Policy Documents

Tip Sheet: State Income Tax Reform

August 1, 2013

State Income Tax Reform         

Problem

Income taxes are considered by many economists to be the most destructive tax, stunting economic growth by taking dollars out of the hands of consumers and businesses and stifling production, innovation, and risk-taking, the main factors driving economic growth. 1

High personal and corporate income taxes are a deterrent to economic development, discouraging new businesses and high-income earners from moving into a new market while encouraging current businesses to leave. High taxes also discourage new capital from coming to a state. 2 

According to recent studies, states with no income tax or those with lower income taxes have performed better economically and have seen greater job and population growth than those with higher taxes.3

Solution

In 2013, many states across the country considered major tax reform proposals that would reduce their reliance on income tax revenue and encourage businesses to move to their states with tax policies friendly to economic growth.  

North Carolina recently passed a comprehensive tax reform plan that is receiving positive attention from many residents, businesses, and public policy groups. The tax reform flattened and lowered both individual and corporate income taxes by eliminating and limiting some exemptions. North Carolina’s bold and decisive reforms should serve as a model for other states to follow.4

Lowering personal and corporate income taxes could dramatically improve a state’s economy while generating new jobs. The ideal reform for state income taxes would be to eliminate them altogether. Barring that, states should lower and flatten their tax systems with as few tax brackets as possible. This can be done in many ways including limiting the growth of spending and devoting budget surpluses to income tax cuts.

States can start lowering their corporate tax by eliminating corporate tax exemptions, subsidies, and credits, thereby creating a fairer, more stable fiscal system for state government while promoting long-term growth for all industries.

Policy Message

  • Point 1: High income and business taxes are a deterrent to economic development by discouraging higher-income earners and new capital from moving into a state.
  • Point 2: All taxes should be applied to a broad base and maintained at a low and economically competitive rate.
  • Point 3: Any income tax must be transparent to taxpayers. The corporate income tax is a hidden, non-transparent tax; eliminating it would force legislators to rely on other, more transparent, taxes. 
  • Point 4: Eliminating corporate income taxes benefits low-income families to an even greater degree than cutting or eliminating the personal income tax, as many low-income families already take advantage of numerous credits and deductions from the personal income tax.
  • Point 5: Maintaining a complex income tax code imposes high administrative costs on the government and high compliance costs on businesses and individuals.
  • Point 6: High taxes on high-income earners encourage the wealthy to move to lower-taxed states, bringing much of their income, capital, and ultimately tax revenues with them.
  • Point 8: A recent study by the Americans for Tax Reform Foundation found, “Each positive 1 percentage point tax burden differential between states decreases the ratio of income migration into the high-tax state by 6.78 percent in a given year.”5

References

1. “What Is the Evidence on Taxes and Growth?” Tax Foundation. http://taxfoundation.org/article/what-evidence-taxes-and-growth

2. “Ten Principles of State Fiscal Policy,” The Heartland Institute. http://heartland.org/policy-documents/ten-principles-state-fiscal-policy

3. “Institute Brief—No Income Tax: The Key to Economic Growth,” Public Interest Institute. http://heartland.org/policy-documents/institute-brief-no-income-tax-key-economic-growth

4. “Governor, Senate, House Reach Historic Deal on Tax Reform,” Office of Governor Pat McCrory. http://www.governor.state.nc.us/newsroom/press-releases/20130715/governor-senate-house-reach-historic-deal-tax-reform#sthash.O9fS8ygB.dpuf

5. “State Income Migration and Border Tax Burdens,” Americans for Tax Reform Foundation. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023511