Cash or credit?

That’s one of the most important choices North Carolina lawmakers could make this year. It’s a choice that could affect future state budgets, the state’s credit rating, even the 2008 governor’s race.

“I’m afraid the history of the last few years is when they run out of money from current-year sources, they just say, ‘Roll out the credit card, and let’s run it up,’” said Rep. Paul Stam, R-Wake, N.C. House minority leader. “And that’s what we would have to oppose.”

Stam and his Republican colleagues have fewer numbers this year to oppose plans from the General Assembly’s Democratic majority. Voters gave House Democrats five more seats in the November election. Democrats now hold a 68-52 majority over Republicans for the session that started Jan. 24. Senate Democrats picked up two seats to boost their majority to 31-19.

“We’re looking at things we can do in education, such as looking at the high dropout rate, looking at what we can do to get kids better prepared for going into the work force,” said Stam’s counterpart, Rep. Hugh Holliman, D-Davidson, House majority leader. “In health care, we’re extremely concerned about a million and a half people uninsured and trying to make health care more affordable. Those are big problems without easy solutions.”

Democratic priorities will likely shape the next state budget, and the majority party has enough votes to decide whether to seek billions of dollars in bond packages during the next two years.

Last summer, advocates started a push for statewide bond referendums targeting school and road construction, water and sewer projects, housing subsidies, and land or “open space” preservation. After the November election, a News & Observer report suggested bond requests could total $9 billion.

Democratic lawmakers could run into opposition from their own party if they consider issuing bonds approaching that figure. State Treasurer Richard Moore, a likely candidate in the next governor’s race, has warned that the state can afford to take on no more than a fraction of that proposed bonded indebtedness.

In a forum for bankers and business leaders in early January, Moore suggested North Carolina could afford no more than $1.5 billion to $2 billion in new debt. “These are all worthy projects with noble goals,” Moore said, according to the Winston-Salem Journal. “But we must maintain our commitment to keep our financial house in order. We can’t allow ourselves to confuse what we want with what our state needs.”

Moore recently trumpeted North Carolina’s return to the top-level credit rating from all three bond-rating agencies. Moody’s Investors Service upgraded its rating Jan. 12. North Carolina is one of only seven states throughout the country earning the top government rating from each credit-rating agency, according to a statement from Moore’s office.

Moore gave lawmakers more wiggle room last week, issuing a new report that says North Carolina could issue up to $384 million in new debt each year for the next decade. That new debt ceiling is nearly twice as large as the limit Moore had recommended a year ago.

Even before the treasurer had issued the report, some legislative Democrats were ready to heed Moore’s warnings. “I think we need to prioritize that list,” Holliman said. “I’m in the treasurer’s camp on that, that we don’t go over our borrowing limit and that we prioritize and do as we can. I see no reason for us to keep raising debt service to the point that it’s a major item in our budget. We’ve always been a fiscally sound state, and I want us to stay that way.”

“On roads, we need this much, and on mental health, we need that much,” he said. “You know, these are big, big dollars. We can’t do everything for everybody. So we’ll have to make choices.”

Others want to hear more opinions before making a decision. “The treasurer has put a limit on us that he wants to do, but I think we may be able to go beyond that,” said Rep. H. M. “Mickey” Michaux, D-Durham. “It’s hard to tell. I’m just going to have to wait and see what the recommendations are that come out of that — from the treasurer and our bond counsel and everybody else.”

Republican leaders say they will urge caution as the state considers new debt. “I think we’ve reached the tipping point in terms of our bonded indebtedness,” said Senate Minority Leader Phil Berger, R-Rockingham, “and I certainly have great concern about increasing that. Even the Democrats, some of them, are now saying that we’ve got to be careful about how much bonded indebtedness we take on.

“And people ought to be worried about it. Some people say ‘let them worry about it tomorrow,’ but it has a component of worry about it today as well because if we borrow the money, that means next year we’ve got to make the first payments on that borrowed money. So that takes money away from our ability to spend on current things. There’s no question we’ve got great needs in the state of North Carolina. There’s no question there are some things long-term that need to be done. I just think we need to be really careful about turning to bonds or [certificates of participation] in order to meet those needs.”

