A

fundamental principle of a free and thriving society

is to ensure that work is valued and rewarded.
Those who produce the goods and services that keep our
communities growing and flourishing should be able to
enjoy the fruits of their labor. Our state tax code plays
a key role in upholding that principle, which is why the
John Locke Foundation has, for 25 years, advocated for
transforming North Carolinas antiquated tax code into
one that keeps rates low, avoids special carve-outs, and
thus is fair, neutral, and unbiased. When fiscal reformers
were elected to huge majorities in the General Assembly
in 2010, John Locke Foundation recommendations began
to be adopted, and in 2013, culminated in historic tax
reform that continues to take shape to this day. The impact
of these reforms has catapulted North Carolina from 44th
to 15th place on the Tax Foundations State Business
Tax Climate Index a significant improvement and a
major step toward the John Locke Foundations mission
of making North Carolina First in Freedom.
This John Locke Foundation report gives an overview of
the economic and political landscape leading up to the
recent historic tax reform that occurred in North Carolina,
as well as the positive change the legislation had on North
Carolinas ranking in the State Business Tax Climate Index.

Changing economic and political landscape

Historically, North Carolinas largest industries were

agriculture and manufacturing, and this economic
landscape shaped the tax code for the majority of the
20th Century. In 1921, the General Assembly enacted a
significant tax code overhaul that imposed a state personal
income tax, corporate income tax, and gas tax. They also
changed the property tax, mandating that it be a local-level
tax only.1 This was the first of what would be multiple
changes to the tax code over the 1920s and 1930s. This
system remained fairly unchanged over the next 80 years.
Manufacturing still has a large presence in the state.
Yet, over the last century, other sectors have grown in
significance. Real estate, finance, and insurance make
up a large part of the states economy, adding to growing
government, professional and business services, education,
and healthcare sectors. Agriculture and mining activities
are now among the smallest sectors in the states economy.2
Due to the changing economic landscape, legislators
recognized that the time had come to change the states
tax code. In 2002, then-Governor Mike Easley appointed
a 15-member panel to recommend reforms to North
Carolinas tax code. He noted that North Carolinas revenue
policy had been created during the Great Depression and

had hardly changed in more than 70 years. Cant we do

better? Easley asked. Cant we do better than what we did
70 years ago? Even though Democrats had overwhelming
control of state government at the time, the commissions
recommendations did not receive legislative approval.
A few years later the 2009 recession hit North Carolinas
economy particularly hard. Unemployment peaked at
11.3 percent and the state saw severe job losses across all
sectors. The following year, Republicans took control of
the legislature for the first time since the late 19th Century.
The 2012 election saw the return of a Republican controlled
legislature and also the election of Pat McCrory, the first
Republican governor since Jim Martin left office in 1993.

Tax Reform

Before 2013, North Carolina had surprisingly high tax

rates when compared to its neighbors in the Southeast.

Tax Changes, 2013 present

Individual Income
Replaced graduated rates with one flat rate
Lowered the individual income tax rate over
several years
Broadened the tax base by closing or limiting
many income tax credits and deductions
Expanded the Standard deduction
Repealed the state estate tax

Business Taxes
Lowered the corporate income tax rate over
three years with a further deduction subject to
a revenue trigger
Broadened the tax base by allowing many
credits to expire
Eliminated local business privilege taxes
Phased in single sales factor apportionment
which determines the percentage of a multi-state
operations total profits that are taxable, based
on the percentage of sales made in the state
Sales Taxes
Modestly broadened the sales tax base to
include certain service contracts and repair/
maintenance services associated with the
purchase of tangible personal property
Eliminated the state sales tax holidays
Eliminated special sales tax rates for
electricity, piped natural gas, amusements, and
entertainment

Spotlight #474: North Carolinas ranking on Tax Foundations State Business Tax
Climate Index

