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Senate | March 11, 2015 | Committee Room | Finance Meeting

Full MP3 Audio File

We’ve got most of the members ??. You may be slow, but you’re not old. Sit down, sir. Bill Cooks here. I know that your committee went way overtime, Colonel, and that’s why we’re late. Yes sir, you did. You went up to 1 o’clock, but that’s alright. It wasn’t your fault. Can’t blame a senator for anything; they won’t take it. [SPEAKER CHANGES] Some of the questions were kind of longwinded. [SPEAKER CHANGES] Well those are the answers. [SPEAKER CHANGES] The answers were worse. [SPEAKER CHANGES] I asked Dr. Scott ??, whom I love and admire, what time it was, and he told me how to make a watch. That’s the only thing I’ll say about that, Colonel. We’ll call the meeting to order of the finance Committee today, and I don’t have a list of pages, but I feel like we’ve got some here, and stand up, pages. Give us your name and where you’re from. [SPEAKER CHANGES] ?? from Raleigh. [SPEAKER CHANGES] Raleigh. [SPEAKER CHANGES] ?? from Moncure. [SPEAKER CHANGES] Moncure? That’s in Chatham County, and most people have no idea where Moncure is. [SPEAKER CHANGES] ?? from Winterville. [SPEAKER CHANGES] Winterville. That’s over near… [SPEAKER CHANGES] What county’s that in, Mr. Chair? [SPEAKER CHANGES] That’s in South Carolina. Yes sir. [SPEAKER CHANGES] Steven Brown, Cerro Gordo. [SPEAKER CHANGES] Cerro Gordo. And I know most of you, unless you’re from down towards the beach, have no clue where Cerro Gordo is. I caught fish down there. Our Sergeant-At-Arms today, I’ve got Canton Lewis and Marcus Kitts, and we thank you. I don’t have any other Sergeant-At-Arms here, but they always do a great job for us, and the purpose of this meeting today is to go ahead with the presentations and the in-service training that we’ve been receiving on operations of finance and the issues that are important to today, and we’ll move into that with Cindy Avrette from the Research Division. We’re going to be looking at the general fund revenues sources today, and before she starts, I’m going to tell you something my grandpa told me one time. He said “Son, I’ve spent 80% of the money I ever made on liquor and women, and I wasted the other 20%.” Go ahead, Cindy. [SPEAKER CHANGES] Good afternoon. The Chair’s asked us to give you – Jonathan and I, to give you a general overview of the state and local revenue sources, and it’s going to be a very high-level overview because most of you are pretty much familiar with what they are, but when you’re thinking about the state and local revenues, it’s sort of… you need to keep in mind that we do have three levels of government and that the state may do anything, may enact any laws except those that are limited by federal law or the North Carolina Constitution, but a county and a city only has the authority to do and to impose the taxes that this general assembly says and authorizes them to do. When you look at who’s responsible for what, because when you look at revenues, you’re trying to allow these governmental units to raise the revenue it needs to take care of the responsibilities that they have, and of course you can just… in a very general picture, you can say “Well what are the responsibilities? How are they divided up between the state, the county and the city?” Very simplistically, back in the 1920s, the state took over many of the responsibilities that in some states are at the local levels, such as education, prisons, courts and roads. Counties by and large have the responsibility for delivering the human services at the county level, and school construction, and your cities have the responsibility of a lot of your utilities. Even though you can break that out and it looks pretty simple, one of the best diagrams we saw was when Karen Molanza from the School of Government made a presentation to the Revenue Laws Committee in December, and you began to see that even though it looks like the lines of responsibility are black and white, they begin the grey very quickly and overlap. You need to keep that in mind as you look at the revenue sources too. I’ve just listed right here the top two revenue sources – general fund revenue sources – that each level of government has, and just as the lines blue very quickly in responsibilities, you’ll also see as we talk about these revenue sources that the lines can blur very quickly there as well. The next three slides I’m not going to spend a lot of time on, but they’re just a pie chart, and they let you see the percentage of revenue that comes to the general funds of each of these units of government from the tax sources. Now you recall from the state level, we don’t only have a general fund, but we also have the highway fund and the highway trust fund. We are not discussing the highway fund or the highway trust fund.

