As North Carolina lawmakers struggle to agree on the second year of the state budget, it’s becoming clear that last year’s decision to cut taxes came too early and went too far. The state compressed its three-level personal income tax rates of 6, 7 and 7.75 percent to a flat 5.8 percent and reduced the corporate tax rate from 6.5 to 6 percent.
Had the Republican-led General Assembly held off on these cuts, North Carolina would be enjoying a budget surplus now. There would be money to increase teacher pay without cutting education elsewhere. There would be money to invest in the University of North Carolina and in the state’s neglected roads, bridges and water systems. And there would be money for modest, well-targeted tax cuts.
Instead, the legislature’s Republican leaders and Republican Gov. Pat McCrory cut taxes in a way that is creating an artificial crisis. The state doesn’t have enough money to meet the needs of its growing population and can’t find a sustainable way to lift the public schools teachers’ pay that has sunk to 48th in the nation. In North Carolina, the rich are getting richer as the stock market hits all-time highs and corporations are profiting from a rising economy, but the state has forgone the tax boom that should have come with that recovery.
USA Today reported last week that a majority of states opened their 2014-2015 legislative sessions this year in their best budgetary position since the start of the recession. Indeed, many states are enjoying overflowing revenues. California has an extra $4 billion. New York has its first surplus since 2008 and just received an investment rating upgrade. Florida, Minnesota and Wisconsin have surpluses of more than $1 billion and are giving money back in tax cuts.
In North Carolina, the news is not so good. The state had a revenue shortfall of $445 million in the 2013-14 fiscal year. The losses are expected to deepen in the fiscal year that started July 1 as the new tax law calls for further income and corporate tax reductions starting Jan. 1. The state’s income tax will drop to 5.75 percent, and the corporate tax will drop to 5 percent.
The overall tax cuts approved last year are expected to cost at least $512 million this fiscal year, but that number could grow by $190 million, according to official estimates. The N.C. Budget and Tax Center, an independent state budget review group affiliated with the progressive N.C. Justice Center, estimates that the additional revenue losses could grow as high as $600 million and put the annual cost of the tax cuts over $1 billion for this fiscal year.
In last week’s budget debate, lawmakers were uncertain of basic numbers about the state’s projected revenues and the costs of Medicaid even as they tried to find money to raise pay for teachers and state employees.
That debate about the numbers showed how uncertain the state’s revenues are, said Alexandra Forter Sirota, director of the Budget and Tax Center. “Let’s stop further implementation of the tax cuts until we truly understand what we’re dealing with.”
Meanwhile, for all the tightening of state revenues, there is no clear evidence that the tax cuts are stimulating the state economy. The unemployment rate has dropped along with the rest of the nation, but much of the drop reflects a reduced labor force. Lately, the state unemployment rate has crept up as more unemployed people have resumed a search for work as the national economy improves.
John Quinterno of South by North Strategies, a Chapel Hill research consultancy that analyzes the state’s labor market, said in a report last week, “Despite recent improvements in some important labor market indicators, labor market conditions in communities across North Carolina still have not returned to their pre-recessionary states. The May data showed little deviation from the basic pattern that has characterized the state’s labor market for the past four years: a sluggish recovery that is not generating enough job opportunities rapidly enough for working North Carolinians.”
The Republicans who lead the General Assembly are committed to tax cuts as an article of faith, but that faith is being sorely tested. Other states are recovering faster and investing more as North Carolina tries to regain its economic health on a starvation budget. Lawmakers should take another look at taxes and find a way to generate revenues that will meet the state’s needs and support its ambitions.