This week’s “Daily Journal” guest columnist is Joseph Coletti, John Locke Foundation Director of Health and Fiscal Policy Studies.
RALEIGH — Bad news has become the norm for incoming legislatures. Better to prepare everyone in August than surprise them in November or January. So here it goes:
THE STATE HAS NO MONEY.
There. Now that we’ve covered the basics, we can provide some context and begin to lay the groundwork to deal with this in a way that can help the state regain its composure and competitive advantage.
By most standards, the state has plenty of money. It will collect $17.6 billion in taxes and fees without the promised-to-be-temporary tax hikes, which is more than the state spent as recently as 2006, or any year before that. Adjusted for population and inflation, however, it is closer to the state budget in 1996. This in itself is not so bad, as there are a number of families in the same position.
Unfortunately, state budget writers forgot the meaning of fiscal discipline while the economy roared through most of the 1990s and 2000s. Income tax collections grew faster than incomes, and the budget ballooned to meet the funds available, adding programs and expanding those already in existence. Strong investment returns meant budget writers did not have to set aside money directly for state employee pensions and so could spend more on new or expanded programs. Budget writers also voted for more than $3 billion in new debt between 2003 and 2009, more debt than approved by taxpayers in 2000 for community colleges and universities (the last time anybody gave taxpayers a vote on debt).
When the bottom fell out in 2008, however, income tax revenues plummeted. The pension system lost 20 percent of the value of its portfolio. Neither has fully recovered yet.
This year, State Treasurer Janet Cowell warned legislators that the state had no room left to borrow. Legislators imposed a temporary tax increase of $1.3 billion, included $1.6 billion from the federal government, and still chose not to meet the annual required pension contribution for the first time in the system’s 69-year history.
North Carolina is in the same position today that many other states and countries have seen before. Our challenges are not unprecedented, but successful responses have been rare. California and Illinois demonstrate what not to do. Chris Christie in New Jersey and Mitch Daniels in Indiana provide more positive models: they are treating voters like adults and laying out the choices ahead for their states.
Academic research and international experience do provide some rules for policymakers in a fiscal crisis. First is to establish a credible plan for fiscal sustainability that ties with economic policy. As a European finance minister said (pdf link) at a recent conference on Greece, “[I]f you are already a fairly rich country [or state], like Sweden, maybe you can allow yourself a high level of taxation and regulation, but if you are still a middle-income country [or state, like North Carolina] trying to grow while sustaining a high standard of living, then you should be more business friendly.”
The right reforms can help set expectations. The OECD, in a report titled “Restoring Fiscal Sustainability: Lessons for the Public Sector,” adds:
“The importance of expectations in successful fiscal consolidations can be seen, for example, in the cases of Denmark (1983-86) and Ireland (1987-89). Contrary to conventional wisdom, their large adjustments (expected to be contractionary in the short run) had positive effects on the economy. Other countries have had similar experiences. … Even large fiscal contractions can be expansionary because they can signal a permanent and decisive change in fiscal policy.” [Emphasis in original.]
Reform is a “social project” that requires rethinking who in society is best at which task. It’s Peter Drucker’s old questions: “If we weren’t doing this now, would we start? If not, how do we get out of it? If so, how should we do it?” This means every aspect of government needs review, including social transfers, corporate subsidies, and the sales tax holiday.
The biggest portion of reform needs to be spending cuts. The OECD suggests at least four parts of spending cuts to every one part of tax hikes. Given North Carolina’s high tax burden compared to nearby states, our mix should be even more heavily weighted toward spending cuts.
Cuts must be strategic if they are to avoid unintended consequences. Across-the-board cuts cause their own problems, efficiency only realigns spending and offers marginal savings, and payroll cuts can easily be rolled back. Further, any plan must include institutional safeguards to ensure continued spending discipline.
Previous alternative budgets offered ways to reduce spending and taxes, but even these are inadequate for the challenge of overcoming a structural deficit equal to 15 percent or more of state spending. The debate needs to be on the fundamental role of government in North Carolina, what it can and cannot accomplish, and how North Carolinians can solve problems for themselves and each other without Raleigh politicians getting in the way. If we do not find a way to solve the spending problem on our own, bond investors will impose a solution on us.