Structural deficit

To borrow or not to borrow, that is one of the questions lawmakers must address this legislative session. They will also decide how to expand, tweak, or contract an annual state budget that totals $18.9 billion.

Decisions made during the last legislative session could affect this year’s debates. Lawmakers chose to spend most of a $2.4 billion budget surplus. “Last summer, we warned the Democrats publicly and in writing that they were spending so much that they would have a $1 billion shortfall,” Stam said. “Yes, they have a $1 billion shortfall, and so, naturally, they’re going to want to raise taxes. And it’s our job to help them keep a lid on spending. And when they try to overspend, expose it.”

Stam refers to a possible shortfall, or “structural deficit,” in the new budget that will take effect in July. The latest projections show the state ending the current budget year with a surplus.

“Our revenues continue to come in a little higher than what we had planned,” said Sen. David Hoyle, D-Gaston, co-chairman of the Senate Finance Committee. “We’re optimistic we’ll waddle through this one about like we have. You know people said there’s a $1 billion shortfall. We still have a structural deficit on recurring expenses versus recurring revenues, but we’ve been dealing with that fairly successfully for the last eight or 10 years, so I guess it will be business as usual.”

Business as usual is what bothers Berger. “The biggest concern I’ve got is that we have, as was indicated when we adopted the budget last year, a deficit coming into this session, at a time when revenues are at all-time highs and the economy is in fairly good shape,” he said. “The fact that we’ve got a budget in place that is out of balance is a real concern. The spending side of the ledger is just continuing to balloon at rates that far exceed the rate of inflation and the rate of population growth. The fact of the matter is that puts pressure on the revenue side.”

Pressure on the revenue side prompts Republicans to predict that Democratic majorities might recommend delaying scheduled tax relief. The final quarter-cent of a temporary sales tax increase is scheduled to disappear July 1. “There’s been a promise made, year in and year out since 2001, that temporary increases in taxes that were put in place to deal with the last budget shortfall that we had would be removed,” Berger said. “When we finally had an opportunity last year with a more than $2 billion surplus to keep that promise, it was not kept.

“It was partially kept, I guess you could say,” said Berger, referring to the decision to chop a quarter-cent off the sales tax rate in the fall. “The rest of it was put off to this year. My concern is that with the revenue figures that we’re seeing and with the fact that we’re now being told that we’re still in a deficit situation as far as the new budget, I think it makes it that much easier for the Democrats again to break that promise.”

Gov. Mike Easley suggested in a 2006 year-end news conference that he might be willing to recommend that the state keep the extra quarter-cent sales tax in place, if he and state lawmakers can agree on a different use for the money. Easley could release his budget plan as early as this month.

If the tax disappears, or “sunsets,” in legislative terms, taxpayers would keep as much as $200 million to $260 million next year. “I think you’ll see the tax sunset,” said Hoyle, one of the Senate’s key tax writers. “I think we made that commitment. Somebody would have to introduce a bill to say we’re not going to do that, and I don’t see that gathering a whole lot of support.”

New taxes

With or without the “temporary” sales tax, some members of the opposition party say a structural budget deficit will lead to calls for more taxes. “I could be somewhat humorous and ask, ‘Do cows moo?’” asked Stam. “They will propose tax hikes, and the question is how many of them and how insistent the drumbeat is for additional programs as to whether they get it or not.”

The justification for the new taxes is predictable, Stam said. “They always use the same tactic and the same argument,” he said. “Take the greatest need in the entire state, and try to convince people that the last little bit of taxes is going to pay for that greatest need. But the truth is the greatest need is paid by the first dollar of taxes that is never in danger. It’s the very lowest item in the priority list that’s paid by the last dollop of taxes. There’s hundreds of millions of slush and corporate welfare in the budget. There’s just no need for additional tax rates.”

