Local Option Sales Tax in North Carolina

North Carolina allows counties (but not cities) to levy four local option sales tax (LOST) upon the approval of public referendum. The four LOST are the Article 39 one-cent tax, the Article 40 half-cent tax, the Article 42 half-cent tax, and the Article 44 half-cent tax. The 100 NC counties now levy the full amount -- 2.5 percent. As the state levies a 4.5 percent sales tax, the total sales tax rate is now 7 percent statewide (except in Mechlenburg County which levies an additional 0.5 percent LOST for mass transit only).

The LOST proceeds are collected by the state, piggybacking on state sales tax, and then allocated to the 100 counties after subtracting administrative costs (slightly less than one-half of 1 percent). Net proceeds of the Article 39 tax are allocated to the county in which the sales taxes were collected. For the Article 40 and 42 taxes, however, net proceeds are placed in a statewide pool and allocated among the counties on a per capita basis. The proceeds of the Article 44 tax are divided in half; one half based on point of sales and the other half on a per capita basis.

Once the proceeds are allocated to the counties, the amounts are further divided among government units in a county, based on either per capita or ad valorem (property) bases, to be determined by the county commissioners. For the 2005-2006 fiscal year, 58 counties use the per capita formula and 42 use the ad valorem one.

After the distribution, cities are allow to use their share for any public purpose that they are authorized to undertake. Counties may do the same with the proceeds of the Article 36 and Article 44 tax. The proceeds of the other two taxes for counties, however, are partially earmarked until at least 2011: 30 percent of the Article 40 tax and 60 percent of the Article 42 one must be used for school capital outlay or for debt service on county borrowing for school projects.

Who gets "LOST"? One major policy issue about local option sales tax is the distribution of proceeds -- among counties, between a county and cities within which, between general purpose or special purpose, etc. The formulas that are used have significant implications on the distribution of fiscal capacity.