An Open Letter From Civitas Board Chair to NC House Repub Caucus

The following email was sent from Civitas Institute Board Chair Bob Luddy to House Republican Caucus members expressing his opinion of the “Liberal House spending plan”:

Subject: House Budget, Major new spending and no Tax Relief

Dear House Caucus Members,

Since 2010, I’ve given consistently to help elect House Republicans.  We now find that based on the Republican budget, special interests such as film producers, non-competitive solar energy manufacturers and out of state companies are favored over hard-working taxpayers and North Carolina businesses.  

I had planned to donate $25,000 this year to the House Republican Caucus to help re-elect a conservative super-majority.

Unfortunately, after seeing the $1.3 billion in additional spending and no across the board tax relief in the proposed house budget I had to reconsider. 

Today, I decided to give the $25,000 intended for the House Caucus to Americans for Prosperity NC to fight the Liberal House spending plan.

BL

NC Tax Reform 2013: Mission Accomplished or a First Step?

The N.C. House and Senate are expected to give final approval today to tax reform legislation. From there, it will go to Gov. McCrory for his approval and then it will become law.

As reported today by the Carolina Journal, national tax analysts are saying North Carolina’s tax reforms “blew other states away.”

Patrick Gleason, director of state affairs at Americans for Tax Reform, spoke to the reduction in the top marginal income tax rate of 7.75 percent that would be drop in 2015 to 5.75 percent

“North Carolina, with a 25 percent reduction in the top rate, pretty much blew the other states away,” Gleason said. Gleason and Elizabeth Malm, an economist with the nonpartisan Tax Foundation, said that North Carolina ranks at the top of the nation in magnitude of tax reforms this year.

Malm said the changes would make North Carolina’s tax code friendlier for business, jumping the Tar Heel State from 44th to 17th in the Tax Foundation’s State Business Tax Climate Index.

The Wall Street Journal has also taken notice:

After months of deliberations and legislative slips and slides, North Carolina’s Republican governor, Pat McCrory, and the GOP leaders who run the House and Senate have finally reached a deal on tax cuts. The plan is an impressive trifecta that will slash the personal income tax to 5.75% from 7.75%; cut the corporate tax to 5% from 6.9%; and eliminate the state death tax.

“This is a big deal for growth, and we still think we can come back in the next couple of years and get the rates even lower,” says state Senate President Phil Berger. More than anyone, Mr. Berger gets credit for making this cut happen when it looked like it might die a slow death. State think tanks like the Civitas Institute, which provided the intellectual ammunition, also deserve praise. (Thanks for the shout-out!)

There is little doubt that the new tax code will be far more favorable to economic growth than the current code. Now the question becomes: is this the beginning or the end for tax reform? Senate leader Phil Berger and tax reform champion Bob Rucho have indicated this is the first step in a transition to more comprehensive tax reforms.

Indeed, the legislation includes a section directing the Revenue Laws Study Committee to study ten tax issues and report its findings next year. Included in  those ten are:

  • possible repeal of privilege taxes
  • the impact of the sales tax refund for nonprofits
  • potential elimination of the franchise tax on corporations
  • the feasibility of expanding the sales tax base to additional services

Each of these issues were included in various earlier tax proposals but didn’t make it into the final bill. The fact that legislators are mandating more study on these items suggests they will be on the table in the near future.

A Brief History of NC’s “Food Tax”

One of the oft-cited criticisms of the NC Senate’s tax reform plan is that it would extend the state sales tax to groceries. Observers may be interested, however, in learning more about North Carolina’s history with taxing food purchases.

North Carolina first enacted a sales tax in 1933, it was promised to be “temporary.”  The rate was 3%. Food for consumption was exempted.

In 1961, the food exemption was repealed, subjecting groceries to the 3% state sales tax.

In 1971, the state authorized an additional 1 cent local sales tax for counties, adding to the total sales tax paid by consumers, including groceries.

The state authorized an additional one-half cent local sales tax in both 1983 and 1985, bringing total local sales taxes to 2%, and combined state/local sales tax to be paid by consumers to 5%, including groceries.

In 1985, North Carolina passed a law exempting the purchase of food with food stamps from the sales tax, this exemption would also apply to the local sales tax on groceries.

In 1991, North Carolina increased the state sales tax rate from 3% to 4%.

In 1996, the state passed a law to reduce the state sales tax rate on food from the standard rate of 4% down to 3%, effective Jan. 1, 1997.

The following year, state lawmakers passed another law lowering the state sales tax on food to 2%.

In the next year (1999), legislators eliminated the remaining state sales tax on food.

In sum, North Carolina has applied a sales tax on food since 1961.

  • From 1961 to 1971, the rate was 3%, and it crept up to 5% by 1985. Remained at 5% until 1991.
  • The rate topped out at a combined state/local rate of 6% from 1991 to 1996.
  • From 1996 to 1999, the state sales tax on food was phased out.
  • From 1999, the state no longer applied the state sales tax rate on food; however the local rate of 2% remained.
  • Food purchased with food stamps was liable for the sales tax up until 1985.

