Prosperity Watch Issue 35, No. 2: Erosion of North Carolina's Corporate Income Tax Contributes to Revenue and Budget Challenges

North Carolina is seeing a steady erosion of a critical pillar that supports the state’s revenues and public investments. North Carolina’s corporate income tax (CIT) generates the third largest source of General Fund revenue within the state’s tax system. Together with the personal income tax and the state sales tax, the three taxes have historically represented around 90 percent of total annual General Fund revenue. While revenue raised from the CIT is relatively small compared to the two more prominent taxes, this revenue plays an important role in funding public investments such as education, healthcare services, public safety, environmental protection, and economic development initiatives.

Unfortunately, the share of General Fund revenue raised through the state’s CIT has steadily declined over the last two decades. In 1990, around 9 percent of total General Fund revenue came from the CIT. However, for FY 2014, the CIT is projected to raise around 6 percent of total General Fund revenue. (See chart) As revenue from the CIT has declined over time, the state’s tax system has relied more on its personal income tax and sales tax for revenue needed for public investments.

 

The tax plan passed by the NC General Assembly and signed into law by Governor McCrory last year includes multiple CIT rate cuts that will further reduce the amount of revenue raised from the tax. For 2014, the CIT rate is cut to 6 percent from 6.9 percent. The tax rate is further reduced to 5 percent for 2015. If General Fund revenue targets are met in subsequent years, the CIT could be reduced further to as low as 3 percent by 2018.

The two initial CIT rate cuts will reduce annual revenue by $343 million dollars by FY 2016. State policymakers chose not to fully offset these costly CIT rate cuts by closing existing corporate tax loopholes, and this contributed to the final tax plan reducing annual revenue by $650 million.

Less state income taxes paid by corporations mean other businesses and North Carolinians will pay more taxes, further cuts to important public investments, or a combination of both. The tax plan passed last year made North Carolina’s already upside-down tax system even worse. State leaders can begin to address this outcome in part by stopping the next corporate income tax rate reduction included in the tax plan for 2015. These corporate tax cuts are unlikely to create jobs or spur the state’s economy and will further challenge the state’s ability to invest in the foundations of economic growth.
 

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