The main reason Gov. Roy Cooper and other North Carolina Democrats cited for opposing the Republican-led legislature’s new budget plan was that it saved too much and cut taxes too much.
North Carolina would be better off, they argued, if the new budget had been more like Cooper’s original proposal. It would have raised core state spending by 5.1 percent in the 2017-18 and 6.7 percent over two years, compared to the legislature’s 3.1 percent and 5.9 percent increases, respectively.
Unlike the federal government, North Carolina can’t borrow to pay operating expenses (thanks goodness). Thus, for every dollar of revenue received, there are just three choices: spend it, give it back to taxpayers, or save it for future needs. I think the legislature’s budget, approved by all Republicans and a few Democrats, struck the proper balance between those options.
First, some numbers for context. The part of the state budget most people focus on is the General Fund, which pays for schools, universities, prisons, and other programs funded primarily by state taxes and fees.
Over the next two fiscal years, the legislature’s budget authorizes new General Fund spending on operations and capital needs of about $2.1 billion. Gov. Cooper’s proposal would have authorized $2.7 billion in new General Fund expenditures during the same period. This is a sizable difference, but hardly the fiscal equivalent of a clash of civilizations.
During the same period, the legislature’s budget puts some $889 million in various savings accounts and credit balances, including the state’s rainy day fund, while the Cooper budget saves about $100 million less. The largest difference is on tax policy. Over the two years, the legislature authorizes $529 million in tax reductions, vs. $73 million in the Cooper budget.
Democrats pointed out, correctly, that the fiscal impact of the legislature’s tax cuts — which reduced corporate and personal income tax rates while expanding the amount of income North Carolinians can receive tax-free, among other changes — wasn’t fully accounted for within the 2017-19 budget biennium. That’s because their fiscal impact begins midway through fiscal year 2018-19.
On an annualized basis, then, the legislature’s tax reductions will save North Carolinians between $900 million and $1 billion a year. A similar calculation is needed for Cooper’s tax proposals, by the way, which would likely amount to a tax reduction of about $93 million a year.
So, why do I think the legislature was right to save more and cut taxes more than Cooper wanted? The savings argument is straightforward — despite building up a sizable rainy-day fund, North Carolina is not yet adequately prepared for a major recession. Last year, University of Arkansas economist Erick Elder constructed models for all 50 states, using data on their revenue volatility and fiscal exposure to recessions. For North Carolina, he estimated that a savings reserve equal to 6.3 percent of annual revenue would be necessary merely to keep spending levels constant during all but the deepest recessions, while a 17.5 percent reserve would allow North Carolina to meet additional spending obligations during such times (for increased Medicaid caseloads and college enrollments, for example).
If you take the midpoint as a reasonable target, that’s 11.9 percent of annual revenue, or $2.8 billion in the current environment. Under the legislature’s new budget, North Carolina’s rainy day reserve and unreserved credit balance together are just under $2.2 billion.
As for the tax cuts, legislative leaders recognize that while they have already enacted significant tax reductions, additional measures will benefit North Carolina’s economy in the long run, particularly those that encourage capital investment and job creation. After all, Florida and other fast-growing regional competitors still have lower overall tax burdens than we do.
Both budgets devote most revenue growth over the next two years to expenditures. But the legislature’s plan balances that with pro-growth tax cuts and savings to head off precipitous budget cuts or tax hikes if a recession comes. Some of the specific provisions of the legislature’s budget may be objectionable, but its basic architecture is sound.
John Hood is chairman of the John Locke Foundation and appears on the talk show “NC SPIN.” You can follow him @JohnHoodNC.