Lower spending is the key to fiscal sustainability

As Tears for Fears sang in the 1980s, everybody wants their taxes lower.

Well, that might not be the exact line, but the sentiment is shared across the political spectrum. Still, examples in other states and at the federal level provide frequent reminders that cutting taxes without cutting spending is unsustainable. In the past few years, Kansas and Oklahoma had to roll back tax cuts because those states did not gain control of spending. Even before passage of the CARES Act earlier this year, the federal deficit had grown when Congress reverted to a bipartisan consensus for high spending after passing the Tax Cut and Jobs Act of 2019.

As Milton Friedman said, “government spending is the true tax.” The best way to ensure low taxes in the future is to keep spending low today and limit spending growth to the rate of inflation and population growth. In the 1990s and 2000s, North Carolina tried it the other way: rapid spending that gave way, when the economy inevitably slowed, to furloughs or layoffs for government employees and tax increases for everyone else.

But even before the budget impasse of the past two years, General Fund appropriations per person remained constant, after adjusting for inflation, since 2011. That spending restraint meant, despite my concerns, North Carolina had billions of dollars available to maintain government programs without needing to cut staff or raise taxes as Governors Mike Easley and Bev Perdue did in the past two recessions. It also meant federal COVID-19 relief could go to small businesses, schools, families of school children, people who lost their jobs as a result of the pandemic or the governor’s shutdown, and other needs. Strong tax collections since July have also helped.

In addition to providing a margin to get through economic slowdowns, spending restraint provides taxpayers with more confidence in their returns on work and investment, so they work more and invest more, which means the economy does better than if government were to spend more and tax more.

How to continue keeping North Carolina’s spending under control

My new research paper, the third paper in our Big Government, Big Price Tag series, considers what the next four years might look like under Democratic priorities for higher spending generally, collective bargaining, and Medicaid expansion instead of continued spending restraint. From fiscal year 2021-22 through fiscal 2024-25, we could expect tax increases to meet the initial higher spending and likely further increases to keep up with the contemplated faster spending growth based on estimates from the previous papers in the series.

Even ignoring the projected deficits that would demand even higher taxes, if North Carolina were to depart from its spending restraint of the past decade, it would mean higher taxes, slower growth, fewer jobs, and less savings to manage through the next economic downturn. From fiscal 2022 to fiscal 2025, the impact in lost real GDP would range from $1.1 billion (a 4.8% spending increase) to $7.1 billion (a 13.4% spending increase including Medicaid and collective bargaining with mediation). Impacts would also include losing from 900 to 5,500 new or existing job opportunities per year and as much as $4.9 billion in General Fund appropriations in fiscal 2025 alone.

A constitutional tax and expenditure limit could ensure continued spending restraint in North Carolina. My paper highlights such a reform, with some improvements that could be made to the otherwise exemplary Taxpayer’s Bill of Rights in Colorado.

North Carolina legislators should first use any revenue in excess of population and inflation to ensure the state’s Savings Reserve rainy-day fund is on a path to meet the standard adopted in 2017 by a nearly unanimous General Assembly and Gov. Roy Cooper. That standard currently has a target for the Savings Reserve to be 11% of General Fund revenue, or $2.585 billion. Covering other liabilities for retirees and capital would provide additional margin for the state in future economic troubles. To ensure transparency and stability, my paper recommends using the broadest measure of inflation, the GDP deflator, and population for the three calendar years before the start of the fiscal year (for fiscal 2021-22, that will mean population and inflation for calendar years 2018, 2019, and 2020).

The General Assembly has managed North Carolina’s budget well since coming out of the last recession in 2011. Their good practice should be assured for years to come with a constitutional amendment establishing a tax and expenditure limit.