State Budget Picture: Structural Imbalance or Propaganda?

In August, the News & Observer reported that the State Budget Director, who was appointed by Governor Cooper in 2022, claimed that, according to a confidential report, income tax cuts will cause a “structural imbalance” to the state’s budget starting in 2026. Unfortunately, this sort of disinformation is not new; opponents of lower taxes have used this scare tactic since reductions to personal and corporate income tax rates began in 2014.

Fortunately, we do not have to take their word for it; we can look at the data. The remainder of this article will utilize reports from the Office of the State Controller to demonstrate that North Carolina has increased tax revenue since the start of income tax cuts in 2014, even when adjusting for inflation and population growth. The analysis will compare the decade before tax cuts, 2004-13, and the decade following the start of rate reductions, 2014-23. The table below depicts North Carolina’s personal income, corporate income, and sales tax rates from 2004 through 2023.

Tax Revenue Growth Rates

Despite imposing considerably lower personal income tax rates from 2014-23, the growth rate in personal income tax revenue was more than double that of 2004-13. The greater growth was achieved because lower income tax rates incentivize productivity and migration, which expand the tax base.

The sales tax rate was comparable during both periods; however, from 2014-23, revenue growth was 42.2 percent compared to -8.3 percent in 2004-13. This is primarily due to the fact that an economy growing at a healthy pace, aided by tax cuts, will enable more consumption spending. Moreover, when people get to keep more of the income they earn, they have more money to spend.

The growth rate of corporate income tax revenue from 2004-13 exceeded 2014-23; however, this revenue source is historically relatively insubstantial. For example, the state has never collected more than $2 billion in corporate income tax revenue, but sales tax revenue has exceeded $10 billion each of the last two years. 

The result is that the combined (personal, corporate, and sales tax) revenue growth rate from 2014-23 was more than ten times larger than that of 2004-13.

Tax Revenue Collected

The corporate income tax was the only revenue source in the analysis for which 2004-13 collected more annual revenue per capita than 2014-23. Looking at the combined revenue generated, which is most important for fiscal stability, even after adjusting for inflation, the 2014-23 period generated an average of 5.5% (or $145) more revenue per citizen yearly compared to 2004-13, when tax rates were higher.

Moreover, the table below depicts how in North Carolina, from 2004 through 2023, lower personal income tax rates have been associated with higher personal income tax revenue per capita.

Budget Surpluses & Deficits

Each decade generated eight budget surpluses and two deficits. However, the surpluses from the lower tax rate period, 2014-23, were substantially larger than those in 2004-13. From 2014-23, the state generated 357 percent more surplus funds than in 2004-13, $11 billion compared to only $2.4 billion. Even after correcting for inflation, the lower tax rate period accumulated $11.8 billion in surpluses compared to just $3.6 billion in the higher tax period, a difference of 224 percent. The surplus is calculated by subtracting the value of projected revenue from the actual revenue collected for each fiscal year (FY). This result flies in the face of naysayers who began insisting in 2014 that tax cuts would cause major budget shortfalls.

Incentives Matter

In summary, the decade of lower taxes generated $1,450 (or $145 per year) more revenue per citizen, even after adjusting for inflation. Furthermore, from 2014-23, the state accumulated $8 billion more in budget surpluses than during 2004-13.

Puzzlingly, despite the data, some blame the policies that grew our economy and revenue over the last decade for the impending “structural imbalance.”

According to the News & Observer article, the State Budget Director stated, “While the state’s economy shows higher wages, higher business earnings and higher retail sales… tax cuts are predominantly what is going to slow down and make sluggish tax revenue growth.”

The director does not seem to understand that wages, earnings, and retail sales are up in no small part because of the decreases in personal and corporate income tax rates.

Lower tax rates are effective at increasing revenue because tax rates are incentives that alter people’s economic behavior. Reduced rates incentivize productivity and migration, which generate greater economic activity and facilitate revenue growth. Also, when individuals and businesses pay lower income tax rates, they can spend more on consumption and investment, which increases sales tax revenue.

So, the next time you hear clamoring about an impending revenue crisis due to tax cuts, you can rest assured that it is a false alarm. In the improbable scenario that the budget will suffer from a “structural imbalance” beginning in 2026, it will not be due to tepid revenue growth, but exuberant spending. If policymakers override Cooper’s recent veto, General Fund net appropriations will have risen from $21.08 billion to $31.65 billion over the last decade, an increase of 50.1 percent.