‘Taxes Ought To Be Fair’ But Are They?
When North Carolina’s current tax code was written, many families were so poor they had to eat cornmeal mush and pig carcasses to survive, banks across the state were closing their doors and a charismatic new president, in his first address to the nation, declared that the only thing people had to fear was fear itself.
That was the early 1930s, a time when the country was in financial collapse and the states were desperate to meet burgeoning social demands.
To stem the financial losses, North Carolina’s legislature took what was considered drastic action and established a sales tax on tangible goods such as furniture, machinery and merchandise. It was only the second or third state to enact such a tax.
Now, 70 years later, the state could make tax history again.
In the midst of one of the worst budget messes in decades, Gov. Mike Easley is one of many officials considering drastic changes to the tax system. Some people hope such changes could ease the state’s current fiscal crisis — a shortfall of more than $ 1.2 billion projected for the fiscal year beginning July 1
— and what inevitably lies ahead.
If such an overhaul took place — one that, for example, could add taxes on now-untaxed services such as haircuts, legal advice, a mechanic’s labor on your car or telecommunications services — then millions upon millions of new revenue dollars would pour into state coffers.
But some people wonder whether these changes would place an unfair burden on taxpayers or on the service providers who would have to add the tax or take a loss to comply. After all, said David Hoyle, the Gaston County Democrat who is co-chairman of the Senate Finance Committee, “Taxes are the price we pay to live in a civilized society, but taxes ought to be fair.”
Earlier this spring, Easley asked a new, 15-member task force for recommendations to help guide budget decisions for the short legislative session that begins May 28. The group was also told to report back in time for next year’s long session about whether the current tax code is fair, whether it needs an overhaul, what could be done to the tax structure to increase the state’s revenue and how much money might be expected if changes were made.
The Commission to Modernize State Finances, which includes lawmakers, local government officials, businesspeople and academics, has met twice as a full group; its three subcommittees have each met at least twice. It will make recommendations to the governor by mid-May, and he will in turn make recommendations to the legislature on what should be done.
“We are competing in a new ballgame today, and it is time that we leveled the playing field,” Easley said in his welcome address to the commission members. “You have a chance to develop a new code that allows us to properly meet the needs of our people now and in the future, and generate enough savings to cover unforeseen emergencies.”
History suggests it won’t be an easy process. Florida voted in 1986 to tax services, prompting such a revolt, including numerous lawsuits by corporations, that the legislation was repealed. Same thing happened in Massachusetts a couple of years later. In fact, though some states including Hawaii and New Mexico tax a limited number of services, no state has successfully established a broad-based plan similar to what could be on the table here.
On the other hand, numerous states experiencing the same fiscal crunch as North Carolina are looking into the possibility, too. Those states include Tennessee and Oklahoma.
“Almost all the states need to take a hard look at their tax systems to measure how well they measure up to modern economies,” said Ron Snell, director of the economic and fiscal division of the National Conference of State Legislatures in Denver.
“It’s an issue that dates back more than a decade. The economy has changed. The things we do have changed. All those are gradual, but they have caught up with us, and they are more visible at a time of economic slowdown.”
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A triple focus
Each member of the governor’s commission belongs to a subcommittee. That’s where all the work will be done. One committee is focusing on the relationship between the state and local governments and on whether the division of services provided by each, as established during the Great Depression, still makes sense. A second is studying whether it is possible to simplify tax law by drafting less complicated forms. And the third is considering “New Economy” issues, which means two
things: the losses the state fears it is suffering to untaxed Internet sales and the changes in what has driven the economy over the decades, namely from an agriculture- and manufacturing-based system to one based on services.
That last one is a potential doozy, as far as taxpayers are concerned.
“It’s a difficult problem that North Carolina and all the states face,” said Ben Russo, an economist at the University of North Carolina at Charlotte and a commission member. “There’s a great deal of concern about the volatility and reliability of different taxes. And particularly, there’s a concern that the Internet and the move toward services is going to make it more difficult for states to maintain their tax bases. And of course these things always become very urgent when there is a recession or there is a downturn in tax revenues.”
Here’s the crux of the issue:
In the ’30s, in response to the Depression, legislators imposed a 3 percent retail sales tax on tangible goods. The state used much of the money to pay for public schools and prisons, which until then had been the counties’ responsibility, according to Charles D. Liner, a tax historian and professor in the Institute of Government at UNC-Chapel Hill.
Save for increasing the tax — it’s now 4.5 percent for the state and 2 percent for most counties — that system has remained relatively unchanged.
What’s different is the economy.
As the decades have progressed, many of the industries that have built our roads and sent our children to school — farms, mills and factories — have closed down or packed up and moved offshore. And a new kind of industry has cropped up: services.
Once upon a time, a farmer would go to the general store and buy goods or equipment, then do all the work on the farm himself. A textile mill would sell a physical product, such as bale yarn or gingham. All tangible, taxable goods.
