Under the Dome

SUNDAY DOME: April surprise – budget gains as tax rates cut

Former state budget director Art Pope says tax cuts are aimed at long-term growth, not a one-year budget surplus.
Former state budget director Art Pope says tax cuts are aimed at long-term growth, not a one-year budget surplus. ehyman@newsobserver.com

The people who watch the state budget like to talk at this time of year about the April “surprise,” the moment (usually in May) when April tax collections are counted and weighed against the official forecast in an exercise that produces certainty about the state of the state’s finances.

The new numbers, if off too much, can lead to scrambling across state government in the final weeks of the budget year, which closes on June 30. It can also alter how lawmakers approach writing the next budget, a process already underway for the spending plan that takes effect on July 1.

But the news last week that North Carolina will have a $400 million surplus in the current budget year – and about $600 million more for the next – generated responses from Republicans and Democrats that weren’t much of a surprise.

Republicans who are in charge were giddy, emphasizing that the sky isn’t falling and their policies are working.

Democrats furrowed their brows, saying the extra money came from middle-class folks who need a break.

There was some truth – and shading – from both sides.

This year’s final forecast was especially viewed through partisan lenses: It’s a measure of the Republican-led tax overhaul, which passed in 2013 but was in effect for the 2014 tax year.

The overhaul included the elimination of a tiered income tax system with rates as high as 7.75 percent in favor of a flat, 5.8 percent income tax on all. (It’s at 5.75 percent for the current year.) Corporate tax rates were reduced. The standard deduction and a child tax credit were increased. But it wasn’t just tax cuts or breaks. Lawmakers broadened what is taxed (extending the sales tax to capture certain items and services) and eliminated certain deductions and exemptions that had lowered many taxpayers’ tax bills.

At one point in the tax overhaul debate, mortgage interest and charitable deductions were on the chopping block. Those survived. A deduction for high medical expenses didn’t. An exemption on $50,000 in business income also went away.

How all those changes would shake out has been a major focus of the state’s political, government and business communities – and added plenty of uncertainty for the budget forecasters.

Views on surplus

In reacting to the news of a surplus, some Republicans pointed to the tax cuts. The speaker of the House, Tim Moore, said in a statement: “The lower, flat personal income tax rate has spurred economic growth and job creation that in turn has provided North Carolina with a budget surplus.”

One of this budget’s key architects was Art Pope, a Raleigh businessman and supporter of Republican causes who was state budget director until last fall. He’s watched closely even after returning to private life.

“Let me just clarify or emphasize one thing right now,” Pope told Dome in an interview after the surplus was announced.

“There was never any expectation that tax cuts would pay for themselves during the very next fiscal year, or the next two fiscal years,” he said. “In the long term Gov. (Pat) McCrory and the legislature believes – and I believe – that reducing taxes will allow for more economic growth as people keep more of their hard-earned dollars and as businesses and employers keep more of their hard-earned dollars and reinvest them.”

But the surplus is not because of the tax cuts, Pope said.

“I was never in a single meeting where we said if we reduce the corporate tax rate or the personal tax rate by X percent then next year revenue will grow by Y percent,” Pope said. “There never was any prediction there. Long term, yes. Short term, or the fiscal year, no.”

And that, Pope said, “is not what happened.”

Democrats have expressed concern that seniors who lost a medical deduction and small business owners who lost the income exemption fueled the surplus.

The Senate’s Democratic leader, Dan Blue, described the surplus in a statement as a “so-called budget surplus.”

“Seniors, small businesses and middle-class families across North Carolina got slammed on Tax Day,” Blue said.

But the forecasters had long ago made assumptions about those changes and the effect on the budget. To use a cliche, those changes – which affected millions in tax receipts – were already “baked in.”

What happened, according to interviews with economists, forecasters and legislative staffers, was that personal incomes were more robust than anticipated. The economy is good, here and in other states. More people are working – the state added 50,000 jobs in 2014 – and paying taxes. A state report notes that capital gains from stock and real estate sales were a part of the growth.

Forecasters had been cautious all along, predicting a shortfall as recently as February. But as tax returns came in, that melted away.

The result in context

It is worth noting that the forecast for an extra $400 million is on a $21 billion budget – a miss of about 2 percent.

Pope said it’s now clear that predictions by Democrats in 2013 of dire results, of major shortfalls below what was budgeted and would hamstring the state, were wrong.

He said he believes, on the broad scale, that the surplus is most likely a result of how people’s paychecks were handled. For 2014, the state reset the tables that determine how much tax money is withheld from taxpayers’ check.

The new withholding schedules were set up with a goal of seeing a pure balance – aiming for an outcome of no refunds and no one writing a check to the state on April 15. Workers saw a bit more in their paychecks each week as a result, and received much less money in refunds in the tax season that ended on April 15.

In previous years, the state had been issuing lots of refunds.

“Good public policy and fairness to taxpayers is not to ask them to give free loans to the government by overpaying their taxes,” Pope said.

Then, personal incomes performed better than expected, and that meant more tax money for the state.

“The surplus is really just a function of a forecast that was pretty close to predicting how this would all shake out,” Pope said. “And it happened to be off – on the good side – by a little bit.”

J. Andrew Curliss

Understanding a surplus

State officials announced a $400 million surplus for the current budget year, which ends June 30. Dome breaks it down.

Fiscal memo

A consensus of legislative and administration staff says the surplus is the result of:

▪ Caution: All previous forecasts were “very cautious,” and left room for a positive change.

▪ Growth: April payments to the state were up 15 percent to 20 percent, well above expectations. The increase was driven by business income, often paid as personal income tax, and gains from stock and real estate.

▪ Refund decline: More accurate withholding tables (see related story) reduced refunds to taxpayers. Refunds were down much more than an expected 35 percent, yielding about $357 million in additional income tax collections than were forecast.

Steep refund decline

The refund decline, tied to the withholding tables change, was a big driver. Officials say the dropoff in refunds was “more than double the biggest year-over-year decline” going back 25 years.

2014

No. refunds issued: 2.3 million

Refunds amount: $1.2 billion

2015

No. refunds issued: 1.8 million (down 22 percent)

Refunds amount: $591.1 million (down 51 percent)

Tax overhaul changes

Some paid more in income taxes as a result of the 2013 tax overhaul. The majority paid less. Here’s how 2014 tax season shaped up for taxpayers:

Taxes decreased: 55 percent to 60 percent

Taxes increased: 30 percent to 35 percent

Little or no change: 10 percent to 15 percent

The forecast

The updated forecast shows a budget for 2014-15 that misses the original forecast by about 2 percent. Here’s how much the forecast missed in recent budget years, which run from July 1 to June 30:

2014-15: +1.9% (May forecast)

2013-14: –2.2%

2012-13: +2.2%

2011-12: +2.0%

2010-11: +0.9%

2009-10: –1.6%

Sources: General Assembly Fiscal Research Division, Office of State Budget and Management, N.C. Department of Revenue

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