For how those two funds are funded. We’re only looking at the general fund sources. And you can see that over 61% in fiscal year ’13-’14 came from income taxes and franchise taxes. And Jonathan is going to talk to you more on those taxes after I step down, but about a third of the revenue from the state comes from the sales tax. You can see at the county level that most of it comes from the property tax and the third level of most raised comes from the sales tax. And then at your municipal level you can see that most of the revenue comes from utility revenue and second property tax, and sales tax is down there at 7%. So we sort of basically looked, we’re going to focus on the sales and use tax. Whenever you talk about the sales tax it’s hard to get way from what we have, and why we have it and how we build that tax structure without thinking about the streamlined sales tax agreement. For those of you who have been around a long time, you will know that this was an agreement that began to surface in 1999. It is a voluntary effort among the states to try to simplify the sales and use tax laws in each state. Back in the ‘90s, the Supreme Court said that a retailer from another state that did not have a physical presence in your state, could not be required by your state to collect the sales and use tax revenue. So the purpose of the streamlined sales tax agreement was to try and make the law simple enough that retailers would voluntarily collect and remit that tax. Now, since 1999, as you know, the world has evolved and Amazon is the latest to voluntarily agree to begin collecting the tax, and most of that is because many of those retailers who didn’t use to have a physical presence here, as they begin to have subsidiaries, as they begin to have distribution centers, etc., expand their presence. But the purpose of the streamlined sales tax agreement as I said, was to simplify the sales tax laws. And part of that was coming up with uniform definitions that are applicable in all the states that are a partner...it is coming up with one rate per taxing jurisdiction, a uniform sourcing rule, so many of the things that we’ll talk about go back to the streamlined sales tax agreement. This chart is a little outdated, but it just vies you a good observation of how many states are part of this agreement. So as I mentioned, under that, we needed to have basically one state rate. We used to have many different sales tax rates that applied to many different things, but right now we basically have two rates. You have the general rate. The general rate is 4.75% at the state level. And you can see that it applies to most of the things that are in the sales tax base -- tangible personal property, digital property, accommodations. With the tax reform legislation of 2013, you expanded that base to include admission charges and service contracts. What’s interesting to note, and here’s where the world becomes grey between state and local, anything that is part of the sales tax base to which that general rate applies is the local sales tax base. Whenever you expand the tax base that is subject to the general rate, you have also expanded what is subject to the state rates--I mean the local rates. And they’re basically three sales taxes that you would want to be a part of. One is the state, the county local rate that is shared with the cities, that is 2%. It’s composed of a 1%, a half of a percent and another half a percent, but that money is the county sales tax that they share with the cities. The second one would be your county only sales tax. That’s 1/4%. I think 27 counties have enacted that, but that money does not have to be shared with the cities within the county. And then your third category would be public transportation. That had a lot of discussion last session. It’s either 1/4% or a 1/2%. Six counties have the ability to impose 1/2% and that money would have to be used for public transportation. But when you’re thinking about the base, this is the base. And whenever you expand that base, you expand the base for those local sales taxes. The other rate that you need to be aware of is what we call the combined general rate. Under the streamlined sales tax agreement, there are a few exceptions, and everything that’s listed here -- telecommunications, video programming, spiritous...