Currently, food consumers pay the local 2% sales tax on most groceries, and the full 6.75% combined state/local rate on certain items including candy, soda, “prepared foods”* and dietary supplements. Food purchased with food stamps is exempt from both the state and local sales tax. North Carolina has 1.7 million food stamp recipients.

*Prepared food is defined as follows: Food that meets at least one of the conditions of this subdivision. Prepared food does not include food the retailer sliced, repackaged, or pasteurized but did not heat, mix, or sell with eating utensils.

a.         It is sold in a heated state or it is heated by the retailer.

b.         It consists of two or more foods mixed or combined by the retailer for sale as a single item. This sub‑subdivision does not include foods containing raw eggs, fish, meat, or poultry that require cooking by the consumer as recommended by the Food and Drug Administration to prevent food borne illnesses.

c.         It is sold with eating utensils provided by the retailer, such as plates, knives, forks, spoons, glasses, cups, napkins, and straws.

SC Guv States Her Desire to Eliminate State Income Taxes

Last month saw Governors from three states (LA, KS, NE) publicly state their desire to eliminate income taxes. Last year Oklahoma introduced legislation to eliminate its income tax (but couldn’t get it passed into law).

Now we hear news that the governor of our southern neighbor is also contemplating income tax elimination:

Gov. Nikki Haley praised state House Republicans on Tuesday for proposing to further cut income taxes.

Measures introduced in the House differ from her recommendation, but Haley said she supports anything that reduces income taxes. Haley wants to eventually eliminate corporate and personal income taxes, as a business recruitment tool. (emphasis added)

North Carolina has a golden opportunity to get ahead of the curve in terms of eliminating the most anti-growth state taxes. Learn more at: www.noincometaxnc.org

Cowell Facebook Fiasco: More Questions That Demand Answers

As the old saying goes, when looking at politics always follow the money.

Having just scratched the surface looking into the Janet Cowell Facebook fiasco, that’s just what I decided to do. The results are unsurprising, and intriguing.

To recap, North Carolina State Treasurer Janet Cowell invested about $26 million of state pension fund dollars in the Facebook IPO. As we all know by now, Facebook stock has dropped significantly, thus the pension fund has lost an estimated $4 million on that risky investment. The losers in this, of course, are taxpayers who will need to continue to finance the now insufficient pension fund. Cowell, in turn, has decided to join a class action lawsuit against Facebook, and the NC pension fund stands to be the lead plaintiff due to the size of its losses.

But there were some big winners in this ordeal, and certainly some connecting of the dots of the major players in this scenario should raise the eyebrows of government watchdogs, taxpayers, and retired teachers and government employees across the state. Following are the most relevant details:

As reported previously, Erskine Bowles sits on the Board of both Facebook and Morgan Stanley – two companies that were winners in this deal. FB of course raised billions from investors on quite possibly overvalued stock, and Morgan Stanley  earned millions as the chief underwriter of the IPO. As reported in the Wall Street Journal:

The deal was lucrative for the lead underwriters. In large IPOs, it is common for fees to be split relatively evenly between several lead underwriters. On the Facebook deal, Morgan Stanley stands to collect $68 million in fees—38.5% of $176 million slated to go to about 30 underwriters, public filings indicate. J.P. Morgan will get about 20%, and Goldman, 15%

And, in spite of the fact that FB stock prices have plummeted, Morgan Stanley made even more money off of the stock through a practice known as “stabilization.” The Wall Street Journalexplains:

Profits made by banks underwriting Facebook Inc.’s initial public offering as the stock fell were distributed this past week from a pool of about $100 million, say people with knowledge of the deal.

The banks together made the money through a process known as stabilization, which is a standard procedure in IPOs, though Facebook’s deal size made the profits larger than normal, these people said.

……

Stabilization works this way, people familiar with the process say: If investors are selling the stock after the IPO launches, pushing the price lower, bankers can step in and buy shares at the IPO price in an attempt to keep it from falling below its issue price. This also serves to cover their short positions. If a short position remains on their books and the stock keeps falling—which was the case with Facebook on subsequent trading days—the underwriters can continue to cover their short positions by buying back shares at prices below the IPO price, netting a profit.

There is no risk to the banks in this effort. If the stock only trades up, the short position is covered when banks exercise what is known as an overallotment option, buying more shares from the newly public company at the IPO price. The banks don’t lose money, and the new public company makes more money when the overallotment is exercised.

So there was no risk to Morgan Stanley as part of this deal, and in fact the drop in FB stock meant Morgan Stanley was able to make tens of millions more on the deal.

Now recall that Erskine Bowles and his wife hosted a fundraiser for Janet Cowell. Any conflict of interest there? Bowles raises funds for Cowell, then Cowell throws millions at the FB IPO in which Bowles sits on not one but two boards of companies standing to reap millions.