Even on the consumer side, a man might head to the local car dealer and buy himself a Packard, a Chevy, even a Caddy. When the car broke down, the owner often would pop the hood and fix it himself. But those days are over. Unless someone has a ’76 Dodge Dart or understands the intricacies of the modern automobile’s computerized brain, he’s not going to be able to fix his own car. So he turns to a mechanic to do the job.
That’s a service, and one on which the state doesn’t collect taxes. Landscapers, house cleaners, hairdressers, mechanics, consultants, interior decorators, plumbers, accountants, personal trainers — all of them provide a service. In fact, nearly 60 percent of the nation’s economy is made up of service industries, up from 45 percent 20 years ago. Nearly none of it is taxable.
That is what Easley thinks he might want to change.
The result? For professional services rendered in North Carolina, (lawyers’ fees, for example) preliminary estimates suggest a new tax would bring the state treasury $ 220 million a year at the current 4.5 percent state sales tax rate, according to David Crotts, a senior analyst with the fiscal research division of the N.C. General Assembly.
For nonprofessional services (such as an auto mechanic’s or electrician’s fee) the state would collect $ 97 million.
If state legislators were to add the local portion of the sales tax (which they could decide not to do), that would mean an additional $ 141 million collected, for a grand total of $ 458 million in new annual taxes.
“As we have shifted more and more and more to a services-based economy,” said E. Norris Tolson, secretary of the state Department of Revenue, “we find ourselves eliminating ourselves from a fairly significant pool of taxes. If you go down and buy a lawnmower to cut your grass, you pay taxes. If you hire a service company, you don’t pay a tax on that.
“That’s what we’re talking about,” he said. “People … demand more and more services because we are more affluent.” And perhaps we should have to pay for those to make the system fair, he said.
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Tax foes wary
This isn’t the first time Easley has turned his attention to examining the tax code.
About 12 months ago, he appointed a loophole-closing commission to hunt down gaps in the code and recommend fixes to the General Assembly. Lawmakers adopted 95 percent of the recommendations, including a measure that eliminated a tax loophole on interstate long-distance telephone use. Before, if someone in Gastonia called Raleigh on a wired phone, the call was considered long-distance and subject to a 6.5 percent tax. Such a call on a cell phone wasn’t taxed. Now, both are taxed at 6 percent, which generated $ 90 million in revenue for the state in 2001.
Another example is the tax on satellite TV services. Before, only cable television service was subject to a tax; now, both are.
Anti-tax evangelists cite this as a reason to be wary of this newest commission. They see it as one more attempt to clean up the state’s financial mess simply by pulling more pennies out of taxpayers’ pockets.
“Their idea that we’re going to solve the problem by raising more revenue is absolutely ridiculous. We’re about to tax ourselves out of prosperity,” said Jonathan Hill, state director of the nonpartisan Citizens for a Sound Economy. “Until somebody tells me that they’ve cut the spending they need to cut, I don’t want to hear about any more tax increases, anywhere.”
He’s willing to listen to proposals from the modernization committee for new taxes if it also recommends cutting taxes somewhere else to even out the impact.
“Then that may be an adequate way to face it, as long as we’re not facing taxes in general,” Hill said. “I will be more than open … but at first blush, we believe that we should cut spending before we start talking. We can’t solve problems by taking more taxes out of people’s pockets. The governor should know better.”
In fact, altering the overall tax rate is exactly what could happen. In other words, the sales tax rate could decrease if the tax base significantly increased. Easley has acknowledged as much.
“What good tax policy means is that you broaden the base and you keep the rate as low as possible,” said Dan Gerlach, a budget analyst and the governor’s key staffer on the modernization committee. “And that’s what we want to do. … You have to do it as part of a package. There are people who benefit unfairly from the tax code, and there are people who are not treated fairly by the tax code. We want to make sure people are treated fairly.
“It’s very tricky,” he said. “We’re not saying any of this is easy.”
In search of the answers to these questions, the committee and its subcommittees will continue their work in meetings that are open to the public. Once they make their recommendations, then the real debate can begin.
“Whenever you change anything, someone is going to get hurt, and then they have a reason to try to prevent the change. So this is an awfully difficult issue that the state is dealing with,” said Russo, of UNC-Charlotte. “It’s a good thing, because technically changes are what improve the standard of living, but at the same time, they raise hell for the people who have to run the state.”
Revenue Secretary Tolson, who is not directly involved with the governor’s committee but who has lent his staff to its cause, had a similar prediction: “Will it be a massive overhaul? I have no clue. Will it take a long time? I suspect it will.
“Once you get a proposal on the table, then you’ve got to start worrying about, ‘OK, whose ox have we gored?’,” he said. “And we’re going to find out pretty quick.”
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