That electricity, pipe, natural gas, so it doesn’t have to be the general rate. In this state the combined general rate is 7% because it is the general rate plus the largest percentage that is allowed to all 100 counties, so that would be 2.25%. The two added together come to 7. That is all state money but except in the case of liquor it is all shared with the counties and cities subject to some kind of formula that the General Assembly put into place and they all have history as to why those formulas are what they are and they vary from tax to tax but even this revenue is shared. The three things that are left in the base that are subject to sales tax, one would be food. As you know food is exempt from the state rate but it is subject to the 2% local and only the 2%. It is not subject to the public transportation tax and it is not subject to the 0.25% that is allowed to counties. The other, aircrafts and boats. These are all exceptions to the streamline agreement. In North Carolina these are subject to a 3% state only rate with a maximum tax of $1,500 and this is something that you all changed in the tax reform legislation. The tax rate for manufactured and modular homes is the general rate but unlike everything else that was specifically excluded from the local sales tax base. There are over 60 exemptions from the sales tax, and if something is exempt from the state tax it is also exempt from the local tax. If an entity is allowed a refund of the state tax it is also allowed a refund of the local tax. The basic exemptions fall into one of four categories. The item is subject to tax somewhere else. That would be motor vehicles. Motor vehicles are subject to a highway use tax, therefore they are exempt from the sales tax or your machinery and equipment. That’s subject to the 1% tax. Because it’s subject to that it’s exempt from the sales tax. Business inputs. Many of those exemptions, if you go back to see why are they there, they were put in because of the idea that you shouldn’t tax a business input. That’s a pyramid from a public policy perspective. you don’t want multiple layers of taxation. Also there are exemptions in there that where you serve a governmental entity, for example, mobile classrooms purchased by a school for use as a classroom are exempt from the tax and then you just have a whole plethora of public policy decisions. Prescription drugs are exempt, food is exempt, many purchases, things sold by a religious or charitable organization are exempt and then you have economic incentives and I admit that it’s often very hard to draw a line between a business input and an economic incentive but there are certain exemptions that were put into the law and at the time it was part of an economic development package. When you look at refunds you will see that most of them are to other governmental units. There are also refunds allowed to nonprofit entities, and those basically fall into religious, charitable, your largest one would be your non-profit hospitals and your non-profit educational institutions, and as you all recall in the tax reform legislation you put an aggregate cap so that the amount of refund any one single entity can receive is capped at a certain level and that is only gonna apply, cause you can see the caps are very high, $31.7 million state, $13.3 million local, so it would almost have to be a large building project at a large school, and lastly, there are several refunds that were put into the law as economic incentives. In the tax reform legislation many of those refunds were allowed to sunset but there are a few that are still there and a couple that you will I’m sure be hearing about if you hadn’t already because they will expire in 2016 and that’s the sales tax refund for interstate passenger air carriers on fuel and the sales and use tax refund for the motor sports industry. As long as we’re on sales tax I just wanted to quickly give you this chart. Heather put this chart together some years ago and I’ve always loved it because I think it illustrates so well and clearly the local sales tax rates, and what I wanna draw your attention to here is on the two half cents, 30% of the revenue the county receives is earmarked by statute for school construction. Of the second half cent that counties receive, 60% is earmarked for school construction. If a county doesn’t feel like they need.

it for school construction. They can always appeal to the local government commission. But it is a process to get out of that. Other than that, the General Assembly has decided that counties have to use a certain part of that revenue for public school capital outlay purposes. In the third column, you'll also see how that money is sourced. And we'll talk about that a little bit in a minute. But you will see that the first penny and the second half, so one and a half cents is on point of collection, and the half a cent is per capita. When it comes to food, as we mentioned, there's a 2% tax on food. It's a local tax only. So how is that money distributed back to the counties? It is a pretty arduous process. Half of it is allocated back to the counties on a per capita basis. But before you decide how much goes on the per capita basis, you have to adjust it per the adjustment formula. So I want to quickly go to the next slide because the adjustment factor, the adjustment formula. What is the adjustment factor. What it primarily means is there's a list of counties in the statute, and there's a factor. And under that factor and under that formula, some counties will get 149% of what they otherwise would have received. And some counties will get 81% of what they otherwise would have received. Most counties fall somewhere in the middle. There's only eight counties that get a dollar for the dollar they would have gotten. There's only eight that are perfect. Some are up and some are down. When did this adjustment factor come into play and what is its history? Prior to 1988, when you decided how a sale was going to be sourced, what county did that sale take place in? So that that's the county sales tax that applies? Prior to 1988, it was based on where the purchaser received the product. Where did that person take possession? Destination-based sourcing. Well, in the wisdom of the General Assembly in 1987, the situs of the sale was changed. Wherever the retailer's place of business was was considered where that sale was sourced, what county would be allowed to tax it. When you made that change, it caused obviously a disruption in what counties received what monies. In attempt to hold counties harmless, this adjustment factor was created. Now let's go back to the Streamlined Sales Tax Agreement that came into play ?? 1999 beginning in the 2000s. One of the provisions in that agreement was that a state had to use destination-based sourcing. So beginning after 2001 our state went back to destination-based sourcing. But this adjustment factor was not discussed during that debate, and it was not repealed. So to some degree, this factor that came into play because we moved from destination-based sourcing to a different sourcing method just remained when we went back to destination-based sourcing. So going back to food, you first ?? on a per capita basis. Then you apply this adjustment factor. And then what's important to note is the statute says that half of it will be considered received by the county under Article 40. And what does that mean? It means that 30% of it is earmarked for public school capital construction. Half of that amount is considered to have been allocated under Article 42, which means 60% has to be used for public school capital construction. The remaining half percent is allocated proportionately to each county based on the amount that they received from the sale of food in 1997. It is deemed to have been allocated under Article 39, and what that means is that there's no restriction on its use. So you can see how things that appear black and white at first become gray very quickly. I'm just going to touch very quickly on the other 6% of the General Fund revenue sources. If you look at that pie chart and go back to it, there's a whole plethora of taxes. This lists those taxes and I've put them into two categories. The first is state revenue. These are the taxes that the state levys that stay in the General Fund. On the other side, i just called it State Share Revenue, because a portion of those taxes is shared by the state with the local governments. Mr. Chairman, I'll be happy to answer any questions on my portion. [SPEAKER CHANGES] Do we have any questions from members? I see one hand. Senator Bryant.

