by Joseph Coletti
Senior Fellow, Fiscal Studies, John Locke Foundation
State budget writers have more challenges than normal as they prepare for the next biennium. First, there are economic headwinds from tariff and trade wars and a broader concern about when the next recession will arrive. Tax reforms at the state and federal level increase the difficulty of forecasting revenue. New budget rules also make year-to-year comparisons more difficult. This uncertainty demands cautious planning for the next biennium.
Revenues through October are 7.2 percent ahead of fiscal year (FY) 2017-18, but the next three months will provide a better assessment of the financial picture for the current fiscal year and the budget that Gov. Roy Cooper and the General Assembly will prepare. Through December 2017, state tax collections were just 1.2 percent higher than the previous year. But when lower federal tax rates took effect in January 2018, revenue jumped 16.9 percent from the previous year. State coffers are still benefiting, as October collections were 12.8 percent higher than a year earlier.
In November, out-of-state companies were directed to begin the collection of sales tax for the sale of goods to North Carolina residents. Revenue estimates range from $50 million to $500 million per year. Sales tax collections have averaged $625 million per month, so it may be hard to see the effect of online sales tax collections that could range from $4 million to $40 million per month, compared to increases of up to $100 million in a typical month.
January 2019 is the first month of state tax reforms that could trim revenue by more than $1 billion per year. Lower income tax withholding from lower rates and a larger standard deduction will contrast with sharp increases during the previous year. The actual effect will not be known until mid-February.
The final results of a year of federal tax cuts will not be known until after the April 15 filing deadline, which is when taxpayers make final estimated payments that produce the April Surprise. Soft stock market returns in 2018 mean capital gains may not provide the same boost as in recent years when April collections have often been more than 50 percent higher than the monthly average.
Spending grew an average 2.4 percent per year from FY 2010-11 through FY 2017-18, slower than the growth in population and inflation. But General Fund spending increased 3.9 percent in the current budget. The increase this year does not include $155 million in capital expenditures that were treated as a reduction in revenue rather than appropriations. Depending on how one adjusts for the change in budget treatment, spending increased by as much as 4.5 percent before the passage of hurricane relief legislation.
In response to Hurricane Florence, the General Assembly transferred $750 million from Savings Reserve and $100 million from other sources to fund hurricane relief. They have reserved $95 million to be appropriated later. Replenishing the Savings Reserve would take 2.5 percent or more of total revenue. A new fund for capital and infrastructure needs is scheduled to receive 4 percent of revenue, or $960 million, to repay debt and build or renovate state-owned property.
Tax collections will drop another $500 million during the next fiscal year, as the state tax cuts continue to take effect. Against this and amid the other uncertainties, there will be renewed demands to pay teachers more, expand Medicaid, improve the criminal justice system, and ensure the long-term sustainability of the state health plan and pensions. Finding places to save will be legislators’ top priority, but with 94 percent of General Fund appropriations used for education, health and human services, and public safety, savings will need to come from what some consider to be essential services.
Add in the new strength of Democrats in the General Assembly and perhaps the only factor that will mitigate the potential for drama is that there is no risk of a government shutdown. If legislators and the governor cannot agree on a new budget, the current spending plan will simply continue unchanged.