Inc. said that the tax increase on cigarettes would hurt the state's critical tobacco industry. The company indicated little comfort that the Senate's proposal is much smaller than the governor's.

"Certainly, 15 cents is better than a dollar, but that's like saying I'd rather jump out of a four-story building than a 10-story building," said Maura Payne, a spokeswoman for Reynolds. "It's just not warranted, in our view."

The state's current cigarette tax is 35 cents a pack. That's on top of the federal cigarette tax, which recently rose to $1.01 a pack.

The entire tax plan was introduced yesterday during a meeting of the Senate Finance Committee. Much debate and many changes are expected, and Democratic leaders urged caution.

The Republican Party criticized the plan yesterday as an underhanded way to create new taxes.

The plan's primary architects are the finance committee's three chairmen: Sen. Clark Jenkins, D-Edgecombe; Sen. David Hoyle, D-Gaston; and Clodfelter. But the components have been discussed for many years by a string of study committees, which have all recommended broad changes to the state's tax system.

The system was designed for an economy based on manufacturing, not a service-oriented economy, and nowadays, the state's revenues tend to fluctuate wildly from year to year, soaring in times of prosperity but lagging during recessions. That pattern produces large budget problems, such as the shortfall of more than $3 billion projected for next fiscal year.

"We think this proposal is a more stable revenue system," Clodfelter said.

The plan is the second piece of the Senate's budget proposal. The Senate has already approved a $20 billion spending proposal for next year.

Meanwhile, the N.C. House is working on its own budget proposal. The House majority leader, Rep. Hugh Holliman, D-Davidson, said yesterday that the House is open to a major tax overhaul this year and that House leaders have consulted with the architects of the Senate plan.

The most prominent proposal in the Senate plan is to begin taxing many purchases that are not currently subject to the sales tax.

Those would include many "personal services," such as spa treatments, tattoos and body piercings. Haircuts, however, would not be subject to sales tax.

The sales tax would also newly apply to other types of services, including storage and moving services, installations, and home and auto repairs.

And people would have to start paying sales tax on "digital products," such as downloaded music, and various forms of entertainment, such as entry into an amusement park.

Many other specifics have not yet been revealed. Businesses, for instance, do not want the state to start taxing legal services or accounting work.

"We're hoping that business-to-business services will not be taxed," said Sherry Melton, a spokeswoman for the N.C. Chamber of Commerce. "We believe that would be particularly harmful to small businesses."

To compensate for broadening the sales tax, the overall sales tax rate would be reduced by three-quarters of a cent. Senate leaders also considered repealing the state's 2 percent tax on food, but they said that the state would lose too much money.

The plan would also limit the sales-tax refunds that nonprofit organizations receive. This provision could hurt such large nonprofit organizations as hospitals.

"We can't continue to grant refunds to a lot of nonprofits," Hoyle said.

Income tax

Under current law, North Carolina has three income-tax brackets, with personal-income-tax rates of 6 percent, 7 percent and 7.75 percent. The Senate plan would lower those rates to 5.25 percent, 6.5 percent and 7.5 percent.

It would also expand the income- tax base by using taxpayers' federal "adjusted gross income" for state tax calculations.

Itemized deductions would be eliminated. Some of those deductions would be converted into tax credits. That would help taxpayers who don't itemize, Clodfelter said.

The plan would also eliminate the so-called "marriage penalty" in the tax code.

Business taxes

Clodfelter said that redesigning the business-tax structure -- including lowering the corporate income tax rate from 5.8 percent to 4.5 percent -- would make North Carolina more competitive with other states and help to recruit jobs.

Many corporate tax credits would be repealed, including a category of credits that were part of the economic-incentive package that resulted in Dell's computer-assembly plant in Forsyth County. The Dell credits would remain in place, but similar credits would no longer be available to companies in the future.

Clodfelter said he doesn't think that eliminating the tax credits would hurt economic development.

"We get absolutely no bang for the buck on those credits," he said, noting that another economic-incentive program, which distributes grants to companies, would remain in place.

■ James Romoser can be reached at 919-210-6794 or at jromoser@wsjournal.com.