On the slide. With the heather slide with the pennies. What does this second half, cent article 42, per capita point of connection, explain that? [SPEAKER CHANGES] Yes ma'am. It was originally distributed on a per-capita basis which means that of your two percent, originally half was distributed point of collection, half per-capita. But in the mid-2000s, that per-capita distribution was changed to point of collection. So now one and a half cents is distributed point of collection, the other half cent per-capita. [SPEAKER CHANGES] And do you know, was there a policy reason or some other dynamic at play in that shift? [SPEAKER CHANGES] Well during that shift, and I left off one row of this because as you recall back in the mid-2000s we had what we called the Medicaid swap, when you had a responsibility at the county level that man counties could not afford. What happened was the General Assembly said the state will take over many of those functions. There had been a half a cent sales tax. That half cent sales tax was repealed, given to the state and in all of that shifting around, the per-capita was changed to point of collection. ?? [SPEAKER CHANGES] All right, let's move on. Seeing one other hand. Senator Tart. [SPEAKER CHANGES] Mr. Chair. One quick thing. Can you explain a little bit for the municipalities, the significance of both the prepared food and occupancy, is it significant and does it, is it more proportional for the urban centers? Does it become a more significant number? [SPEAKER CHANGES] With your occupancy tax revenue, I don't know how much money that is. That money is basically earmarked for use in travel and tourism. It's not a general fund source of money. There are many cities and counties that have an occupancy tax. But as I said, that's earmarked use, it's not just general fund. There are only I think six municipalities and counties that have a prepared meal tax. That's a one percent, I think that's a one-percent tax on top of the sales tax. Most of those one percent, some of them are dedicated but some of them are for any public use but I would very much doubt it's a significant amount of money. [SPEAKER CHANGES] ?? I see no other hands, we'll move on and we're hoping to get through all three of these presentations today, folks. And I believe we can. If you'll go ahead, Jonathan Tart. [SPEAKER CHANGES] I'll try and be brief, Mr. Chairman. I'll give a very brief snapshot of income and franchise taxes but spend most of the time talking about apportionment and specifically a single sales tax. I feel like I've talked to many of you several times about this but it continues to be a hot ?? [SPEAKER CHANGES] Jonathan, I think we need to remind everybody, on this single sales factor, this is one of the key, key things we're going focusing in on and paying close attention to. So thank you for your attention to that. [SPEAKER CHANGES] So, we'll jump right in here. Personal income tax. So 2013 legislation you know eliminated most credits and deductions. You start with federal adjusted gross income, then you make adjustments to get to what you could think of as North Carolina adjusted gross income. Take a deduction equal to the higher of your standard deduction or the sum of your charitable giving, mortgage interest and real estate property tax, capped at 20k. Credit for children, that is 125 dollars or 100 dollars if you're under certain thresholds. The rates were reduced, as you know in 2013, moved from a tiered schedule to a flat rate system. The rate's 5.75 starting in 2015. Moving on to franchise taxes. You'll collect 500, 550 million a year from this tax, from about 76,000 C corporations and about 147,000 S corporations. The tax is $1.50 per thousand dollars and supplied to the highest of three bases that you calculate. The first base is called the apportioned capital base. Capital base is similar to what you'd think of in accounting as a net worth calculation, but it's apportioned if you're a multi-state business. So a lot of people when they think about here's single sales factor or apportioned, they think well this just impacts corporate income tax, but it also impacts your corporate franchise tax because of this apportioned capital base. And of the three bases, this is the primary base used. This is where most of the money comes on, is paid on this base. The two alternative bases other than that one, is the depreciated value of the

