By Dan Kane
Second of three parts
In the thick of the Great Recession four years ago, state lawmakers fought into the evening over a proposed one-penny increase in the state’s sales tax to prevent further cuts to schools, courts and health care services.
House Minority Leader Paul “Skip” Stam grabbed the microphone and told his colleagues the increase amounted to a 20 percent hike in the sales tax, which would go from 4.75 to 5.75 percent. It was regressive, hitting working families much harder than the wealthy. The Apex Republican said it was the kind of tax increase that Democrats said they despise.
“Every year they argue about it and how terrible it is,” Stam said, “and every year they ask us to vote for it.”
The tax increase passed, bringing in nearly $2 billion during the next two years and drawing complaints from the affected groups.
But other groups were silent, some of them representing significant special interests. That’s because over the years, those groups have won breaks that allow them to pay no tax, or a lesser rate.
Manufacturers, for example, pay a 1 percent tax on equipment purchases that is capped at $80. Utilities can sell to businesses and residences at a reduced rate of 3 percent. Many charitable nonprofits, including hospitals, pay little or no sales tax.
Loggers, computer software makers, NASCAR racing teams and some air carriers avoid at least some of the sales tax on some of their purchases. Newspapers and broadcasters escape sales taxes on some of their purchases.
All told, the 102 sales tax breaks on the books in North Carolina cost the state an estimated $3.1 billion each year in lost revenue, more than enough to run the state’s prisons and courts for a year, according to the most recent Department of Revenue review. Seven of those loopholes, pushed by Democrats and Republicans, have been added since 2007, and those alone cost $9.8 million last year, the department estimates.
The 2009 sales tax increase that Stam opposed was costly both to those it taxed and to the state treasury because of those it didn’t. If the state had collected the extra penny on each dollar from those who have won sales tax loopholes, it could have brought in an additional $1 billion over two years.
Once again this year, the sales tax is at the center of the legislative debate on taxes and spending. Proposals include taxing some services and eliminating some tax loopholes in order to reduce income tax rates. The favored status of businesses that sell to other businesses, however, could be expanded.
The state’s sales tax of 4.75 percent has become a hodgepodge, as the construction business shows. Buy stone mined from North Carolina? Pay no state sales tax. Rent a backhoe? Pay the full tax. Materials to erect a building for a business are subject to the sales tax, but they are exempt if they are used for a building owned by a nonprofit, such as a church or hospital.
“I assume all it is, is, who was politically strong at a certain point of time and had enough clout to get the sales tax taken out of their products,” said Sam Hunter, president and CEO of general contractor T.A. Loving. “And it was probably all justified because it was good for the economic climate at the time.”
State Sen. Dan Clodfelter, a Charlotte Democrat who led a failed effort to revamp the tax code four years ago, is trying again this year. He said raising the sales tax “has become the path of least resistance” in the legislature.
“And the General Assembly’s fiscal staff will tell you that each time we do it, we’re raising it on a shrinking base, and we’re getting less and less revenue as we move forward,” Clodfelter said.
The growing list of exemptions makes the sales tax more vulnerable to economic downturns. It contributes to a tax policy that long ago stopped reflecting North Carolina’s economy, which has been shifting away from the production of goods that are taxed, and toward more services such as landscaping, personal shopping, spa treatments and legal fees that mostly escape taxation.
Experts say the state’s economy has flipped from two-thirds goods and one-third services to one-third goods and two-thirds services.
Sen. Bob Rucho, a Mecklenburg County Republican who chairs the tax-writing Senate Finance Committee, says this is the year for major tax reform. Rucho has discussed a plan to eliminate the corporate and individual income taxes in favor of a sales tax that includes more services.
But Rucho has his own exemptions in mind. He says that business-to-business purchases should not be taxed.
Help for farmers
One of North Carolina’s first sales tax exemptions was for the purchase of horses and mules.
That exemption is still on the books, along with more than 10 others that benefit farmers and agribusinesses. Today, they have sales tax breaks that include exemptions on feeds, building materials for barns, and pesticides for crops.
The agriculture tax breaks show how quickly tax breaks can get on the books and how little scrutiny they receive afterward.
In 1978, with little fuss, state lawmakers amended a sales tax exemption for farmers to extend it to agricultural medications. At the time, there was a dispute within the state Department of Revenue about whether such items were exempt under current law.
“This would affect revenue very little, if any,” the appropriations committee minutes state.
Back then, it probably didn’t have much effect on state revenues. But today, it costs roughly $4 million a year.
