by Joseph Coletti
Senior Fellow, Fiscal Studies, John Locke Foundation
A $700 million accounting change made the North Carolina House’s $23.9 General Fund budget difficult to compare with past budgets and with Gov. Roy Cooper’s spending proposal. The budget bill (HB 966) eventually passed and headed to the Senate. Senators expect their version to be ready in late May and ready for the conference committee with House appointees by June 1. The General Assembly’s Fiscal Research Division expects revenues for the current year, ending June 30, could be $700 million higher than originally forecast, making their job easier.
On a comparable basis, the House proposal would spend $600 million less through the state General Fund than Cooper proposed. The governor’s budget would have appropriated $24.5 billion for operating expenses, $1.3 billion (5.6 percent) more than the current year and $740 million for debt service. The House budget totals $23.9 billion, $700 million (3.1 percent) more than the current year, with $721 million in debt service. Cooper’s budget proposal for the year that begins on July 1st is $1.3 billion more than the year that ends on June 30th.
In 2017, the General Assembly created the State Capital and Infrastructure Fund (SCIF) to combine all payments for capital, whether debt or current funding. The SCIF receives four percent of General Fund tax revenue plus one-fourth of any unreserved cash balance. As the state relies less on debt, it will need to direct less to principal and interest payments and have more available to pay for capital projects from current funds. Cooper would have repealed the SCIF to redirect more than $250 million to operating appropriations and instead would take out $288 million in limited obligation bonds. In addition to the $721 million for debt service, the House reserves $250 million for repairs and renovations, $218 million for other capital projects, and leaves $13 million in the SCIF for future use. Conspicuously missing from the SCIF line items are debt or spending for a $2 billion public school construction plan.
The House follows statutory requirements to set aside 15 percent of tax revenue growth, $104.6 million in the Savings Reserve, bringing the balance to $1.5 billion. But it does not provide any additional funds to replenish the $750 million used for hurricane relief. It also sets aside $73 million in a reserve for information technology projects, treating them more like other capital projects.
The House anticipates $12 million in gross premium tax revenue from the new Medicaid managed care prepaid health plans, slightly less than the $13.2 million in Cooper’s proposal. The House increases the standard deduction and takes steps to reduce the franchise tax on business value, but it also would hold internet marketplaces responsible for collecting sales tax on items sold through their sites into North Carolina. All told, tax revenues climb $6.7 million for the year, but because the premium tax is more of a transfer as part of Medicaid reform, it seems reasonable to consider just the $5.3 million reduction from the other items as a true tax policy change.
From baseline revenue and unreserved balances of $25.9 billion, the House budget appropriates $23.9 billion, transfers $1.4 billion to reserves, and leaves a $600 million unreserved balance. In contrast, Cooper’s budget would have appropriated $24.5 billion and transferred $1.3 billion to reserves or debt service, leaving an unreserved cash balance of $75 million.
As in previous years, more than 85 percent of state tax dollars go to education, Medicaid, and public safety. Of the $23.9 billion in General Fund appropriations, public schools from kindergarten through 12th grade receive at least $9.7 billion in state tax dollars, Medicaid receives $4.0 billion, and public safety receives at least $2.8 billion.
Appropriations grow faster in the second year of the biennium (4.0 percent) than the first (3.1 percent). Second-year growth may also be faster than the combined rate of inflation and population. This would make spending 7.2 percent higher in Fiscal Year (FY) 2020-21 than it is in the current year (FY 2018-19). The House’s approach is more reasonable than Gov. Cooper’s two-year proposal, which would have increased spending 5.6 percent in FY 2019-20 but just 3.0 percent in FY 2020-21.
Consider that in 2017, Cooper sought a first-year increase of 4.9 percent and promised slower growth the second year for an increase of 6.5 percent over the biennium. When 2018 came around he proposed spending 5.0 percent more on operations than the budget that actually passed, which would have resulted in a two-year increase of 7.7 percent. It seems reasonable to conclude that, barring an economic downturn, Cooper will want to increase spending by much more next year than his current budget proposal indicates.
Spending growth is concentrated in just six areas over the biennium, accounting for $522 million (74 percent) of the $710 million increase in FY 2019-20 and $795 million (82 percent) of the next $966 million in FY 2020-21. These increases cover salaries and benefits for state employees and teachers, Medicaid costs, “Raise the Age” implementation to keep most juvenile offenders out of the adult criminal justice system, an initiative to get more use out of University of North Carolina facilities by scheduling more summer classes, public school enrollment, and grants for movie productions. The Medicaid and school enrollment growth projections are particularly high in the second year of the biennium which could simply indicate a cautious budgeting approach, not an expansionary vision.
Salaries and benefits for teachers, principals, corrections officers, and other state employees would increase $422 million in FY 2019-20 and another $551 million in FY 2020-21. Retirees would receive a temporary 1 percent cost-of-living increase. Teacher salaries would climb 4.6 percent, principals would receive a 10 percent bump, corrections officers 5 percent, and most other state employees 1 percent. Fulfilling the promises on health and pension benefits would take $173 million of the $422 million in FY 2019-20 and $319 million of the $551 million in FY 2020-21.
Medicaid spending is expected to increase $32 million in FY 2019-20 and add $180 million more in FY 2020-21 to keep up with enrollment and care costs. With the transition to managed care through private insurers, the caution seems warranted. Fortunately, the House does not include the massive expansion of Medicaid that Cooper proposed. Although Cooper’s budget anticipated hospitals covering the state’s share, expansion would cost $6 billion, including federal funds, over two years. The effects of expansion would be felt throughout the Medicaid program so that state spending under Cooper’s budget would cost $60 million more than the House budget in FY 2020-21 and $166 million more in FY 2021-22.
The UNC System would receive $35 million each year to better use campus facilities by encouraging more students to take courses in the summer term. The House would allocate $29 million in FY 2019-20, increasing to $44 million in FY 2020-21 so the juvenile justice system can accommodate more youth offenders as a result of the Raise the Age law. Lawmakers misunderstood how much was still available for movie production grants and so reinstated the appropriation $31 million annual appropriation
Enrollment in public schools is expected to dip in FY 2019-20, but more of those students would be in the exceptional children or limited English proficiency programs, leading to a $3 million increase in FY 2019-20. Statewide enrollment growth of 6,000 students in FY 2020-21 would increase appropriations another $50 million in FY 2020-21.
Looking ahead, the Senate will have more money available but seems likely to keep spending similar to House level and set aside more money for savings. If the windfall appears to be recurring, Senators may also provide more tax relief.
Strong economic growth and federal tax reform have combined to improve state revenues for North Carolina as for other states, though it may be short-lived. Spending increases in the 4.7 percent range, which would allow government to continue doing the same things the same way for more people at higher cost, would soon outstrip the money available from current taxes. Slower spending growth would provide more saving, better ensure sustainability, and make further tax cuts possible. House leaders wisely pulled back from the 3.5 percent growth they originally set as a target with Senate leaders. The Senate should be even more restrained in its budget proposal later this month.
Gov. Cooper has indicated repeatedly his commitment to expand Medicaid at any cost, which means he will likely veto any budget that passes the legislature. State law ensures that government will not cease functioning during a stalemate between the legislature and governor, but instead will continue to function at current spending levels. Delaying pay increases until January provides more time for lawmakers to reach agreement across party lines on the importance of taking care of essential government functions while building savings.