taxpayer's property in North Carolina. And then the last alternative base is 55% of the appraised value of that property. Corporate income tax rates reduced by the 2013 legislation 5%. 2015 could be lower and '16 and '17 if certain revenue targets are met. Calculation similar to the personal income tax where you start with the federal number and make adjustments. Now that was quick but we wanted at this spot. So if you're a multi-state business, you've got to apportion. And-- SPEAKER CHANGES What is apportion? SPEAKER CHANGES I'll get to it. So apportionment--I'll get there. First of all, apportionment impacts not only corporate income tax, not only corporate franchise tax--those are the two majorities that it impacts. But to some extent, even personal income tax. If you have a pass-through entity--S-corp, LLCs--and they're multi-state and they have out-of-state owners, that income is apportioned. They file personal tax returns on that apportioned income and pay taxes to the estate.?? So it affects income and franchise taxes, personal and corporate income. So why do we have apportionment? If I have a dollar of income and I'm doing business in ten states, you don't want the dollar taxed by every--each state. It's actually illegal under the United States Constitution. So you've got to divide it up, you have to divide it up. So, for example, if I have a dollar of income or capital to be taxed, and I'm doing business in ten states, if I do 5% of the work in State 1, State 1 ought to have the right to tax a nickel out of that dollar. If I do 10% of the work in State 2, they ought to be able to tax a dime, and so forth. Until in a perfect world, in theory, one dollar, no more, no less, would be subject to tax in the states where I do business. That's the theory. That is not the reality. The likelihood is that less than the full dollar will be subject to tax in the states where I do business. And the reason primarily is because there's no uniformity amongst those ten states as to how you apportion that dollar. There's no uniformity. There used to be more uniformity. Historically, at the national level, there was a model formula suggested for states to use so you'd have a uniform apportionment percentage. But as of 2015, only a handful of states still do it. Why do we not have a uniform formula? Because states started increasing the weight of the sales factor. In fact, they're moving toward what is known as a single sales factor, to try to create an economic development environment conducive--as an incentive--for companies to put property and payroll into a state. So they didn't consider property and payroll at all. Historically, the formula did include property and payroll. The uniform formula was based on the taxpayer's in-state property, payroll, and sales. You added those up and you divided by their total payroll, property, and sales. That gave you a percentage that you applied to that dollar of income. And that's how much a particular state could tax. But again, they've started moving to single sales factor to encourage property and payroll investment in a state. North Carolina has not gone to a single sales factor yet, for most firms. It's been discussed for about three years now. We do have it for some firms. We have it for a qualified capital-intensive corporation, which in general is a company that's going to invest a billion dollars in the state. We have it for excluded corporations. That's-- SPEAKER CHANGES Tell them that number of investments again. SPEAKER CHANGES One billion dollars. SPEAKER CHANGES A billion. SPEAKER CHANGES We have it for excluded corporations, and that, generally speaking, is an investment-type company, securities companies, and construction companies. That's excluded corporations as defined by statute. And finally, we have single sales factor for public utilities. But for most firms, we have increased the weight of the sales factor to double weight, but not all the way to just single sales factor exclusively. So in the formula I described where it was based on in-state payroll, property, and sales, we count the sales two times to give you four factors instead of just three. And I'll explain that here. I'm moving to a hypothetical, a very simple hypothetical that I believe makes this make sense if you haven't heard about it before. So on the left we'll do a comparison of an apportionment percentage calculation using our double-weighted factor. On the right you see a calculation using the single sales factor. We'll assume for the hypothetical that the company has 4% of its pro

Of the day role in North Carolina and its super cinemas sales are in North Carolina so long ago always sells factor again cells that are counted twice that of the 4% of the payroll in the state the 2% sales count slicing the total of 12 you divide the foreigners coming as a 3% portion of cities said North Carolina $1000 gain from been for a salmon caught the ball with the subject at under double a factor know if we were a single cells factor was really sample the prop the payroll and this is not considered in (SPEAKER CHANGES) Jacqueline Gibson is so you simply take a 2% sales and in a single cells that are they would have a 2% for Smith's agent a sense of a dollar would be taxed the state of the Federal the knows that this is sending his company is looking to build and located $500,000,000 manufacturing plant in its lawyers and accountants and one of the fed was alerted tax liability Monday after putting this plan into a state for comparative purposes and so is the senate is 500,000,000 on new investor in North Carolina would increase their share of copying payroll as they pass play from 4% message in a previous line up to 50% of his father may invest some Ellis limited