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Overspending plays largest role in state's fiscal woes

JLF analyst says return to 1990s spending levels would save $3 billion

Contact: Joseph Coletti
919-828-3876
jcoletti@johnlocke.org

January 07, 2009

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RALEIGH -- Rampant state government spending bears much of the blame for North Carolina's current budget woes, according to a new John Locke Foundation Spotlight report. State spending has increased 41 percent in the last 20 years.

Click here to view and here to listen to Joseph Coletti discussing this Spotlight report.

"Returning state spending to 1990s levels would save the government and taxpayers $3 billion," said report author Joseph Coletti, JLF Fiscal Policy Analyst. "That would generate more than enough money to cover the projected state budget hole."

"No one should be surprised that North Carolina faces a shortfall for the current budget year and another projected shortfall for the new budget year that starts July 1," Coletti added. "The state's tax structure is based on two volatile taxes: the progressive income tax and the sales tax. The General Assembly has failed to budget accordingly."

Budget writers relying on volatile taxes should set aside money in good economic times to cope with the inevitable downturns, Coletti said. "Instead the General Assembly has consistently failed to plan ahead, creating a spend-and-tax roller-coaster ride of a state budget process for the last 20 years. Budget writers spend too much when tax revenues are high and raise taxes when revenues are low."

Lawmakers should be cautious about budget estimates involving individual income and sales taxes, Coletti said. Those two taxes and the corporate income tax make up roughly 90 percent of state General Fund revenue each year.

"Income tax revenue grows faster than the economy during expansion periods, as people earn more and move into higher tax brackets," Coletti said. "The flip side is that income tax revenue shrinks faster than the economy in a downturn as people earn less and move into lower tax brackets."

The story is similar for sales tax revenue, since people tend to make more and larger taxable purchases during economic good times, Coletti said. "Wise budget writers would adjust to the cycles linked to income and sales taxes by spending less than is available in fat years and setting aside a portion of tax revenue to maintain core services in lean years," he said. "Once adequate reserve funds are set aside, the government could return the rest of the tax revenue to taxpayers."

Numbers show that North Carolina lawmakers instead follow a pattern of spending heavily in years of plenty, raising tax rates in lean years, then repeating the process, Coletti said.

"In the current budget year, state government appropriations per person equal $2,311," he said. "That's more than the inflation-adjusted $2,248 per person figure from the 2000 budget year, at the peak of the previous spending cycle. Spending by state government has ebbed and flowed over time, ratcheting upward with each cycle."

There's a "worrisome" trend in the current cycle, Coletti said. "The overspending in this cycle has focused on continuing programs, rather than one-time building or capital expenses," he said. "That means state government has to find ways to pay for these programs next year, the year after, and well into the future."

North Carolina state government spent 3.9 percent more per person in the 2008 budget year than in 2000, Coletti said. "Per-person operations spending climbed an inflation-adjusted 8.8 percent during that same time period," he said. "And from the time the budget bottomed out in 2003 to the 2008 budget year, per capita spending adjusted for inflation climbed 14.7 percent."

Average state appropriations through the 1990s totaled an inflation-adjusted $1,848 per person, Coletti said. "Returning spending to that level would save the state $3 billion from the current $21.4 billion budget," he said. "That's more than this year's projected shortfall."

The spend-and-tax budget cycle has created other problems, Coletti said. "First, lawmakers have devoted too little money to North Carolina's Savings Reserve Account, the rainy day fund," he said. "Past experience and best practices from other states show the savings reserve should be at least 10 percent of the previous budget year's General Fund spending. North Carolina's reserve is less than 4 percent, and Gov. Mike Easley could take half of that reserve -- or more -- just to help the state government pay bills through June."

Another problem involves hidden debt, Coletti said. "The General Assembly has violated in recent years the spirit of a constitutional provision requiring a balanced budget," he said. "Lawmakers do this by borrowing money without voter approval. Legislators have approved $3.1 billion in new debt without a vote from taxpayers since 2003. This is equal to the size of the last bond package voters approved in 2001. Lawmakers have used this tactic as their preferred way of paying for new buildings and other capital projects this decade."

Now is a good time for lawmakers to change their ways, Coletti said. "Lawmakers today should see clearly the negative impacts of their spend-and-tax cycle," he said. "To avoid similar problems in the future, they should take steps to retire that roller-coaster ride and adopt a more sound approach to state budgets."

Joseph Coletti's Spotlight report, "Spending Beyond Government's Means: Even politicians must face fiscal truths," is available at the JLF Web site. For more information, please contact Coletti at (919) 828-3876 or jcoletti@johnlocke.org. To arrange an interview, contact Mitch Kokai at (919) 306-8736 or mkokai@johnlocke.org.

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