North Carolina has eliminated a very bad tax in a very bad way. Gov. Pat McCrory (R) signed HB 1050 to revoke municipalities' authority to tax businesses beginning in 2015. North Carolina did a good thing by eliminating a terrible tax. But it also curtailed local government taxing authority, which is rarely, if ever, good policy.
Local option business taxes, whether imposed on income, gross receipts, or personal property, are terrible ways to raise revenue. Only 14 states authorize their use, and they raise a paltry sum compared with the property tax or even local option sales and income taxes. Virtually all the public finance experts who have studied the issue denounce their use. Local business taxes stifle economic growth. As a result, they heighten competition among jurisdictions. That competition in turn causes local governments to offer incentives to attract or retain business, and those incentives are rife with political favoritism. Taxing business at the local level is inefficient and ineffective. So North Carolina eliminating those taxes is good in that regard.
But the measure places limits on local government taxing authority, and limits on that authority are limits on political autonomy. I'm a fervent supporter of localism because I believe strong, autonomous local government is a normative good. Local governments are more economically efficient and more democratically responsive than state or federal governments.
We should be wary of any attempt to weaken local autonomy, and limiting taxing authority does just that. Historically, tax limitations have resulted in more centralized financing of local services. State bureaucracies can't efficiently finance and govern local matters. Opponents of the North Carolina proposal noted that it would cause localities to rely more heavily on property taxes. That's a good thing. There is no better way to fund local government services than through property taxes. But as we have seen time and time again, states are willing to limit property taxes as well.
Local option business taxes are inefficient and generally lousy ways to pay for government, but local governments should be free to decide whether to use them. In the end, most will choose not to.
This is an excerpt of an article that first ran in State Tax Notes magazine