databases of their percentages of using a double life advocate in what would be if we have single cells fact so we have a 50% copy and 50% payroll that Simpson (SPEAKER CHANGES)sales will assume that remains constant on the body of a form with always sales in this company has seen use a portion of cities increase from 3% to 26% after the $500,000,000 investment in the state on the rise in Zaire mays free sample because the puppy payroll investment associated with the new plan is not the city got a late in the apportionment seems silly remains in 2% cited under this scenario 26 saves and all would be taxed of the weight still 2¢ under single sale and those files that this is pretty simple married just what it wanted some taxing income face as tax liability Monday outside and now they have an inmate in income sudden attacks in $1,000,000,000 in the course and cattle about me an example before portion of Bellamy (SPEAKER CHANGES) said if rates as as it is considered a significant difference so again this is a very unstable scenarios made up largely made of those illustrate the point that outdated in economic development so because you see how long did about the payroll is not considered when his company did a large buildup investments they do was tell us is big with the Garces tax liability and some companies, middle attacks claiming they like to locate income not only in a stated as lower rates than a place within one and one portion of sentence because sometimes I could be one more important than a pointer to differential have a right to get a big incentive for Simpson says one argument for that, we have 21 states in the country that are now moves to single cells fracture of course, if nothing to say this is only a son Mrs. Be aware that if you lose a single cells are not a monitored by the way to beat this thing, mathematically if I had as its wasteland with sales of North Carolina and I have copied payroll and I don't assume that they will and more about taxes won't increase limits and mathematically is mussel them as they arrive in talking to 11 more be a it's a new stadium and if the final thing is a problem and has indicated that some of it, and these demonstrators they have one single cells that would be a little bit easier because you have all businesses going in the same way,(SPEAKER CHANGES) Kyle all you have some companies trying to fit themselves into a box of being excluded corporation of new financing cells that are you so you anyone have that controversy over from the neighbors say so is the necklaces and satellite Georgian and passed the assembly and a single cells that are emerging as if some industries can see is a slightly, or whether the way that him, since the top of another dead of their money and should bit of that question so you're so said Wells up , let me see if find additional different .......

[SPEAKER CHANGES] ?? Be sure I'm understanding it correctly, and I don't know who names these things, single sales apportion- [SPEAKER CHANGES] I think ?? invented all of that. [SPEAKER CHANGES] That explains it. As I understand it, in the Catawba Valley, where we're trying to replace the 30,000 manufacturing jobs that have been lost since 2000, we are in fact fighting headwinds of an additional layer of state tax on plant expansions and new facilities and additional employment, by this, the way we are doing this calculation. [SPEAKER CHANGES] Companies that have a lot of property and payroll investment in the state or that are looking to do that and they have a lot of sales outside the state? That is ?? where they usually win if you go to the single sales tax. [SPEAKER CHANGES] Speak into the mic clearly. [SPEAKER CHANGES] I apoloogize. Yes sir, if you have a payroll and property intensive company like a manufacturer, they typically do benefit from single sales factor. And in fact, when they are looking to make the economic development decisions, or even just tax planning decisions, they want to look at how low their apportionment percentage will be. Sometimes it's more important than a point or two differential in a rate. [SPEAKER CHANGES] Other questions? I do want us to get to our last portion but I've got good burning questions. Now we will handle any of these as we go along because you've not heard the last of single sales factor. I can promise you that. Senator Bryant, quickly. [SPEAKER CHANGES] How much does this affect-if we were to switch to single sales factor? What, how would it affect our availability, say in a upcoming year, pick a sample year or whatever? [SPEAKER CHANGES] If we did it full single sales factor in 2016 it would reduce general fund revenues by approximately 100 million. Maybe a little more, 100 to 105 million. [SPEAKER CHANGES] Very good question. However, you know you can do things over time or you can do things all at once. There's other ways of dealing with all of this. Seeing no other hands, I'm going to ask our Chief Counsel and guru to come forward now, Michael Hannah. Floor is yours. [SPEAKER CHANGES] Thank you, Mr. Chairman, members of the committee, my