By all accounts, the $22.2 billion General Fund budget just passed by the North Carolina House is only one step in a dance routine that may well last throughout the summer. As a former dance teacher, I’ll take this opportunity to explain what to look for as the Senate and Gov. Pat McCrory make their way into the ballroom.
First, while all the various participants hear the same music, they don’t entirely agree on how best to interpret it. North Carolina’s fiscal situation is much improved from the one Republicans inherited when they won control of the legislature in 2010. The state’s economy is improving. Job growth is outpacing the national and regional averages.
Thus General Fund revenue is up $1.3 billion this year over last, an increase of 6.2 percent. Some of that is, however, a one-time surge of revenue related to tax timing and other factors. For the coming 2015-16 fiscal year, General Fund revenue is projected to grow $673 million (3.1 percent) followed by $851 million in revenue growth for 2016-17 (3.9 percent).
In response, the House crafted a budget that continued many of the policies initiated two years earlier — including a scheduled cut in the corporate tax rate from the current 5 percent to 4 percent next year (having a fiscal impact of $109 million) and then to 3 percent in 2016-17 (a cumulative impact of $349 million).
For the remaining revenue availability, however, House leaders decided essentially to make up for “ground lost” during the Great Recession and its immediate aftermath, particularly in the areas of facilities, supplies, and compensation for public employees. Under the House budget, official General Fund spending will grow 5.1 percent in 2015-16. If you include some off-budget spending for facility repairs and film subsidies, the increase rises to 6.2 percent.
Some conservatives in Raleigh see these growth rates as excessive and troubling. They far exceed contemporaneous increases in projected revenue, or in inflation and population growth (projected at a combined 2.7 percent for the coming year). Count me among those worriers, along with Senate leaders and, reportedly, Gov. McCrory.
That brings me to a second point: the virtue of savings. The House budget adds $200 million to the state’s rainy-day fund — which depending on how you figure it is either at or below the bare minimum required by current law. Factoring in other account transfers and unspent balances, the net effect is to increase state savings about $222 million next year.
That may sound like a lot. But given how much of the 2014-15 surplus is one-time money and the inadequacy of the current rainy-day balance ($652 million), many conservatives see the House proposal as insufficient.
I should add that there are some on the Right, including a few House and Senate members, who don’t want to build up a large rainy-day fund. They reason that if a recession or natural disaster strikes, the General Assembly ought to feel a strong incentive to cut spending further rather than rely on fiscal reserves.
The truth is, however, that the primary effect of rainy-day funds in those situations is to head off “temporary” tax increases that can persist and fuel higher spending in the future. The phenomenon is called the “ratchet effect.” When revenues fall below projections and expenditures above them, lawmakers initially resort to spending reduction. Then they raise taxes, citing the fact that they’ve already taken the first step with spending cuts.
States with healthy rainy-day funds are less likely to make it to that second step. As academic economists Yilin Hou and Donald P. Moynihan found in a 2008 empirical study of rainy-day funds, “reserves appear to offer a much better leverage against tax hikes in the next year than for program cuts in the current fiscal year.”
As North Carolina’s budgetary dance continues into June and July, expect to see more debate about spending growth and savings reserves. It won’t be as upbeat and exciting as a samba, admittedly, but what taxpayers really need here is a good solid waltz with a big lift at the end.
John Hood is chairman of the John Locke Foundation. Follow him @JohnHoodNC.