How The Flat Tax Revolution Of 2022 Was Sparked In North Carolina

A reporter for WUNC — the NPR member station covering Raleigh, Durham, and Chapel Hill — referred to North Carolina as the “Rip Van Winkle State” during the June 3 episode of a program covering North Carolina politics. That reference came amid a discussion about the state’s pending medical marijuana bill, during which the head of North Carolina Policy Watch, a progressive think tank, lamented they are “sort of late to the game in North Carolina with so many issues.”

By attempting to paint North Carolina as some sleepy backwater that is a few steps behind the civilized world simply because medical cannabis has not yet been legalized, the aforementioned reporter and think tank executive betray a lack of awareness about the way in which their own state, whose politics and policy developments they are paid to follow, has been on the leading edge of multiple policy innovations, including some of the most economically consequential reform movements of the past decade.

2022 will see at least four states move from a progressive personal income tax system with multiple tax brackets to an income tax code with one flat rate. A Bloomberg reporter recently described 2022 as a year marked by “tax-cut fever we’ve seen in almost every state capital.” To put the state tax policy developments of this year in context, only four states in all of American history prior to 2022 have passed legislation to move to a flat tax. The first five months of 2022, however, have already produced four new flat tax states.

The nationwide flat tax movement that has gained momentum in 2022 is part of a broader trend that began in earnest nearly a decade ago in North Carolina, where lawmakers began making significant changes to the tax code in 2013. Following the first Republican takeover of state government in more than a century, GOP lawmakers enacted tax reform that moved the state to a flat income tax, making North Carolina only the third state at the time to ever do so.

Kentucky subsequently became the fourth state in history to move to a flat income tax in 2019. The fact that lawmakers in at least four states have moved to a flat tax this year alone, matching the previous total for all of prior history, is why the current trend has been described as a flat tax revolution.

While North Carolina was in the vanguard of states moving to a flat state income tax, the experience in North Carolina also provides inspiration to reformers in other state capitals because it demonstrates how quickly a tax code can be transformed. Before North Carolina lawmakers began reforming their tax code in 2013, the state had a progressive income tax with a top rate of 7.75%, which at the time was the highest personal income tax rate in the entire southeast (that honor now belongs to South Carolina’s 7% top personal income tax rate). On January 1, 2022, North Carolina’s now flat income tax dropped from 5.25% to 4.99% and is scheduled to fall to 3.99% in 2026.

North Carolina’s latest round of income tax rate reduction is the result of a bipartisan budget deal enacted last year that, in addition to the personal income tax relief, will entirely phase out North Carolina’s corporate income tax over the next decade, making North Carolina only the third state with no corporate income tax or business gross receipts tax.

The number of states where lawmakers have passed or introduced similar tax reform has increased over the past year. Imitation is the highest form of flattery and many states have been flattering North Carolina. Most recently, Governor Brian Kemp (R-Ga.) signed legislation into law at the end of April that will reduce and flatten Georgia’s personal income tax rate, taking it from a top rate of 5.75% down to a flat 4.99% by 2026. Under Georgia’s new reform, the state income tax rate draw down will be contingent upon certain revenue triggers being hit.

Revenue triggers are a tool that North Carolina lawmakers previously used to facilitate income tax relief. Revenue trigger-facilitated tax reform has helped North Carolina realize repeated budgets surpluses at the same time that billions of dollars have been returned to taxpayers in the form of income tax relief.

Another state where lawmakers are now using revenue triggers to reduce and flatten the income tax is Arizona. An April court ruling confirmed the state’s new flat 2.5% income tax rate, which was enacted by Arizona legislators and Governor Doug Ducey (R) in 2021, will be allowed to take effect.

Arizona’s current top income tax rate of 4.5% will be gradually brought down to a flat 2.5% rate over the next few years. This new rate will see Arizona improve from having the nation’s 16th lowest top individual income tax rate to 10th lowest.

Aside from the immediate relief that comes with the move to a lower, flat income tax rate, proponents of such reform note that flat taxes provide lasting taxpayer protection by making it more politically difficult to raise the income tax in the future. “Graduated taxes divide taxpayers into groups, allowing politicians to play them against each other and ultimately rob them all, one at a time,” explained Grover Norquist, president of Americans for Tax Reform. “Flat or single rate taxes, on the other hand, put all taxpayers on the same team and require politicians to answer to everyone together.”

Another state where lawmakers have followed in North Carolina’s footsteps this year on tax reform is Mississippi, where Governor Tate Reeves (R) signed a tax reform package in April that will cut and flatten the Magnolia State’s income tax. Mississippi currently has two income tax brackets with rates of 4% and 5%. The new tax relief package championed by Speaker Phillip Gunn (R) and Governor Reeves moves the state to a single flat income tax rate of 4%.

When looking for the state that made the most significant changes to its tax code this year, that award probably goes to Iowa, the other state where lawmakers enacted tax reform in 2022 that moves in the same direction as North Carolina’s reforms. In March, Iowa Governor Kim Reynolds (R) signed into law a reform that, like Kemp’s in Georgia & Reeves’ in Mississippi, cuts and flattens the state income tax rate. The bill enacted by Governor Reynolds will bring Iowa’s personal income tax, which has a top rate of 8.53% today, down to a flat 3.9% over the next four years.

The income tax relief enacted by Iowa legislators and Governor Reynolds, in addition to allowing individuals and families to keep more of their paychecks, will also yield significant savings for small businesses, the majority of which file under the personal income tax system. According to IRS data, more than 210,000 Iowa sole proprietors, along with more than 100,000 partnership and S-corp owners, file under the individual income tax system in Iowa and will see their job creating capacity increase thanks to the tax relief enacted this year.

While 2022 has seen a historic number of states move to a flat income tax, some blue state legislators are seeking to head in the other direction by going from a flat to a progressive income tax. An upcoming initiative referred to the statewide ballot in Massachusetts this November will ask Bay State voters to approve a new graduated income tax rate that would apply a 4% income surtax on annual earnings above one million dollars, bringing the new top rate to 9%.

While that tax hike is being advertised as a way to get more money from the rich, in reality it will also hit thousands of Massachusetts small businesses, reducing their job creating and sustaining capacity. According to IRS data, more than 13,000 small business owners in Massachusetts file under the individual income tax and have income that would be hit by the so-called millionaires’ tax.

However, as Massachusetts voters have demonstrated five times over the last 30 years, most recently in 1994, and as Illinois voters proved in 2020, even overwhelmingly left-leaning electorates will reject proposals to end the equity in taxation that comes with having a flat income tax. Massachusetts’ leading politicians fancy themselves as trendsetters. In reality, the new graduated income tax rate proposed in Massachusetts, if it’s not rejected by voters, will turn out to be an instance in which the Bay State is a national outlier.

Some states, like North Carolina, serve as models that lawmakers in other states seek to emulate. Meanwhile other states, like Massachusetts and Illinois, serve as models that other states seek to avoid.