name is Mike Hannah. I've had the pleasure of serving as counsel to the Senate Finance Committee for the last four years. I'll be speaking to you today about economic development issues. However, and tax reform in particular. But tax reform is only one part of what is needed for a strategic long-term plan for North Carolina to have a better and more competitive economy. You also need these other factors: budget, education, transportation, energy, and so forth. Now I'm going to focus today on, on tax reform but the information that I'm going to provide to you today is going to show you that in North Carolina job creation has not kept up with workforce growth, wage and income growth, and unfortunately, poverty is actually worse in North Carolina than it is in the U.S. From 1990 to 2000, we were 11th, which is pretty good in wage and income growth. However, by 2014 we had fallen to 43rd. I'd like to put this in the context of economic development spending. This chart shows North Carolina's expenditures on development spending from 1999 through 2013. This includes all the tax credits that are out there, Bill Lee Credits, Article 3J, but it also includes JDIG, and all the other types of incentives. And this is compiled by the Fiscal Research Division. Since-from 1999 to the end of 2014 this state has spent $16 billion on economic development spending. So let's see what did the state receive in return for the $16 billion? This chart shows North Carolina per capita income as a percentage of the U.S. average. From 1969 through 1999 we were doing pretty well. We see growth in North Carolina per capita income as a percentage of the average. However, starting in 1999 you start to see a decline. By 2013 we had fallen to 86% of the U.S. average. So we were back to where we were in about 1987. This chart shows job creation performance North Carolina from 1999 to 2013. In the blue you see the growth in the labor force and the workforce. The brown shaded areas show you the growth-the growth of jobs

And job creation in North Carolina. I ask you to focus on December 2006 and the numbers below the dates represent the number of folks that are employed. Compare December 2006 to December of 2013. From the chart that I showed you previously that pertains to economic development spending, the state spent $8 billion from 2007-2013 to 10,000 net jobs were created during that same period. This is to me the most troubling of the slides. This shows the southern states, the percentage of people living below the poverty rate comparing in 1983 which is the blue bar to 2013 which is the red bar. You see the arrows there for North Carolina, it’s the fifth from the right, the US is on the far left, but look at North Carolina. Compared to 1983 we have more people living below the poverty rate in 2013 than we did in 1983. So back to this chart. From 1999 to 2014, $16 billion was spent and what happened in return? Decreasing per capita income, job growth was pitiful, and most importantly poverty also grew in North Carolina. So you have to ask yourselves looking at economic development expenditures what is the best and most efficient way to incentivize companies to come to North Carolina. This is from Brett Lange’s report from 2009. I’ve taken the executive summary and pulled five of the important facts that he mentioned last week and also five of the most important facts I believe to us today. To me the most important one up there, number three, the majority of the tax credits do not benefit distressed counties. The majority of the tax credits were claimed for investments in machinery and equipment, not job creation, and also according to the 2009 report, discretionary incentives are more effective than tax credits at inducing job creation. So the second aspect of our comment, I’d like you to look at is the sales tax base. This chart shows spending by North Carolinians on items that are subject to the sales tax.The green bar on the left shows 1970, the bar on the far right shows the 2000s and the numbers are similar according to Fiscal Research, are similar for the 2010 period. What this chart shows you is that compared to the 1970s North Carolinians spend less of their income on items that are subject to the sales tax. The sales tax was enacted in 1933. Supposed to be a temporary tax. By 1939 it was a permanent tax. It was originally enacted as a tax on the sale of tangible personal property. By the 2000s we’re only spending 37% of our income on items that are subject to the sales tax, so this means the sales tax base has been shrinking at least since the 1970s. The downside to that is in order to maintain revenues starting in 1991 prior General Assemblies had to raise the sales tax rate from 3% to a high of 5.75%. A shrinking tax base means higher rates. Why has the sales tax base shrunk? Well, there are many factors that impact it. Legislative decisions, the enactment of special tax preferences, we have sales tax exemptions for some entities, refunds for some entities, lower tax rates for other entities. Food was exempted from the sales tax