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North Carolina has emerged as a formidable leader in tax competitiveness in the past decade. A standout example in the Tax Foundation’s State Tax Competitiveness Index, the state has ascended from a relatively low 44th place in 2013 to 12th in 2023. The reforms that fueled this ascent have been transformative: tax rates reduced, tax bases broadened, and burdensome incentives phased out. Corporate tax rates are now among the lowest in the nation, at 2.25%, and the personal income tax rate, set at 4.25%, is slated to fall further to 3.99% by 2026.
However, a key component of this reform, North Carolina’s tax reduction triggers, deserves a closer look. While the goal is admirable, the current system is overly rigid and may pose risks to long-term fiscal sustainability. It’s time to fine-tune this mechanism to align with the economic realities of the modern world.
North Carolina’s New Transportation Commerce Tax Takes Effect July 1, 2025
Tax Reduction Triggers: A Structured but Imperfect Mechanism
North Carolina’s 2023 tax reform law (S.L. 2023-134) established a clear path to reducing corporate and personal income taxes. By 2030, the corporate income tax will be eliminated, while personal income tax rates will be lowered through a trigger system, based on General Fund revenues exceeding specific thresholds.
The current formula allows for up to three personal income tax reductions between 2027 and 2034, provided the state’s General Fund revenue exceeds pre-determined targets. For instance, if the 2025-26 fiscal year revenues surpass the $33.042 billion threshold, taxpayers will see a reduction of 0.5 percentage points to a 3.49% rate in 2027.
While the mechanism promotes fiscal discipline, tax reductions only occur if the state has sufficient funds; its inflexibility risks undermining North Carolina’s long-term fiscal health.
The core issue lies in the rigid, fixed revenue targets set by statute. These targets are set without accounting for crucial economic factors such as inflation, population growth, or macroeconomic fluctuations. For instance, inflation in recent years has regularly exceeded the Federal Reserve’s target of 2%, reducing the real value of these revenue thresholds. Furthermore, shifts in federal policy, such as reductions in state transfers and adjustments to tax cuts under the Tax Cuts and Jobs Act (TCJA), could create additional revenue unpredictability.
The lack of flexibility in the current framework could lead to tax cuts being triggered at inopportune moments, potentially straining public services and creating fiscal instability during economic downturns.
Refining the Trigger Mechanism for Sustainable Tax Reductions
To build a more sustainable, adaptable tax reduction framework, North Carolina’s policymakers should consider several refinements:
1. Inflation Adjustment
The most immediate step should be to adjust the revenue thresholds for inflation. This could be done by resetting the existing thresholds to reflect inflation since the law was enacted and then indexing future thresholds to a reliable economic metric, such as the Consumer Price Index (CPI) or the GDP deflator. This adjustment would help maintain the purchasing power of the state’s revenue collection, ensuring that tax cuts do not outpace the state’s ability to fund essential services in an inflationary environment.
2. Population Growth Adjustment
North Carolina’s population has grown significantly over the past decade, with a surge in new residents seeking infrastructure, education, and public services. The state’s current revenue targets do not account for this increasing service demand. Introducing a population growth metric into the trigger system would allow North Carolina to better align its tax policies with the growing fiscal demands of a larger population. This would enable the state to continue offering high-quality public services while reducing taxes sustainably.
3. Rainy Day Fund Contingency
To build additional fiscal resilience, North Carolina should consider implementing a safeguard that requires the state’s rainy-day fund to be fully funded before further tax cuts are triggered. This would ensure that the state has sufficient reserves in times of economic uncertainty to weather unexpected challenges without resorting to tax hikes or service cuts.
These changes would create a more responsive, responsible framework for tax reduction that adapts to the state’s evolving economic and demographic realities.
Balancing Growth with Fiscal Prudence
North Carolina has successfully created a pro-business, pro-growth tax environment, and its reforms have attracted businesses and individuals alike. However, the current rigid framework for tax reductions risks undermining these gains. With unpredictable economic shifts, a static trigger system could trigger tax cuts at the wrong time, potentially leading to reductions in essential services or strained public finances.
A more flexible system is necessary to pause tax reductions when the economy is underperforming and only proceed when the fiscal conditions are favorable. The alternative, relying on lawmakers to pause the triggers, creates the potential for political gridlock or the outright elimination of tax reductions. This move could endanger the progress the state has made.
By making these refinements to the trigger mechanism, North Carolina can continue to offer competitive tax rates while ensuring fiscal stability and meeting the growing needs of its population. In this way, the state can preserve its pro-growth climate without sacrificing the essential public services that support long-term prosperity.
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