As lawmakers were adding the tax break to the books, the state’s farm economy was just beginning to evolve from small family farms that primarily produced cotton and tobacco to tightly controlled “contract” farms that raise hundreds of millions of chickens and millions of hogs for meat. The processing companies pay no sales tax when they purchase feed, medicines and veterinary care, which they give to farmers at no cost.
Another tax break helped fuel the growth in contract swine and poultry farming. In 1986, state lawmakers passed sales tax exemptions on hog and poultry housing, and extended the exemption to related equipment in 1987. One of those seeking the legislation, The News & Observer reported in 1995, was state Sen. Wendell Murphy, a Duplin County Democrat who then was one of the nation’s biggest hog producers.
A powerful colleague, Democratic state Sen. Harold W. “Bull” Hardison of Kinston, sponsored or co- sponsored the legislation. In 1988, Murphy gave Hardison a $100,000 contribution for his unsuccessful campaign for lieutenant governor. Marvin Johnson, president of House of Raeford Farms, then a top turkey producer, also gave Hardison’s campaign $100,000.
Both contributions were well above the $4,000 maximum for a primary election, but no charges were filed because the contributions weren’t discovered until after a two-year statute of limitations had expired.
That tax break on housing materials cost the state an estimated $7 million in revenue last year, according to the Department of Revenue.
This growing segment of the ag business caused an explosion in livestock and poultry, while the number of farms dropped. It has also raised public health, environmental and animal welfare concerns because of the volume of animal waste generated and the use of antibiotics to prevent animals in close confinement from catching and spreading disease.
This transformation produced agribusinesses that now generate more than $6 billion in annual revenues and 42,000 jobs, not including spinoff activity. But much of the infrastructure that fueled its rise is exempt from the sales tax, and that revenue loss has grown dramatically, too.
In 1976, the Revenue Department estimated the farm tax break without the medications cost the state $8.2 million. That tax break, which continues to include feeds and litter along with medications, cost an estimated $140 million in 2011. More than 90 percent of that comes from the exemption on feeds, which are the largest expense for livestock or poultry production.
The tax breaks also help farmers who shun factory farm methods.
At Fickle Creek Farm in Orange County, Noah Ranells and Ben Bergmann raise free-range pigs and chickens in open pastures and avoid the use of antibiotics and hormones.
“Feed is a big, big expense for us,” Ranells said.
State Agriculture Commissioner Steve Troxler said these are good tax breaks that help keep down the cost of pork, chicken, peanuts and other farm goods for consumers, while helping farmers whose profit margins are often slim. He fights for the exemptions if there’s talk among lawmakers to take them away.
“There’s one thing I want to remind you and everybody else,” said Troxler, a Guilford County Republican. “Everybody eats. Good government helps provide good food at a price everyone can afford.”
But Troxler and the farm lobby have largely stayed out of the debate when lawmakers passed general sales tax increases.
“When you start talking about general sales tax, that’s not a part of my job,” Troxler said. Working on a plan
This year, as a Republican-controlled state government talks about tax reform, Rucho is pushing a plan that would raise the sales tax, eliminate some sales tax breaks and add a business license fee. He hopes that the structural overhaul would boost the economy by eliminating corporate income taxes that typically get passed on to the consumer.
“In a consumption-based tax, every time a product is bought or sold, it creates business income, it creates gross domestic product activity, and it creates jobs,” Rucho said.
A retired dentist originally from Worcester, Mass., Rucho moved to Charlotte in 1977. He began his seventh term in the Senate this year. He has a reputation as a feisty debater, and has long cast a hard eye at tax increases and increased government regulation.
His tax plan is meeting with resistance, even among Republicans. It has not been embraced by House Speaker Thom Tillis or Gov. Pat McCrory, who talk in less-specific terms about lowering the corporate and income tax rates while keeping them on the books.
Democrats say Rucho’s plan, which closely resembles one previously backed by the free-market think tank Civitas, would shift more of the tax burden to lower-income people who pay little in income taxes but spend a higher percentage of their income on goods and services.
But Democrats were in charge when they raised the sales tax three times since 2001, because it was an easier way to generate more income. The dozens of sales tax exemptions for special interests continued to grow; few were weeded out.
‘Soft spot’ for chiropractors
Sometimes the way tax breaks get on the books illustrates the clout of special interests who have the resources to influence lawmakers.