But wait, that’s not all.

Representing the North Carolina pension fund in the lawsuit – and jockeying to become lead counsel in the case – is the firm Bernstein Litowitz Berger & Grossmann. The New York based firm stands to make a lot of money in legal fees if they are chosen lead counsel.

An examination of political contributions to Janet Cowell’s campaign since 2008 courtesy of the NC State Board of Elections shows that employees of Bernstein have donated nearly $75,000 to Cowell in the last two elections cycles.

Interestingly, the donations include three in-kind donations for room/lodging in New Orleans. The contributor of this in-kind donation is Anthony Gelderman III, who is highlighted in this 2004 Forbes article as one who has “used political ties to turn Louisiana’s pension funds into a profit center for his New York law firm, Bernstein Litowitz.” Indeed, the article discusses a previous class action suit in which Bernstein tried to bill its clients (including major public pension funds) more than $10,000 per hour. The article also notes that Bernstein’s business model seems to include cozying up to politicians and then leverage that relationship for lucrative class action suits:

Despite its New York roots, Bernstein Litowitz is especially influential in Louisiana. The state’s public pension funds have retained the firm for at least 15 class actions. Bernstein Litowitz has contributed more than $90,000 to Louisiana politicians since 1996. It gave $38,000 last year, 83% of its contributions nationally.

Now it appears they are bringing that shady practice to North Carolina.

Every step in this story involves the politically-connected (Bowles/Morgan Stanley, Bernstein Litowitz) reaping major financial rewards, with taxpayers and perhaps NC state retirees on the hook. And Janet Cowell is squarely in the middle of it.

This whole Facebook fiasco begs a number of questions:

  • Was the risky Facebook investment a quid pro quo deal between Cowell and Bowles?
  • What about the selection of Bernstein as counsel in the class action suit, given their generous donations and cozy relationship with Cowell?
  • What was Cowell doing in Louisiana multiple times in the last few years?
  • What is a New York based law firm with much of its business in Louisiana doing donating to the North Carolina State Treasurer, if not sniffing an opportunity to someday milk the pension fund for outlandish legal fees by representing the fund in a class action suit?
  • Will NC taxpayers be on the hook for $10,000 an hour legal fees?
  • Should retired teachers and state and local government employees be comfortable with how their pension is being managed?
  • Does anybody else see any conflict of interests in this whole ordeal?

State and local government retirees – and taxpayers –  deserve some answers.

UPDATE: This original post included an erroneous spreadhseet of Bernstein, Litowitz Berger & Grossmann employees’ contributions to Cowell – it mistakenly listed several donations from earlier election cycles twice. The total came to nearly $100,000. The corrected spreadsheet is now available at the link provided above, and reflects what should be the correct total amount of nearly $75,000. Civitas regrets the error.

The Myth of Consumer Spending

In virtually every news report about the economy, we hear reports on consumer spending – whether it be up or down. Consumer spending constitutes 70 percent of the economy, we are told, and therefore a boost in such spending is needed to spur economic growth. Liberal politicians also spout these lines when advocating for Keynesian spending schemes designed to “boost aggregate demand” and get the economy moving again.

Like most economic news reporting and Keynesian dogma, however, this concept is completely backwards.

As economist Mark Skousen discusses in this excellent article, consumer spending is indeed not the driver of the economy.

The truth is that consumer spending does not account for 70 percent of economic activity and is not the mainstay of the U. S. economy. Investment is! Business spending on capital goods, new technology, entrepreneurship, and productivity are more significant than consumer spending in sustaining the economy and a higher standard of living. In the business cycle, production and investment lead the economy into and out a recession; retail demand is the most stable component of economic activity.

Granted, personal consumption expenditures represent 70 percent of gross domestic product, but journalists should know from Econ 101 that GDP only measures the value of final output. It deliberately leaves out a big chunk of the economy — intermediate production or goods-in-process at the commodity, manufacturing, and wholesale stages — to avoid double counting. I calculated total spending (sales or receipts) in the economy at all stages to be more than double GDP (using gross business receipts compiled annually by the IRS). By this measure — which I have dubbed gross domestic expenditures, or GDE — consumption represents only about 30 percent of the economy, while business investment (including intermediate output) represents over 50 percent.

Thus the truth is just the opposite: Consumer spending is the effect, not the cause, of a productive healthy economy.

Skousen also reveals that it is in fact a higher savings rate that is associated with greater economic growth, because savings is what makes investment spending possible and a higher savings rate translates into lower interest rates. Lower interest rates makes it more affordable for entrepreneurs to invest.

Now contrast this revelation with government policies that discourage savings, such as capital gains taxes and inflationary “stimulus” spending that erodes the value of people’s savings.

Skousen’s article articulates economic lessons sorely needed by journalists, politicians, and big-government advocates alike. Read the whole thing.