Prosperity Watch (Issue 46, No. 3)

February 26, 2015

Revenue raised from North Carolina’s tax system is not growing at the pace it has in the past nor at a level sufficient to ensure that the state can invest in public schools, public health and modern infrastructure—the building blocks of a strong economy.  Contrary to claims that policymakers in North Carolina are making, the state is not experiencing a revenue surplus. Instead, revenue has been coming in below budgeted levels, generating  shortfalls for the previous fiscal year as well as the current one.

The recent official consensus revenue forecast makes clear two major concerns. First,  the rate of revenue growth is raising too few dollars and will put the current fiscal year budget (FY 2014-15) out of balance. Second, persistently sluggish revenue growth in future years will also mean the state has too few dollars to meet the ongoing commitments of the state for core public services. This second point means the state will not be invest in core public services as the economy grows, adapt to the changing needs of its citizens and communities, or pursue new initiatives to position the state competitively.  Regardless of some policymakers claims, revenue will be coming in below what is needed and cannot be considered a surplus until it outperforms projections.

A healthy revenue system should see robust growth in tax collections during an economic recovery.  As people return to work and spend more in the economy, as wages grow, and as corporate profits rise, once-collapsed revenues due to economic conditions should grow.  In the long-run, a revenue system should experience year-over-year growth that is in line with how the economy performs.  When this outcome doesn’t occur it is either because the economy is not performing as well as portrayed, because the cost of tax changes are greater than anticipated or because policy decisions have limited the potential for revenue to grow with the economy.

North Carolina’s average year-over-year revenue growth back to 1990 is 4.7 percent.  However, since July of last year and looking ahead to June of this year, the state’s actual revenue collections are now expected to grow just 2.9 percent, far below that historic average—despite the economic recovery (see chart below). This subpar growth is also below what state economic analysts initially anticipated and the result is that the budget for FY 2014-15 is experiencing a current year shortfall not a surplus.  Revenues are not meeting expectations, throwing the budget out of balance.

Since the 2013 tax plan passed, revenue projections have been revised downward time and time again. In July 2013 when lawmakers passed the biennial budget, they anticipated having $21.35 billion available in general fund revenue in the current fiscal year.  By July 2014 when lawmakers adjusted the second year budget, policymakers based their spending decisions on a revised and lower $21.08 billion in revenue.  Current estimates now suggest that just $20.73 billion will be available this fiscal year which while more than what was actually available in FY 2013-14, is farless than was originally budgeted.

Moving forward, projected revenue growth for the next biennial budget cycle will continue to be constrained due to the economy and the 2013 tax plan. This will limit the ability of the state to make critical investments in core public services.  A limited list of identified budget pressures—such as school enrollment growth—amounts to $448 million for FY 2015-16, roughly two-thirds of the current projected revenue growth of $679.8 million.  This means that policymakers are likely to face challenges in meeting ongoing commitments and will be unable to make progress towards replacing the worst of the cuts that have been made or pursuing new initiatives.

Again, year-over-year revenue growth is to be expected at this point in the recovery and does not mean that the state is experiencing a surplus.  In fact, current levels of revenue growth are proving too sluggish to meet expectations meaning that policymakers face a current year shortfall and will be far more limited in their ability to reinvest in the next biennial budget.