Financing the Future Roland Stephen April 15, 2009.

Financing the Future

Roland StephenApril 15, 2009

Presentation Outline

• Who we are and what we did

• Changes in North Carolina’s Economy

• Problems with North Carolina’s system of revenue

• Elements of reform

Who We Are

• The Institute for Emerging Issues (IEI) is a public policy, think-and-do tank.

• We convene leaders from business, non profit organizations, government and higher education.

• We tackle some of the biggest issues facing North Carolina's future growth and prosperity.

What We Did• In 2005 IEI convened three working groups

• 2006 Emerging Issues Forum--options for reform

• Five Community Forums held across the state

• Many presentations to local government, chambers and community groups

• Participation in Study Commission

• Organized Business Committee on Financing the Future (BCFTF).

North Carolina’s Future

• Population Change: Urbanization, Composition, Dependency Ratio

• Economic Transformation: Knowledge and Service-based economy

• Financial Demands: Healthcare, K-12, Higher Education, Infrastructure

Shift to a Knowledge Economy

Sectors 1977 2005

Tobacco, Textiles and Apparel

22% 7%

Pharmaceuticals, Technology, Food

Processing, Banking, Auto Parts

10% 17%

% Share of NC’s Economy: Old Versus New Sectors

Source: North Carolina in the Connected Age by Michael Walden (UNC Press, 2008)

Financial Demands Medicaid expenditures have risen rapidly and will continue to rise as the population ages.

$0

$500,000,000

$1,000,000,000

$1,500,000,000

$2,000,000,000

$2,500,000,000

$3,000,000,000

1985-86 1990-91 1995-96 2000-01 2005-06

Financial Demands The cost of higher education will rise while the cost of new schools will be concentrated in rapidly growing urban areas.

6.0

10.0

14.0

2005 2010 2015 2030

Bill

ion

s o

f $

K12Higher

Critical Question

What are the tax policy implications of the dramatic changes facing North Carolina?

State Revenues: Problems

• Balance Among Sources

• Narrow Bases

• High Rates

• Complex

• Volatile

• Unfair

• Inadequate

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

Pe

rce

nt o

f C

orp

ora

te P

rofits

0.00

0.10

0.20

0.30

0.40

0.50

0.60

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f GD

PAs a Percent of Corporate Profits

As a Percent of GDP

State Revenues: Corporate Income Tax

State Revenues: Corporate Income Tax

Causes of shrinking base:

• State credits and exemptions

• Tax planning

• Federal policy (depreciation etc.)

Corporate Income Tax Rate (TY 2008)6.9 6.5

6 65.5

5

0

1

2

3

4

5

6

7

NC TN GA VA FL SCSource: Federation of Tax Administrators

State Revenues: Corporate Income Tax

Business Tax Burden (as % of GSP)

5.24.9 4.7 4.5

3.93.6

0

1

2

3

4

5

6

FL US SC TN VA NC*

Source: Ernst & Young, "Total State and Local Business Taxes: 50 state estimates for fiscal year 2008," January 2009.

State Revenues: Corporate Income Tax

State Revenues: Personal Income Tax

U.S.

General Sales & Gross

Receipts32.7%

Selective Sales14.9%

Licenses6.9%

Individual Income33.7%

Corp Net Income5.9%

Other Taxes4.0%

Property2.0%

North Carolina

General Sales & Gross

Receipts24.7%

Selective Sales16.2%

Licenses5.9%

Individual Income45.2%

Corp Net Income6.8%

Other Taxes1.2%

Top Marginal Income Tax Rate, Selected States, 2008

State Revenues: Personal Income Tax

9.50 9.30 9.00

7.757.00

5.75

0.00

2.00

4.00

6.00

8.00

10.00

12.00

VT CA* OR NC SC VA FL TN

tax r

ate

Source: Federation of Tax Administrators, March 2006.

State Revenues: Sales Tax

• Relies on a shrinking base.

• Regressive dependence on goods

• Complex

• Volatile

State Revenues: Sales TaxThe sales tax base is shrinking as percentage of the economy.

38

40

42

44

46

48

50

52

54

79 84 89 94 99 04

Pe

rce

nt

State Revenues: Sales Tax

The sales tax base rests on the more volatile component.

State Revenues: Sales Tax

As a result sales tax rates are constantly raised.

0

2

4

6

8

10

12

82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

Nu

mb

er

of

Ch

an

ges

Decreases

Increases

State Revenues: Sales TaxYet rate increases do not raise total revenues

0.0

0.5

1.0

1.5

2.0

Perc

ent

67 72 77 82 87 92 93 94 95 96 97 98 99 00 01 02 03 04

National sales tax revenues as % GDP.

State Revenues OverallHigh rates and narrow bases contribute to

volatility:

Year over Year Change in Tax Collections 1990 - 2008

-2

0

2

4

6

8

10

12

Total State Tax Collections for NC

Local Revenues and Responsibilities

• Match revenues to responsibilities.

• Ensure adequate state funding for state responsibilities (schools)

• Provide local revenues for new local responsibilities (roads).

State Revenues: Solutions

Comprehensive change to be achieved through:

• Balance among sources of revenues

• Broad base

• Low rates

State Revenues: SolutionsBCFTF Recommendations:• Explore alternative ways to tax corporations in

the place of an income tax • Use Federal Adjusted Gross Income for

calculating personal state income taxes and reduce rates

• Extend the sales tax to many services and previously exempted tangible items and reduce rates

• Local responsibilities should have adequate and appropriate sources of funding

“North Carolina needs a tax system that is competitive, stable, adequate and fair if we are to prosper in the 21st Century economy.”

If not now, when?

If not us, who?