While most state legislatures are finished for the year, lawmakers in a few states have gone into overtime, spending their summers in windowless rooms working to finalize state budgets for a new fiscal year that began over two months ago. Of the handful of states where lawmakers have been working to finish overdue budgets, three of them – North Carolina, Alabama, and Pennsylvania – took significant steps in recent days to resolve their impasses, some of which are good for taxpayers, some bad, and some that are simply inept.
The Good: North Carolina
After 11 weeks of negotiations, legislative leadership in the North Carolina House and Senate announced a final budget deal early last week that was subsequently approved by both chambers. The new budget, which was signed into law by Gov. Pat McCrory (R) on Friday, will further reduce income tax rates and build upon a successful record on tax reform in the Tar Heel State. The historic tax reform plan enacted in 2013 – referred to by Tax Foundation economist Scott Drenkard as one of the top three “most beneficial state tax reforms in the last decade” – took North Carolina’s progressive income tax, with it’s 7.75 percent top rate (then the highest income tax in the Southeast) and moved to a flat 5.75 percent income tax. The new budget finalized last week will take the rate down further, to 5.499 percent in 2017. Due to this change, North Carolina will soon have a lower income tax rate than neighboring Virginia and all other bordering states with the exception of Tennessee, which does not impose a tax on wage income.
The new budget includes $2.8 billion in income tax relief for North Carolinians over the next five years. While part of this will be offset by expansion of the state sales tax to some services, the overall budget provides a net tax cut. In addition to allowing North Carolinians to keep more of their income, the new budget will also increase job-creating capacity for the more than 800,000 North Carolina small businesses that file under the individual income tax system.
The new budget also makes a change to North Carolina’s corporate tax apportionment formula that will benefit many in-state employers. Until recent decades, businesses in most of the country calculated state corporate tax liability using a formula based on a company’s in-state property, payroll, and sales. However, many states have moved to a new formula in recent years, under which a company’s state corporate tax liability is based on the share of total sales that occur in-state. This is referred to as the “single-sales factor” formula for state corporate tax apportionment. Tennessee Sen. Mark Green (R), who has introduced a bill that would implement the single sales factor system in the Volunteer State, points out that the old apportionment formula punishes investment and the hiring of new workers. North Carolina’s move to a single-sales factor formula, as Green puts it, removes a “disincentive for businesses to create high paying jobs and invest in property.”
North Carolina’s corporate tax rate, which stands at 5 percent today, will drop to 4 percent next year in accordance with the 2013 tax reform act. If revenue triggers are met, North Carolina’s corporate tax rate will drop to 3 percent in 2017, giving it the lowest corporate rate among the 43 states that levy such a tax. The additional income tax relief included in North Carolina’s new budget will build on the successful reforms of 2013 and make the state even more economically competitive.
The Bad: Alabama
Like North Carolina, Alabama is a state where Republicans control both chambers of the legislature and the governor’s mansion. However, while tax rates are going down in North Carolina, they’re going up in Alabama thanks to the new budget approved by legislators last week.
Alabama Gov. Robert Bentley kicked off the year by proposing more than $700 million in higher taxes, targeting car owners, smokers and vapers, public utilities, insurance companies, financial institutions, and corporations. As part of his push for higher taxes on Alabama residents, Bentley threatened to defund local projects in the districts of legislators who opposed him. Alabama’s Yellowhammer News describes how Bentley’s drive for higher taxes this year flies in the face of his top campaign commitment to voters, which was his promise to the people of Alabama that he would not raise taxes if elected:
During a 2010 gubernatorial campaign debate, then-state Rep. Bentley unequivocally said ‘I am not for raising taxes,’ citing tax hikes’ negative impact on businesses. ‘When you hurt businesses and you tax businesses, you’re going to lose jobs and we need to be creating jobs,’ he said. He went a step further and signed Americans for Tax Reform’s ‘Taxpayer Protection Pledge,’ committing himself in writing to opposing all tax increases. During his most recent campaign, Bentley’s re-election ads also prominently displayed the words ‘No New Taxes.’”
Lawmakers resisted Bentley’s campaign for higher taxes throughout the regular session and the first special session in August. However, up against a budget deadline last week, Republicans in the legislature relented, voting to give Bentley $86 million in higher taxes. This represents a tax hike that is less than one-eighth of what Bentley sought at the beginning of the year and $174 million less than Bentley asked for during the first special session.
Of the $86 million in higher taxes approved by Alabama legislators, $70 million comes comes from a 25 cent per pack cigarette tax hike. The remaining $16 million comes from a nursing home and prescription drug tax increase. Since tobacco taxes are a declining source of revenue, cigarette tax hikes often serve as a placeholder for further tax hikes on the broader populace. Alabama lawmakers end their budget standoff having made state finances more reliant on people continuing to smoke, with a tax hike that disproportionately hits low-income Alabama residents.
The Ugly: Pennsylvania
While North Carolina and Alabama are under unified GOP control, another state where lawmakers have been working to end a summer budget standoff, Pennsylvania, has divided government. At the same time Democrats captured the Pennsylvania governor’s mansion last November with Tom Wolf’s defeat of then incumbent Gov. Tom Corbett (R), Republicans increased their majorities in the state legislature. The GOP also improved its leadership in the state senate when the more conservative Sen. Jake Corman ousted Sen. Dominic Pileggi, a union-funded Republican from the Philadelphia suburbs, as majority leader.
Gov. Tom Wolf (D) began his first year in office calling for a $4.5 billion tax hike, which would be the largest tax increase in Pennsylvania history. Wolf has proposed a severance tax on natural gas extraction, despite the fact that the industry is already singled out with a special tax enacted in 2012, referred to as an impact “fee.” Wolf also introduced a 20 percent income tax hike and a 10 percent sales tax increase. To their credit, Republicans in the legislature have stood strong all year in opposition to Wolf’s push for a massive tax hike.
Now, more than two months into the fiscal year with no budget, legislative Republicans are moving to pass a short-term budget, which was approved by the Senate last week and will be taken up by the House this coming week. Wolf has said he will veto the stopgap budget that Republicans are preparing to send to his desk.
It’s unclear how or when Pennsylvania’s budget standoff will end. As the Pittsburgh Post-Gazette editorial board described it on Friday, “the governor and the legislature are nowhere on reaching a 2015-16 budget accord.” What is clear is that elections have consequences, and the consequence of last year’s election is that Pennsylvania taxpayers now have a governor who wants to pile onto the more than 20 federal taxes approved over the last six years with billions more in higher state taxes, thinks selling booze is a core function of government, and that increased competition in the market results in higher consumer prices.
While North Carolina continues to be a national model for tax reform, Alabama lawmakers and Pennsylvania’s governor demonstrate what not to do. As Americans for Tax Reform president Grover Norquist says, “no state is a total failure, some just serve as bad examples.”
Patrick Gleason, originally from North Carolina and an alumnus of N.C. State University, is director of state affairs at Americans for Tax Reform and a senior fellow at the Beacon Center, a free-market think tank based in Nashville, Tenn. Follow Patrick on Twitter @PatrickMGleason. Paul Blair, state affairs manager at Americans for Tax Reform, contributed to this article, which originally was published Sept. 20 at Forbes.com.