North Carolina's tax system has evolved significantly since the American Revolution, reflecting economic, social, and political changes, with ongoing debates about balancing tax cuts with funding public services.

North Carolina Department of Revenue in Raleigh, NC.

By Joshua Peters

North Carolina’s tax laws have undergone significant evolution, much like those of many other states, since the American Revolution, which was fueled by the cry of “No taxation without representation.” This evolution mirrors the broader economic, social, and political shifts within the state. This article offers a brief overview of the historical development of North Carolina's tax laws, highlights key figures who have shaped its tax policies, examines the main tax categories currently in place, explores how tax revenues are allocated, and delves into ongoing debates about potential tax reforms and what a solution could entail.

Historical Development of North Carolina Tax Laws

North Carolina’s tax system has its roots in the colonial era, where taxes were initially levied on land and personal property to support the colonial government. After the American Revolution, the state adopted a new tax system, which included property taxes and various excise taxes. The need to finance the state’s war debt and maintain essential public services drove the early development of these tax laws.

In the 19th century, as North Carolina transitioned from an agrarian to a more industrialized economy, the state’s tax system expanded. The introduction of corporate income taxes in the late 19th century marked a significant shift, reflecting the growing importance of manufacturing and commerce in the state. One of the earliest influencers was Governor John Motley Morehead (1841-1845), known for advocating infrastructure development funded by state revenues.

The early 20th century saw the adoption of sales taxes, which became a primary revenue source for the state. The Great Depression, however, placed immense strain on the state’s finances, leading to significant reforms, including the introduction of the personal income tax in 1921 by Governor Cameron Morrison (1921-1925). This period also saw the state take on greater responsibility for funding public education and set the foundation for modern tax policies in North Carolina.

In more recent history, Governors Jim Hunt (1977-1985, 1993-2001) and Pat McCrory (2013-2017) made notable contributions to tax policy. Hunt’s administration focused on improving public education and economic development, which required a stable tax base, while McCrory’s tenure was marked by significant tax reforms aimed at reducing the state’s income tax rates to stimulate economic growth.

Main Tax Categories in North Carolina and Allocation

North Carolina’s tax system today is composed of several key categories:

• Income Tax: The state imposes a flat income tax rate, which, as of 2024, is 4.75%. This rate applies to all taxable income, with certain deductions and credits available for residents.
• Sales Tax: North Carolina has a combined state and local sales tax rate that varies by county. Local rates add an additional 2-2.75%, making the total sales tax rate range from 6.75% to 7.5%.
• Property Tax: Property taxes are levied at the local level and are based on the assessed value of real estate. These taxes are a crucial source of funding for local governments, particularly for public education and infrastructure. The mean property tax rate in North Carolina is roughly 0.77% of a property’s assessed fair market value.
• Corporate Income Tax: North Carolina’s corporate income tax rate is 2.5%, one of the lowest in the nation, reflecting the state’s pro-business stance.
• Excise Taxes: These are taxes levied on specific goods such as alcohol, tobacco, and motor fuels. The amount of excise tax varies based on the unit of measure (e.g., per gallon for fuel, per pack for cigarettes, per liter or gallon for alcohol) and the quantity of the goods being sold. These taxes are often earmarked for specific purposes, such as funding transportation infrastructure from motor fuel taxes or public health programs from tobacco and alcohol taxes.

The revenue generated from these taxes is used to fund a variety of state services and initiatives. The largest portion of North Carolina’s tax revenues goes to public education, including K-12 schools and higher education institutions. Healthcare, particularly Medicaid, also consumes a significant share of the state budget. Other areas of expenditure include public safety, transportation infrastructure, and social services.

The allocation of tax revenues is a reflection of the state’s priorities, with a strong emphasis on education and public welfare. However, this allocation is often the subject of political debate, particularly in times of economic downturn or budget shortfalls.

Current Debates and Proposals for Tax Reform

In recent years, there has been considerable debate in North Carolina around lowering tax rates further, particularly the personal income tax. Proponents of tax cuts argue that reducing tax rates will make North Carolina more competitive, attract new businesses, and stimulate economic growth. They point to states like Florida and Texas, which have no state income tax, as models for fostering a business-friendly environment.

Opponents of further tax cuts, however, warn that reducing tax rates could lead to significant budget shortfalls, threatening funding for essential services like education and healthcare. They argue that the state’s recent economic success is due, in part, to its investments in these areas, and that cutting taxes too deeply could undermine long-term growth and prosperity.

One of the most significant proposals under discussion is a gradual reduction in the state’s income tax rate, with the ultimate goal of eliminating it altogether. This proposal has garnered support from conservative lawmakers and business groups but faces stiff opposition from those concerned about the potential impact on public services.

Potential Solution to the Current Debate

Balancing the need for state-provided social services with the desire to foster personal economic activities is a central challenge in tax policy. The Laffer Curve, a concept in economics that illustrates the relationship between tax rates and tax revenue, offers a framework for addressing this challenge. By finding the optimal point on the Laffer Curve, North Carolina can aim to set tax rates that maximize revenue without stifling economic growth, thereby supporting both public services and personal economic freedom. This balanced approach would ensure that the state continues to provide high-quality social services, such as education and healthcare, while also cultivating a dynamic and thriving economy.