North Carolina will collect about $400 million more in revenue this year than state officials expected – a surplus that officials said is the result in large part of taxpayers receiving lower refunds or paying more to settle up in this year’s tax filing season.
The state’s last official prediction, made in February, had forecast a budget shortfall of about $270 million.
Republicans immediately hailed the surplus as good news that they said shows tax changes in recent years have left the state in strong financial shape. Democrats cast the surplus as a disappointment, saying much of it was generated by middle-class taxpayers who lost deductions or exemptions and paid more this year.
A consensus report, developed by the state budget office and the legislature’s nonpartisan Fiscal Research Division, says the projected surplus is “predominately due to higher income tax payments and lower refunds from the 2014 tax year.”
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Wages, sales tax receipts and withholdings from paychecks have been relatively flat or down, the report says.
But there was “strong growth in business income, which resulted in a surge of final payments this April,” the report says.
Business income tax payments in April were up in the range of 15 percent to 20 percent, in line with what some other states have seen, the report says, and were “well above expectation.”
“It appears that the increase was driven by increases in business income, which is often paid under the personal income tax, and by capital gains from the sale of stocks and real estate holdings,” the report says.
Officials said that previous budget forecasts were conservative due to uncertainty about how tax code changes lawmakers passed in 2013 would play out.
“The cautious forecast left more room for a positive April ‘surprise’,” says the report, authored by Barry Boardman of the legislature’s staff and Nathan Knuffman of the state’s budget office.
Gov. Pat McCrory announced the numbers at a gathering of county commissioners Wednesday morning, saying the projections are “even better than we anticipated.”
“We have a growing economy in North Carolina for the first time in five or six years,” he said. “It shows that fiscal responsibility does work.” By the close of the day, McCrory, a Republican who will seek re-election next year, was highlighting the surplus in a solicitation for campaign money.
The consensus report says that refunds to taxpayers fell sharply in the tax filing season, down 57 percent from the previous year.
State revenue officials had earlier estimated reduced refunds due to tax code changes – but were predicting drops in the range of about 35 percent. The bigger-than-expected drop in refunds “resulted in an additional $375 million in personal income tax collections than projected in February,” the revenue report says.
Democrats used the revenue projections to criticize Republican tax policy and focus attention on those whose taxes went up. “There is a fundamental disconnect between the governor’s rhetoric and the reality of middle-class families,” House Democratic Leader Larry Hall said. “Wages are down, but tax collections went up.”
Taxpayers who saw smaller refunds – or owed the state money this April – said in interviews the surplus isn’t worth celebrating.
Dan Sheehan, a 73-year-old retiree in Raleigh, said he’s received a $120 state refund each April for years. But this year, his tax preparer instead told him to write a check for $320.
“We’re on a fixed income, and all of a sudden – bang – they take a bite out of it,” Sheehan said. “The only break we got this year was that the gas tax went down.”
State Budget Director Lee Roberts said less money was issued in tax refunds this year because the state tightened withholding formulas – so workers saw less money taken from their paychecks throughout the year, instead of overpaying the government and getting a refund in April.
McCrory acknowledged the perception of some taxpayers, but said most saw a cut in their total taxes paid.
“They noticed (the smaller refund) more than the new net revenue they had every month or every week in their paycheck,” McCrory said.
That’s true for taxpayers who benefited when the state eliminated a tiered income tax rate schedule that had been pegged to income levels. The state’s 2013 tax overhaul lowered the overall rates to a flat 5.8 percent in the 2014 tax year and to 5.75 percent this year.
For some, that income tax cut wasn’t enough to offset the loss of tax credits and exemptions that were also eliminated in an effort lawmakers said was to simplify the system and instill more fairness. That group includes businesses who previously had an exemption on $50,000 in income as well as Sheehan and other seniors who had received a tax deduction on medical expenses.
Calls to restore medical deduction
Several seniors said the state should use the surplus to restore the medical deduction. Legislation to bring back the tax break is under review in the state House and amounts to about $38 million a year.
“We know that you’re getting our money, and you’re supposed to think about giving it back,” said John Bland Jr., another Raleigh retiree who said he’s paying more under the new tax system.
McCrory said Wednesday that the medical deduction should be a top priority as the legislature begins crafting its budget. “We’ve gotten a lot of feedback on that in the past year, and now we have the opportunity to help those that need assistance,” McCrory said.
That will compete with other budget pressures. In addition to the surplus for the current fiscal year, budget staffers estimate that revenue will increase $564 million in the fiscal year beginning July 1. That would be a 2.64 percent increase over the $21.4 billion the state expects to now take in this fiscal year.
Legislators must fund increases in education and Medicaid costs and will hear from a variety of competing needs, including pay raises for state employees.
The House develops a budget first this year, and is planning to vote on it during the week of May 18. It would then head to the Senate in a process expected to result in a new spending plan around July 1.
Both McCrory and Senate leader Phil Berger called Wednesday for the state to save some of the forecasted surplus.
“We need to continue to build up our reserves in the state budget,” the governor said, arguing that the state’s current 3 percent reserve isn’t “sufficient enough.”
“We need to prepare for those things that are unanticipated and out of our control.”
Berger made the same case a few hours later. “We expect to exercise some fiscal discipline” in the budget, he said. “There’s going to be another recession. It’s going to happen again. ... Our rainy day fund only has about half of what it needs to have in it.”
Key numbers in assessing the state’s budget year, which ends on June 30.
February forecast shortfall
May forecast surplus