Tax reform is always a work in progress as legislators seek to raise revenue for the government without impeding the economy. Business taxes are particularly tricky, in part because businesses have greater legal ability to change than people do. The names and functions of business taxes add to the challenge.

The franchise tax is not a tax on local franchises of chain restaurants or stores. Instead, it is a tax on the net worth of a corporation apportioned to North Carolina. Some have compared it to local property taxes people pay on homes and cars, which are unpopular but necessary and a better option than taxing income. Others have criticized it as a tax on investment and wealth accumulation that hampers growth.

Nearly every corporation in North Carolina (and any limited liability company that opts to pay corporate income taxes instead of passing all earnings on to the partners) is subject to the franchise tax. It is one of the oldest sources of revenue for state government and has had the same 0.15 percent rate since 1933. In 2013, the General Assembly exempted electric and water utility companies from the tax.

In 2015, the General Assembly simplified how corporations were to calculate the franchise tax and raised the minimum tax from $35 to $200 for returns filed after January 1, 2017. That change may have contributed to the jump in franchise tax collections from $524 million in fiscal year (FY) 2015-16 to $752 million in FY 2016-17. If so, the increase may have come from small businesses with little in the way of assets and earnings.

In most years, the franchise tax is state government’s fourth largest source of revenue after personal and corporate income taxes and the sales and use tax. Because the tax applies to the total value of the corporation, it is less volatile than the corporate income tax, which had revenue ranging from less than 40 percent of revenue when corporate earnings peaked in FY 2007-08 to 126 percent in the recessionary FY 2000-01.

With corporate income tax rate reductions continuing, the corporate income tax has covered nearly the same range FY 2014-15. The $544 million in franchise tax revenue was just 41 percent of the $1.3 billion in corporate income tax revenue that year, but the franchise tax will bring in $684 million this year, nearly as much as the $710 million from corporate income tax collections.

In addition to lowering corporate income tax rate, the General Assembly changed the apportionment method to determine how much of a corporation’s income is taxable in North Carolina. Income had been apportioned on the corporation’s North Carolina personnel, property, and sales, but is now based solely on sales. Basing the tax on sales in North Carolina is intended to encourage investment in the state by eliminating the tax penalty for hiring people or building a facility.  For example, a company that has all of its facilities and employees in Virginia but makes all of its sales into North Carolina would owe the same tax as a company based in North Carolina. On the other hand, taxes should be connected to some benefit received by the taxpayer, use of government services, and investments based on their physical presence in a state, not on the sales they make into a state.

Scott Drenkard of the Tax Foundation sees more states moving, as North Carolina has, to a single sales factor to apportion income for taxes because it shifts more of the burden to companies that are not in legislators’ districts.

Putting taxes in context, economists Austan Goolsbee and Edward Maydew have found potentially significant costs to society when corporate taxes are based, in part, on personnel because corporations already pay a payroll tax. By extension, because North Carolina’s franchise tax is based in part on how much property a corporation has in the state, it seems reasonable that a corporate income tax that has a weight for property would result in similar costs.

As currently structured, North Carolina’s franchise tax and corporate income tax are complementary. If state policymakers want predictability in funding, the franchise tax provides that. If they want to capture some of the economic gains during periods of growth, the corporate income tax provides that. We can expect continued adjustments to corporate tax rules and rates because, even if there were a single right answer, the questions about how and what to tax keep shifting.