So far this year, we’ve had three state budget plans submitted by the three main actors in the drama: Gov. Pat McCrory, the North Carolina House, and the North Carolina Senate. While important differences remain to be settled between the two chambers, I’m struck by the remarkable similarities.
All three plans feature modest spending growth (below the combined rates of inflation and population) plus large deposits into savings accounts and significant pay increases for teachers (bounded by 4.1 percent and 6.3 percent, on average, for the House and Senate respectively). Both legislative chambers propose the same cut in personal income taxes by increasing the standard deduction, although the House would implement the tax cut over four years while the Senate would do it in two.
This augurs well for a new budget to be in place on or near the start of the 2016-17 fiscal year in July. North Carolina is poised to save money for a rainy day, cut taxes again for most households, and devote more dollars to high-priority state services — all at the same time.
How is this possible? The short answer is that state revenues are beating the original forecast while state expenditures are lower than forecast. But the shortness of that answer has allowed some politicians and activists to invent their own, elaborated version that advances a skewed understanding of North Carolina’s fiscal history.
One familiar myth is that the state’s better-than-expected revenue growth proves the legislature actually increased the tax burden on North Carolinians over the last five years, rather than decreasing it as GOP leaders claimed. The claim here is that while those tax reforms may have reduced income-tax liability, they also expanded the sales tax on services to such a degree that most low- to middle-income households ended up paying more tax than before.
This claim is simply false. Careful analysis by the nonpartisan legislative staff as well as the John Locke Foundation found that most households received net tax cuts from North Carolina’s reforms, although there were some households whose tax savings were limited or nonexistent (typically because they benefitted from special exclusions or credits that lawmakers properly eliminated as part of reform).
Moreover, liberals who complain about the sales-tax broadening rarely note that today’s state sales tax rate of 4.75 percent is lower than the 5.75 percent in place before the Republicans took control of the General Assembly in 2010. North Carolina is now collecting less sales tax as a share of total retail sales than it was under Democratic rule (and I say this as someone who did not favor the Republicans’ sales-tax broadening).
Here’s the bottom line about the current revenue surplus: it isn’t primarily due to the sales tax, anyway. For the 2015-16 fiscal year to date, North Carolina’s sales-tax collections are up $225 million, or 4.3 percent, over the same period a year ago. The real driver is income tax revenue, which is up $915 million, or 10 percent. That upswing, in turn, is explained not by higher tax rates on income but instead by more people holding more jobs and receiving more taxable income.
In other words, the effective state tax rates on both sales and income are lower, on average, than they were before Republican lawmakers became the majority in Raleigh. State tax revenues are growing because the tax base — North Carolina’s economy — is growing.
The other major explanation for the state’s improved fiscal position this year is that enrollment in Medicaid, colleges, and other state institutions has turned out to be lower than expected. In fact, expenditures for Health and Human Services (including Medicaid) are running about $173 million lower in 2015-16 than in the previous fiscal year. Overall, General Fund spending is up only 1 percent.
Rather than seeing these revenue and budget surpluses as an excuse to go on a spending spree, Gov. McCrory and the legislature are responding prudently and, more or less, in accord. Sorry if that’s a boring story. But it’s the truth.
John Locke Foundation chairman John Hood is the author of Catalyst: Jim Martin and the Rise of North Carolina Republicans.