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A creative reform approach: The USA Tax

Consumption tax addresses N.C.’s economic problems

By John Hood
Special to the Observer

RALEIGH North Carolina’s economy remains in dire straits.

Since the onset of the Great Recession, North Carolina has suffered one of the nation’s highest unemployment rates. Even earlier than that, however, our much-vaunted “Dixie Dynamo” economy was sputtering. Our growth in per-capita income and GDP has been subpar since the late 1990s.

Why is fundamental tax reform, an issue that languished in Raleigh for decades, now at the top of the state’s political agenda? Because a new generation of leaders in both the legislative and executive branches accepts the reality that North Carolina must make its economy more competitive – and that tax reform can help accomplish that.

It’s no panacea, admittedly. The causes of North Carolina’s economic decline are numerous and complicated. But part of the answer lies in making our state a more attractive place to work, invest and create new businesses.

The wrong solution

Some claim that state taxes are too small to affect economic growth, or that raising taxes to finance more government spending would be a better strategy for economic recovery. They are simply wrong.

The academic literature on state fiscal policy has expanded significantly over the past decade. It reveals that tax rates do affect growth, and that higher marginal tax rates on total personal and corporate income do the greatest damage to the economy by discouraging savings and investment. More generally, careful studies show that the cost of doing business – including labor, energy, regulatory compliance and taxes – is the key lever that moves economic decisions.

We should fund most state services with a broad-based tax on consumed income, rather than our current practice of taxing both consumed and invested income. Some conservatives believe that the only way to do this is to abolish the entire income tax system and impose a high sales tax on all goods and services sold at retail.

But this option has severe drawbacks. Attempting to tax transactions in the Internet age offers a 20th-century solution to a 21st-century problem. Furthermore, the current version of this idea would replace our current $1.7 billion in taxes on corporate income and franchises with a new $4 billion net-worth tax that would give North Carolina one of the highest business-tax burdens in the country.

Two alternatives

There’s a better way. The John Locke Foundation recommends a form of consumption taxation called the USA Tax, for Unlimited Savings Allowance. It allows households to subtract their net savings and charitable giving from their net income, and pay tax on the remainder – which is, by definition, the amount spent on retail goods and services.

We offer two options. Plan A replaces North Carolina’s current state taxes on personal income, corporate income, retail sales and estates with a USA Tax of 8.5 percent. There would be no new administrative burdens for businesses acting as unpaid tax collectors for government.

Indeed, Plan A would significantly alleviate those burdens, while resolving the tax discrepancy between online vendors and brick-and-mortar retailers.

Our Plan B is a bit less ambitious. It retains the state sales tax, albeit at a lower rate of 4.5 percent, and replaces current personal income, corporate income and estate taxes with an USA Tax rate of 6 percent.

Both plans would lead to thousands of new jobs in North Carolina, according to an independent assessment by economists at Suffolk University in Boston.

By combining the best features of the state’s two biggest revenue sources – the collection system of the income tax and the consumption focus of the sales tax – the USA Tax offers a creative solution to a longstanding problem that North Carolina can no longer afford to ignore.

Charlotte native John Hood is president of the John Locke Foundation. You can read more about the proposed USA Tax plans at www.JohnLocke.org.
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