base, but the most important factor has been changes in consumer buying patterns. As we have seen from the prior graphs and charts, more spending by consumers on non-taxable services and less on taxable items. In the 1930s when the tax was enacted you didn’t even go to the barber shop. Grandma put a bowl on your head and cut your hair with the sheep shears, so the nature of consumerism in North Carolina has changed certainly since the tax has been enacted. Sales of services now represent about 2/3 of the economy for consumers. This is not, this problem is not limited to North Carolina. It’s actually a national phenomenon. This chart shows in red services as a share of household consumption in the US. The blue is typical sales tax base share of household consumption on items that are subject to the sales tax

You see it is a national problem. So if I were to ask someone that is an expert on sales taxes, Walter Hellerstein is probably the Einstein of sales taxes for this, for the United States. In one of his treatises, he makes the statement that sales tax is, in fact, a tax on consumer spending. Historically, it has been a tax on the consumption of tangible personal property at retail, but the absence of a sale tax on services is really a product of historical accident rather than logic. As I said before, fewer services existed when sales taxes, state sales taxes were enacted. Also from Walter Hellerstein, the purchase of a retail services is in fact consumer spending. If I go to Lowe's or the Home Depot to buy tools or a hammer, that transaction is a retail consumption transaction. That's no different than if I go and have someone cut my hair. So there is really no logical difference between tangible, personal property and services that would warrant a different tax treatment, and North Carolinians have recognized this for many years. Back in 1951, then revenue commissioner, Eugene Shaw, expand the sales tax base to include services. Since then, many, many different calls to expand the sales tax base to include more retail services. I think you can see a clear trend. Next, income tax issues. On the left, the pie chart shows the portion of state revenue that is obtained from income taxes. The blue represents personal income tax. The green represents corporate income tax. In 1970, the state relied on income taxes, corporate and personal, for about 49.8% of the revenues. By 2014, that had grown to over 60% of revenues coming from income taxes. The problem with that is that the income tax base is not very stable. This chart shows, it compares the changes in sales tax and income tax collections. The zero line across the middle represents zero fluctuation, so to the extent that either one of those lines goes above or below the zero line in the middle, this means that it is volatile. The blue line is, represents the collection of income taxes. The green line represents the collection of sales taxes, and you can see that income taxes are less stable source of income than sales taxes. If you take the income tax blue line from the last chart and divide it between the corporate income tax and the personal income tax you see that volatility increase. Sales tax has about an 8% volatility. The income tax you see sometimes can be as high as 30%. This volatility in the income tax revenue stream has created many budget shortfalls over the years. This is a history of those shortfalls. In the interest of time, we'll simply go through them very quickly and say there will be another recession. There always has been, and there will probably be another budget shortfall, so the question becomes could the next serious shortfall be worse if the state doesn't do something to reduce its reliance on volatile income taxes as a source of revenue? From 2013, I believe it was in May, there was a Senate finance committee meeting. We had four independent economists, and for the first time in the history of the universe, economists agreed on a few items. The first of those, our current tax code is outdated and unsuitable for the 21st century. Economic incentives have not produced jobs. You heard Brent Lane last week make that statement also. We need to reduce personal and corporate income tax rates. Income taxes tax production and capital investment. We need to broaden the sales tax base to include more retail goods and services, eliminate sales taxes on B to B transactions, but also importantly tax reform is only one factor in creating a better North Carolina economy. So in summary, this is why more tax reform is needed. Our current tax code really is based upon what was enacted in the 1930s when Roosevelt was president. These statutes do not work well in a 21st century economy. Questions, mister chairman? [SPEAKER CHANGES] Great job, you finished on time. Session's gonna begin in about 5 or 6 minutes and so, if you have a burning question, come by 300 ??, see Michael

Kinda, he's always over there and he's always willing to talk and check with him. There was some of the ?? stuff today, but good stuff. Thank you very much. The meeting's adjourned.