In 1996, chiropractors bundled contributions to provide roughly $10,000 each to four lawmakers: Senate leader Marc Basnight, a Manteo Democrat who retired in 2011; House Speaker Harold Brubaker, an Asheboro Republican who left the House last year and began lobbying this year; and state Sens. Fountain Odom, a Charlotte Democrat and chief budget writer, and Marc McDaniel, a Greensboro Republican. Democracy North Carolina, a nonpartisan campaign-finance watchdog, found the contributions.
The next session, Odom sponsored a bill that allows chiropractors to sell nutritional supplements without having to charge the sales tax. Today, the tax break costs the state roughly $400,000 a year. Two years ago, state senators tried to eliminate it along with a handful of other tax breaks, but ran into resistance and gave up.
Odom, a lawyer who left the legislature in 2002, said he did not recall the legislation. But he said he never pushed legislation in exchange for political contributions. He said he has a “soft spot” for chiropractors because they helped his father, who suffered from a bad back.
Joe Siragusa, a retired chiropractor and executive director of the chiropractors’ state association, said the tax break is on vitamins and other supplements that chiropractors sell without a prescription.
“Our position is it’s part of the treatment plan, part of the service that you are getting from the doctor’s office, and it shouldn’t be taxed,” he said. “So you can look at that statute like it’s a tax break, or you could look at it like it’s bringing equality to the way supplements are treated.”
Those same supplements are sold in health stores, but purchasers would have to pay the sales tax.
A break on jet fuel
Lawmakers could simplify the tax code by exempting from tax all items purchased to produce any good or service. Tax experts from across the political spectrum support this because the tax on such “business inputs” usually just gets passed on to the consumer.
“In a theoretical world, everything a business buys should be exempt, and everything a person buys should not,” said Mark Robyn, an economist with the Tax Foundation, a national free-market group.
Rucho said his plan includes that provision, which would keep many sales tax breaks on the books, such as a refund of sales taxes on aviation fuel that professional racing teams buy to fly to events. Annual savings to the racing teams: $150,000.
He would target for elimination the exemptions on sales to consumers. That would mean potentially cutting about two dozen sales tax breaks from the books, including two of the largest: the exemption on prescription drugs and insulin that cost the state $465 million in 2012, and the exemption on food sales for home consumption that saves consumers an estimated $622 million.
Those are tax breaks that help everyone, but Meg Wiehe, state tax policy director for the Institute on Taxation and Economy Policy, and other advocates for low-income families say abolishing them will hurt the poor disproportionately. They say if lawmakers were to go that route, one way to protect the working poor would be to increase what’s known as the Earned Income Tax Credit, which can reduce or eliminate someone’s income and sales tax liability.
That credit, however, has already been allowed to expire by the legislature this year. McCrory signed the bill.
Cap on yacht taxes
Rucho’s plan could raise more taxes from the sale of planes, boats and vehicles. They now pay no more than 3 percent sales tax, and planes and boats are capped at $1,500 per item. That means someone who buys a $100,000 boat pays the same tax as someone who purchases one at half the price.
It’s an annual break that costs the state $10 million, but one that is promoted by yacht dealers. Last year, Beaufort Yacht Sales in Beaufort advertised a 47-foot Caliber long-range cruiser for $628,000, and pointed out the maximum tax would be $1,500. Without the cap, at 3 percent the tax would be close to $19,000. If taxed at the regular state rate of 4.75 percent, it would be nearly $30,000.
The boating business also spends to influence lawmakers. In 2003, Fountain Powerboats in Washington, N.C., helped underwrite a weekend of meals, lodging and boat rides for House freshmen lawmakers, and in recent years the company had hired a husband-and-wife team to lobby lawmakers. It has since closed.
Sonny White, a broker for Beaufort Yacht Sales, said the $1,500 cap helps keep the boating business in North Carolina competitive. The state is home to nearly 60 boat builders, according to a boating business website. Florida’s tax, for example, is 6 percent and is capped at $18,000. South Carolina’s is capped at $300.
White said the boat business is a significant employer, including the roughly 25 people it takes to build each yacht, sellers such as himself, dock employees who lower it into the water and surveyors who check its specifications. “You have a lot of people who work in this business, and they pay a lot of personal income taxes,” White said.
Yacht owners in North Carolina also pay personal property taxes on the boats in their home counties, he said, just as car owners do.
But perhaps the biggest reason to keep the tax break in place, he said, is raising it wouldn’t bring in much more money anyway.
“If someone’s rich enough to buy a boat, they don’t have to do it here,” he said. “They can jet to Europe.”
Staff writer Joseph Neff contributed.