RALEIGH, N.C. –  In the halls of the General Assembly, the phrase “tax reform” is like a mantra.For years, state legislators have been repeating those words, pursuing a goal that nearly everyone agrees on in principal: an overhaul of North Carolina’s outdated tax system.

The system was created in the Great Depression, when factories and farming were the main engines of the state’s economy. Now, with the economy based more heavily on services, the state tax system tends to cause sharp year-to-year fluctuations in state revenues. In times of economic downturn, that pattern amplifies the state’s budget problems.

Numerous committees and experts, both within and outside the legislature, have studied the issue, and there is broad agreement on the solution. The tax base should be expanded, tax rates should be lowered, and loopholes and deductions should be minimized.

But last week, legislators adjourned for the year, ending yet another legislative session in which tax reform got lots of buzz but ultimately was tabled.

“What we designed in a horse-and-buggy day is self-defeating, and not serving our purpose,” said Richard Vinroot, a former mayor of Charlotte and former candidate for governor.

“We need to have a revenue stream that’s consistent with where we are in our economy.”

Vinroot, a Republican, is on the board of the Institute for Emerging Issues, a group led by former Gov. Jim Hunt, a Democrat. The institute promotes better public policy, and it has urged state legislators to enact tax reform.

But no tax reform plan has ever come up for a vote in the General Assembly. This year, Democratic leaders in the N.C. Senate released a long list of proposed tax changes and tried to get those changes incorporated into the state budget.

The changes, however, were never put into a formal bill, and Democrats in the N.C. House balked at the Senate’s proposal. House Democrats said that tax reform should not be rushed into law in the midst of a budgetary crisis.

Legislators do plan to continue holding meetings this fall to try to come to agreement on a plan.
“They will travel the state, hopefully, in different locations, to allow the public an opportunity to speak and weigh in with their thoughts,” said Senate leader Marc Basnight, D-Dare. “And if the House and the Senate agree to recommendations, we will be called back in for a special session on taxation. Hopefully that occurs.”

House leaders are considerably cooler to the idea of a special legislative session to address tax reform.

House Speaker Joe Hackney, D-Orange, said he would support a reform plan if it is revenue-neutral and has bipartisan support. Neither of those things was true of the changes that Senate Democrats were pushing this year. Those changes would have raised a significant amount of new revenue in the first year.

“That was a tax increase masquerading as tax reform,” said the Senate’s Republican leader, Sen.
Phil Berger, R-Rockingham.

What Democratic budget writers ultimately settled on in the 2009-10 budget was a different set of tax increases: a $1 billion package of tax increases that the Democrats said was necessary to help close a budget shortfall. Most notably, they raised the sales tax to 7.75 percent from 6.75 percent.

Raising the sales tax is a strategy that legislators have used before to solve short-term budget shortfalls.

The problem, experts say, is that raising the sales tax undercuts the reform that everyone agrees is needed. In the long run, raising the sales tax exacerbates the problem because it increases the state’s reliance on a narrow revenue stream that responds harshly to the ups and downs of the economy.

The reason is simple. During recessions, people stop buying things, and the state collects less sales tax.

Proponents of large-scale tax reform say the state should lower the sales tax rate but also broaden it so that it applies to many more goods and services. Many states charge sales tax on a variety of services, but North Carolina’s sales tax is generally limited to tangible goods.

During economic downturns, people might not buy a new car, but they’re still likely to take their old car to the mechanic. If North Carolina charged a sales tax on those visits to the mechanic, the state’s revenues would likely not be hit as hard by a recession.

Proposals vary on which specific services should be taxed. They include a wide range of service providers, from exterminators to hair dressers to lawyers.

The same reasoning applies to corporate and personal income taxes. A tax reform plan might lower income tax rates while simultaneously expanding the base by eliminating deductions.

Any plan is sure to be controversial, because some interest groups are likely to be hurt and others would likely be helped.

Vinroot said it would take “backbone and courage” to pass a sweeping plan — which explains why no plan has ever come close to passing despite years of studying the issue.

“I think legislators and political people — of which I’ve been one — don’t like to deal with hot issues,” Vinroot said. “We’d rather deal with God, mom and apple pie.”