Gov. Mike Easley took office this month with the state of North Carolina facing a estimated budget deficit of $486 million for the current 2000-2001 fiscal year, ending in June, with another half-billion-dollar budget gap projected in FY 2001-2002. Since North Carolina law requires a balanced budget each fiscal year, Easley and the incoming General Assembly must adjust the current year’s budget to bring it into balance as well as agree on a new budget for the 2001-2003 biennium that equates spending and revenue projections.
While these challenges are widely characterized as a “fiscal crisis,” they need not be. The governor, with a new administration and a somewhat different philosophy of governing than his predecessor, now has an opportunity to rethink the state’s approach to budget policy. The changes he must make can promote prosperity and job creation and place North Carolina on track for strong economic growth in the future.
All Balanced Budgets are Not Equal
A budget deficit simply implies that during the fiscal year revenues to the state’s general fund are less than spending. A balanced budget can be achieved by either reducing spending, increasing revenues (e.g. raising taxes), or both.
As noted, in North Carolina, the state is required to balance its budget each year. This requirement is sensible. Deficit spending is a hidden tax that masks the true burden of government. It deceives taxpayers, leading them to believe that government services cost less than they actually do. If the state is to have an informed electorate, the taxes that they pay should reflect the actual size and scope of their government.
This noted, the way that the budget is kept in balance makes a big difference to the long term health of the state economy From the perspective of economics and, just as importantly, individual liberty reducing spending is unambiguously preferred to raising taxes. This is because taxation transfers control of revenues, and therefore resources, from consumers, businesses, and entrepreneurs in the private sector to legislators and bureaucrats in the public sector. Lowering government spending, on the other hand, moves resources from public to private sector control.
Private sector consumers and entrepreneurs face important incentives that are not confronted in the public sector. Because participants in the private sector are making decisions about how to spend, save, and invest their own money, the incentives created by the system of profit and loss become paramount. To earn profits businesses must allocate resources toward uses that are consistent with consumer preferences. When they fail they incur losses and incentives are created to reorganize their decision making to more accurately reflect what consumers want. Also, because they are trying to maximize their profits they are keeping their costs of production as low as possible. Consumers will also try to gain the most value for the dollars they spend, putting further pressure on producers to use resources effectively. Ultimately, this process is what spurs economic growth, creates jobs, and ensures that the goods and services North Carolinians want are produced.
Bureaucrats and elected officials face two insurmountable problems when attempting to allocate revenues efficiently. First, because public sector decisionmakers are not spending their own money, they are not motivated by market driven profits and losses. Therefore, they are unlikely to identify and act on the preferences of consumers, i.e., the citizens of North Carolina. Second, even if they were motivated to act efficiently they would not have the information necessary to take such actions. In a market, prices for resources and consumer goods inform producers about the desires of their customers. Since taxpayers are not directly purchasing the output of state government there is no market price to guide it in budgeting decisions.
Government resources, therefore, tend to be allocated based on political concerns and the personal preferences of those in power. The News & Observer recently noted this reality, pointing out that Governor Easley, in making decisions about state fiscal policy must “tr[y] to please supporters, achieve its own goals and still balance the budget.”1
A policy of economic growth and prosperity dictates that the current budget shortfall be addressed through controlling state spending, not hiking taxes, which stifles entrepreneurship and dampens prosperity. Spending restraint will shift resources from the less efficient public sector to the more efficient private sector.
Applying Key Principles
The current and projected budget deficits create an opportunity to reorient and reprioritize the entire budgeting process. This should start with two basic principles. First, government spending should preempt the market activities of North Carolina’s private sector as little as possible, enhancing the state’s long term economic health. This implies that the state pursue an agenda of reducing its budget wherever and whenever possible.
The second goal, consistent with the first, would be to prioritize spending in such a way that the state performs only those functions that are constitutionally or federally mandated and that are not more appropriately carried out by the private sector. This approach will create as much prosperity as possible for the greatest number of North Carolinians. Furthermore, it would send a clear message to the special interests, both in the private sector and within the state government, that, contrary to the observation of The News & Observer, the purpose of this administration is not simply to “please supporters” and “achieve its own goals.” Easley can use this opportunity, then, to not only find ways to “get the state through” the current fiscal imbalance, but to actually reduce the size and scope of North Carolina’s state government.
Some Places to Begin
- Subsidies to Business Sound principles of both economics and justice suggest that no state should tax its citizens to subsidize its businesses. Government subsidies, either direct, or indirect through “economic development programs,” industry specific research programs, or “free” services and consulting that the state might provide, make some industries and businesses more profitable than others, not because consumers prefer their products but because they are favored by politicians and bureaucrats. Such subsidies distort business and consumer decision making, create inefficiencies in resource allocation, and dampen prosperity for North Carolina’s citizens.
Examples of such programs include marketing and business recruitment programs in the Department of Commerce (DOC) and Department of Agriculture; the Tourism, Film, and Sports Development Division of the DOC; the International Trade Division of the DOC; and the Wanchese Seafood Industrial Park, to name only a few. In past alternative budgets, the John Locke Foundation has identified over $40 million in possible DOC budget cuts3 and over $17 million in the Department of Agriculture,4 relating to what might best be called corporate welfare.
