Prosperity Watch Issue 42, No. 1: State budget underfunds in expansionary period, undermines economy

Investment in core public services – such as educating children, building a modern infrastructure and catalyzing research and development – supports economic opportunity and a strong economy. States must balance their budgets each year, and in turn, during downturns states often reduce spending levels and subsequently reinvest during expansions. Aligning spending with business cycles makes sense within the immediate fiscal constraints of declining revenue; however, fiscal decisions also play a role. Decisions by policymakers to pursue spending cuts rather than identify revenue options, to cut revenue rather than ensure adequate revenue is available during an expansion, or to not address the volatility in a tax system contributes to the level of revenue available for public investments.

States across the country are beginning to reverse the worst cuts made during the Great Recession, when revenue plunged and lawmakers scrambled to balance state budgets, often times with spending cuts. North Carolina continues to underfund education and other crucial public investments in order to pay for tax cuts that took effect this year. State investments are 6.6 percent below pre-recession levels even though North Carolina is in the fifth year of the official economic recovery. This is in great contrast to North Carolina’s experience during the previous three economic recoveries. Spending did not dip after the 1981 and 2001 recoveries, and lawmakers restored investments to the levels that were in place when the 1990 recession hit within three years, primarily because policymakers also identified revenue options alongside spending cuts.

The fiscal year (FY) 2015 budget—the seventh budget enacted since the Great Recession hit—has yet to bounce back and reach prerecession spending levels. The reasons for the state’s continued underinvestment are clear. The tax cuts already are costing the state much more than expected and will continue to reduce the revenue that is available for public investments next year and beyond.  Just as the tax cuts are not likely to benefit the economy through job creation, spending cuts have clearly harmful impacts on the economy. Contrary to common debate, the cuts made in recessions are not to eliminate waste, fraud and abuse but, as we have seen in North Carolina, go to the core of the effective and efficient delivery of public services.

Let’s review the three important ways in which continued underinvestment hurts the state’s economy.  First, budget cuts lead to public sector layoffs whether that be environmental engineers, teachers in classrooms or maintenance staff for state properties. More than 20,000 jobs in state and local government have been lost since September 2008 – the peak of public sector employment – and an estimated 91,000 jobs in state and local government are needed to continue to serve the needs of a growing population.  Without these public sector workers, the unemployment rate remains high and consumer spending in local communities remains depressed. Furthermore, budget cuts can reduce the availability of contracts for private companies, which impact the provision of services provided and businesses’ bottom line. Medicaid cuts and increased provider rates on health care providers in North Carolina is a clear example of this impact. Other areas such as contracts for school cafeteria food or the provision of mental health services also feel the impact of underinvestment in public services. Finally, when the state forgoes investment in the foundations of a strong economy—an educated workforce, a modern infrastructure, healthy communities with a high quality of life for all residents—its competitive position is undermined.

North Carolina’s continued underinvestment in core public services has been the result of policymakers’ decisions to cut taxes and reduce the reach and quality of public services in communities across the state.  The economic consequences have been clear via fewer public sector employees and private contracts and will only grow in the long-term as the state fails to prepare for a 21st century economy.