This was combined with narrow bases for many of the

taxes included in the Tax Foundations State Business Tax
Climate Index. After years of talking about tax reform
and unsuccessful attempts to modify the tax code by past
legislatures and governors, reform-minded legislators
were ready to tackle significant tax reform to help the state
rebound from a detrimental recession and ensure relative
stability during future downturns.
Legislators delivered on their promises and in 2013
enacted a historic tax reform package that lowered rates
and broadened tax bases. North Carolina became more
competitive among its neighbors and also set the standard
for how to successfully implement tax reform in todays
political climate. The legislature continued to build on those
successes in 2014 and 2015 by reducing tax rates further.
In addition to comprehensive tax reform, North Carolina
businesses can expect to see a drop in the unemployment
tax ranking in upcoming years thanks to prudent financial
management. In November 2015, Governor Pat McCrory
announced that the states unemployment reserve fund
had ballooned to $1 billion, meaning that businesses
across North Carolina will see the surcharges on their
state unemployment taxes drop in January 2016, resulting
in more than a half-billion dollars in tax relief.3

State Business Tax Climate Index

Every year the Tax Foundation publishes the State

Business Tax Climate Index, which allows taxpayers,
businesses, and policymakers to easily compare state
tax systems. This ranking of the states is not based on
how much is collected by certain taxes but how the states
structure their tax systems. If states wish to change their
tax structure or are debating the competitiveness of a tax,
this index is a tool frequently referenced as a source by
lawmakers on both sides of the aisle.
During the 2013 legislative session, North Carolina
lawmakers looked at the State Business Tax Climate Index
very carefully and framed their tax reform legislation to
make North Carolina more competitive relative to its
neighbors. At the time, the Tax Foundation ranked North
Carolina 44th in the country -- meaning that only six states
were less competitive than North Carolina.
The Tax Foundation estimates that, once all reforms are fully
phased in, North Carolinas overall ranking will be 13th best
in the country.4 According to the 2016 index, North Carolina
is now ranked as the 15th most attractive business tax climate.
While North Carolina ranks high on the index, the state
can increase its ranking even further. Property taxes and

unemployment insurance taxes are levied in every state, and

while changes can be made to these taxes, several states that
score the highest on the index do without one or more of those
types of taxes. Wyoming (#1), South Dakota (#2), Nevada
(#5), and Texas (#10) have no corporate or individual income
tax; Alaska (#3) has no individual income or state-level sales
tax; Florida (#4) has no individual income tax; and Montana
(#6) and New Hampshire (#7) have no sales tax.
That doesnt mean that North Carolina must discard one of
these taxes to make the top 10. For example, Indiana (#8)
and Utah (#9) both levy all major tax types but do so with
low rates on broad bases. That should be our ongoing goal.
Given where we started, becoming a top 10 state in the
State Business Tax Climate Index would be a remarkable
achievement for North Carolina. But the ranking is and
always will be a mere reflection of what should be our
ultimate goal -- to have the most competitive, pro-growth,
and fair tax code in the nation. Thanks to the tax reform
legislation passed in recent years, we are headed in that
direction.
Sarah Curry is Director of Fiscal Policy Studies
at the John Locke Foundation.
Endnotes

1. Roby B. Sawyers, Ph.D., CPA, The History of State and Local

Taxes in North Carolina Changes in Sources and Burdens,
November 28, 2006, ncleg.net/DocumentSites/committees/
FiscalModernization/Comission%20Meetings/Nov%2028%20
and%2029/Nov%2028%20Presentations/History%20of%20
State%20and%20Local%20Taxes%20in%20NC%20Paper.pdf
2. Bureau of Economic Analysis, Gross Domestic Product
(GDP) by State. GDP in current Dollars.

3. Barry Smith, Unemployment Insurance Surplus = $560 million

tax cut, Carolina Journal, November 12, 2015, carolinajournal.
com/exclusives/display_exclusive.html?id=12559
4. Liz Malm, North Carolina Illustrated, Tax Foundation,
November 5, 2015, taxfoundation.org/article/north-carolinaillustrated

Spotlight #474: North Carolinas ranking on Tax Foundations State Business

Tax Climate Index

Spotlight #474: North Carolinas ranking on Tax Foundations State Business Tax
Climate Index