In addition the state should abolish the Golden Leaf Foundation which uses proceeds from the state’s suit against tobacco companies to subsidize businesses and “economic development.”5 These funds, which are expected to reach $2.3 billion over the next 25 years,6 were meant to reimburse taxpayers for alleged healthcare costs of tobacco use and are therefore more appropriately applied to deficit reduction or tax cuts.
- This is one of the fastest growing programs in North Carolina’s budget. While much state spending on Medicaid is mandated by federal law, a great deal can be saved by scaling back optional benefits. As it now stands, Medicaid in North Carolina is more generous than most health insurance plans provided by private sector employers. For example, the state budget as modified last year allocated more than $90 million for dental services and nearly $7 million for optometry services for FY 2000-2001, neither of which is covered by most private health plans. Other areas for possible savings either through outright cuts or system reform include prescription drugs and nursing home care, both of which incur significant costs. The Locke Foundation has suggested that over $31 million could be saved by partially eliminating optional services.7
In the long run, we suggest that the state reform the program by replacing direct payments to health care providers with contracting out, vouchers, and medical savings accounts. This would give participants in Medicaid grater latitude for personal choice in health care plans and would introduce market mechanisms into the health care system that would save not only the state government money but consumers of health care generally.
Since 1996, Mecklenburg County has experimented with private contracts to deliver health insurance to low-income recipients in the Charlotte area. As of early this year, there were four independent health plans participating in the program. While the initiative was undertaken in part to enhance access to medical services by making use of existing private managed care networks, cost savings was also projected. Over three years of full implementation, the annual growth rate of Medicaid expenditures for these patients has averaged 5.3 percent while Medicaid costs in the rest of the state have increased at a 6.5 percent annual rate.8 There is reason to believe that similar cost-containment success, or better, could be accomplished through more aggressive privatization strategies, including giving patients financial incentives to consume care wisely.
- Higher Education North Carolina provides a very generous subsidy to its residents attending state run universities or colleges. The typical student attending a four year state university receives a subsidy from the taxpayers of about $36,000,9 violating a basic principle of economic efficiency, those who receive the benefits of a service should pay its costs. This ensures that the service in question is not over consumed and that resources are not wasted.10 Furthermore, despite rhetoric to the contrary, the system is not about helping those who can’t afford a college education. In 1998 the median family income for a student attending the UNC system was over $12,000 higher than the median income for all families in North Carolina.11
By increasing the tuition for in-state students attending the UNC system to more closely reflect the cost of the educational services, along with increases in means tested aid, the state treasury can reap significant savings. A tuition structure where top tier schools (UNC-CH and NCSU) would charge $6,000 annual tuition; tier II schools (eg. ASU, ECU, and UNC-W) would charge $4,000; and tier III schools (ECSU, FSU, UNCP, and WSSU) would charge $2,000 would allow for a state budgetary savings of $330 million annually.12 In the short run, a tuition increase of approximately 15 percent in the state’s public universities and community colleges would generate significant revenue to offset state appropriations without placing an onerous burden on students.
- Other Areas There are other areas where savings can be realized or revenues shifted. Much of the Cultural Resources budget simply subsidizes selective arts organizations, causing many of the same economic distortions and inequities as does corporate welfare. The Locke Foundation has recommended over $22 million in savings on such programs. Revenues can also be shifted within the budget. At present, there is a $200 million State Reserve Unemployment Insurance Fund generated by unused unemployment insurance contributions. Interest from this fund is used to pay for pork barrel spending unrelated to unemployment insurance. This $200 million can and should be used to pay down the current deficit. The same can be said for a reported $265 million in unspent and unobligated Hurricane Floyd relief funds.
Futhermore, as the Locke Foundation has long recommended, the state should restructure its employee benefits to contribute less to the over-funded retirement plan and more to the state employee health plan, while simultaneously giving workers more choices and incentives through a defined-contribution retirement plan and lower-cost health options such as medical savings accounts. Finally, the state should take immediate steps to sell assets that would be best managed by the private sector, including the North Carolina Railroad and the state ports at Wilmington and Morehead City.
The state of North Carolina must balance its budget and this Spotlight has suggested some areas where spending can and should be reduced. By introducing sound economic principles into the budgeting process, large dividends can be reaped for both the state government and the general population. This can only occur if the state rethinks its approach to fiscal policy. By leaving more resources in the private sector and taxing less the state will enhance economic growth, create prosperity and serve its citizens in the most responsible way possible.
Roy Cordato, Vice President for Research
- Amy Gardner, Budget Worries Easley, The News & Observer, January 4, 2001, p.11A.
- See www.osa.state.nc.us.
- John Hood and Don Carrington, “Changing Course III: An Alternative Budget for North Carolina,” Policy Report, No. 26, March, 1999, p. 21.
- Ibid. p. 20.
- Ibid. p. 19.
- Ashley M. Gibson, “CHS Mulls Medicaid HMO options,” The Business Journal (Charlotte), January 5, 2001.
- George Leef, “A New Model for Financing UNC,” Clarion, March-April 2000, p. 18.
- For an excellent discussion of this issue as it relates to the UNC system see Ibid., pp. 21-26.
- Ibid. p. 18.
- Ibid. p. 29.