Fiscal cliff or political posturing?

In response to the most recent two-year revenue projections, Gov. Josh Stein warned that “North Carolina is approaching a fiscal cliff.”

Should North Carolina budget writers hit the panic button?

Not at all.

With this year being a “long session” at the General Assembly comes the responsibility of crafting a biennial state budget. The revenue forecast produced by the budget office and the Fiscal Research Division offers guidance for legislators in this task.

Stein’s reaction and media headlines are largely in response to these projections showing revenue to be nearly flat in Fiscal Year (FY) 2025–26 (which begins July 1) to the current fiscal year, and then falling 2.4% the following year, which would be an $823 million drop year over year.

In a growing state like North Carolina, the prospect of falling revenue makes many a legislator in Raleigh nervous.

But some added context reveals that it is far too premature to sound any alarms, for several reasons.

This Year Is Running a Surplus, and the State Is Sitting on Significant Saved Funds

According to the revenue report, actual revenue for the current fiscal year (ending June 30) is now projected to be $544 million higher than previously estimated. If this projection holds up, that will provide budget writers with more than half a billion extra dollars to carry over into the biennium.

In addition, as of Jan. 31, the state is sitting on billions of dollars in saved and unspent funds. According the State Controller’s office, there is $3.7 billion in the Savings Reserve, $1 billion in the Stabilization and Inflation Reserve, plus another $1.9 billion in unused, unreserved funds.

Obviously, the recovery needs of western North Carolina remain substantial, but even so, North Carolina remains very well positioned to handle any modest downturn (should there actually be one) in revenue in the coming biennium.

These Estimates Are Very Preliminary and Subject to Change

The February revenue forecast won’t be the last one before the new fiscal year begins. Indeed, the next forecast will include the annual “April surprise” for revenue, as the state gets a clearer picture of revenue after income tax refunds and additional payments are factored in. After that, revenue projections will be revised upward or downward, possibly significantly.

The report itself cautions that there are several “risks” to the forecast, including tax deadlines being postponed in areas impacted by Hurricane Helene, the economic impact of possible national tariffs, and continued uncertainty about future inflation.

These factors make the FY 2025–26 forecast preliminary at best. The projection for FY 2026–27 — the one causing panic among certain elected officials — carries still greater uncertainty for the above reasons and more. How are forecasters supposed to predict with great accuracy the tax revenue generated a full two years from now by North Carolina’s more-than-$600-billion economy?

Recent History Shows Forecasts Have Greatly Underestimated Revenue

The report asserts the belief that “Economic factors exerting upward pressure on the forecast are outweighed by downward pressure from reductions in the individual and corporate income tax rates.” In short, it blames tax rate cuts for diminishing revenue.

But we’ve seen this movie before.

Ever since the historic tax cuts of 2013, revenue projections have substantially underestimated actual revenue. The projections have been based — in no small part — on errant predictions of the “downward pressure” on revenue from tax cuts.

For the decade spanning FY 2014–15 through FY 2023–24, exempting the Covid year, revenue forecasts have underestimated actual revenue by a total of roughly $12.6 billion, with individual fiscal year misses ranging from $430 million to $4.8 billion. The only non-Covid year to produce less revenue than predicted was FY 2023–24, which had a relatively small shortfall of $31.8 million.

This is not to disparage those in the budget office and Fiscal Research. They are charged with an impossible task: predicting tax and other revenue from an often unpredictable, changing economy nearly the size of Poland’s.

The trend, however, has been clear over the last decade: A dramatic underestimation of revenue based in part on a faulty belief that tax cuts will starve the state of funds.

Perhaps a greater threat to future revenue will be a national economic downturn. The report acknowledges a concern that the current, strong economic momentum will see a “gradual slowing starting in late 2025.”

This “slowing” may end up being significant, as some have warned the seeds for an economic pullback have already been planted.

Conclusion

It’s far too early and there’s far too much uncertainty to raise any alarm bells about the latest revenue forecast. Those publicly hitting the panic button, like Gov. Stein, are politically motivated to generate fear and use this forecast as cover to implement policies they’ve been pushing for years.

An AP article said that the forecast was likely to “validate” arguments by Democrats that “future tax reductions should be repealed for corporations and high wage earners and a new law greatly expanding taxpayer-funded grants for children to attend private school should be pulled back.”

What’s that old adage about never letting a crisis go to waste?

In this case, the “crisis” is nothing but talk and far from certain. Moreover, the personal income tax cuts will be implemented only if revenue targets are hit. If there indeed is a “fiscal cliff,” then those cuts will be halted.

Stein and company’s fearmongering is highly premature and irresponsible. North Carolinians have benefited from more than a decade of tax reforms, and fiscal restraint has state government well positioned to absorb any shocks from a national downturn. Don’t be fooled by political posturing masquerading as fiscal panic by politicians looking to exploit recent news for their same old agenda.