Stam’s Senate counterpart is not as certain that Democrats will openly seek a tax increase. “I don’t think anybody’s really talking about that,” Berger said. “The closest thing that I think people are talking about in terms of new taxes is this idea of modernizing the tax code. I actually believe that there are some things that we need to look at in terms of the tax code, but I am wary of some of the calls for modernization and feel that is, in essence, a call for a tax increase and an attempt to do that without folks realizing that’s what’s transpiring.

“The reality is that if in fact the Democrats do all of the things they’ve promised they’re going to do and continue to do things as they’ve done in the past, we don’t have adequate revenue under the current tax levels to meet that. We already are the highest-taxed state in the Southeast. There’s just no question about that. The Tax Foundation tells us we’re actually, as far as tax policy, 40th in the nation. There are only 10 states that are worse than us in terms of tax policies for business purposes. So this idea of modernizing the tax code seems to me kind of plays right into what appears to be a possible need for increasing revenues in order to fund further increases in spending.”

Hoyle helps lead the legislative commission studying modernizing the N.C. tax code. The group faces “interesting” challenges and opportunities, he said.

“If additional revenues are absolutely necessary to balance the budget going forward down the road, I think the proper place to address it is with this modernization study commission,” Hoyle said. “Let them make some recommendations. It may be something politically acceptable. It may not be.”

Sales tax swap

One item on the table is a proposed swap of state and county revenues and responsibilities. One form of the swap involves the state taking over county Medicaid obligations and one cent of the county sales tax revenue. In return, lawmakers would give counties the option of raising the sales tax rate by another one cent.

“That’s obviously being debated,” Hoyle said. “There are some folks who say we need to look very, very carefully at that. Some people say it’s a tax increase any way you look at it. But it will be on the table. It will be out there for discussion. It may be tweaked. It may be changed. It may pass out of this commission. It may not. It’s just hard to say what’s going to happen.

“We’re intending to give some interim report in probably May to the General Assembly, so that may be part of the interim report. It may not. It depends. There’s a lot of mixed emotion about that issue.”

Hoyle has not made his own decision about supporting the sales tax swap. “I’m going to listen,” he said. “I have concern about the additional sales tax going on at a full penny. I don’t know whether the full penny is necessary. Maybe a half-cent might make me a little more agreeable. The state’s going to have a windfall pickup [the difference between the additional sales tax revenue and the increased Medicaid cost] the first two, three, or four years until the lines cross when the inflation gets us. But I’m going to keep an open mind to everything.”

Another top Democrat also questions the proposal. “That’s been floated out there about a year now,” Holliman said. “I haven’t seen how those numbers work out, so I’m still not convinced that’s fair either way. But I’m sure it will be an item on the table. A lot of counties are very concerned about the Medicaid expense. To a lot of our low-population counties, it’s a big problem. It’s one we’re going to have to address. It’s hard for us to absorb everything on the state level.”

Stam gives the idea mixed reviews. “I agree with relieving the counties of the Medicaid burden because they have no control over that expenditure,” he said. “They shouldn’t be asked to pay for it if they can’t control it. I don’t agree with anything that increases the sales tax for many reasons. It’s nondeductible for most people against your federal income tax, so every dollar we get from the sales tax instead of a deductible tax is 20 cents to Washington, D.C.

“Second, it’s highly regressive. And it’s just high enough. I believe we’re the highest among the states around us, so it’s a competitive disadvantage for our merchants.”

Lawmakers should take a different approach to funding state government priorities, Stam said. “I think every year for the last four or five years, spending has significantly exceeded population plus inflation, which is one measure of spending growth,” he said. “Obviously, if there are more people or if the value of money decreases, a budget that inflates at that rate is not taking a bigger bite of the economy. But we have vastly exceeded that over the last four or five years. It’s unsustainable. Last year, the increase in spending was 9.7 percent, when the rate of inflation plus population growth was 5.6 percent.”

Mitch Kokai is an associate editor of Carolina Journal.