John Locke Update / Research Brief

N.C. Senate Budget: Tax Cuts and Spending Restraint

posted on in Fiscal Insight, Spending & Taxes
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The Senate budget spends $22.9 billion, up 2.5 percent over the 2016-17 budget and 3.75 percent over actual spending.  Like Gov. Roy Cooper’s budget, it raises pay for teachers and state employees. Unlike Gov. Cooper’s budget, it includes no new debt and does not expand Medicaid.  More importantly, it lowers tax rates and implements a higher standard deduction that yields $300 million in tax relief to North Carolina’s low-income earners and $1 billion in tax relief overall.

General Fund vs. Total Spending

Senators made it clear that their budget will be a key piece in the debate over state spending, taxes, and policy for the next two years.

Debates about the state budget are limited to a fraction of total spending. In general, the typical budget debate focuses on the $23 billion General Fund.  But state government also spends $3 billion in taxes on transportation projects through the Highway Fund and the Highway Trust Fund.  It funnels more than $15 billion in federal revenues through its coffers and billions more from tuition, lottery receipts, unemployment taxes, and other sources. All told, the state spends upwards of $55 billion providing goods and services each year. As such, I use the term “appropriations” for items paid with state tax dollars and “spending” for items paid from all sources.

A Conservative Alternative to the Governor’s Budget

Some growth in appropriations is simply the cost of keeping up with inflation and population growth. In those terms, Gov. Roy Cooper would increase spending the first year and cut appropriations the second year, though his plan to expand Medicaid by taxing hospitals would increase total spending by more than $4 billion in Fiscal Year (FY) 2018-19, or $383 per person. The Senate plan would reduce appropriations slightly each year, with no off-budget increases. State appropriations per person, adjusted for inflation, have been consistent since FY 2010-11, the year before Republicans gained majorities in the General Assembly.

Appropriations alone cannot provide a complete picture of the level of services the state provides, in part because federal grants, lottery funds, and other sources have grown as a share of total state spending. That said, per-capita inflation-adjusted state appropriations have remained roughly constant since FY 2008-09, a pattern last seen between FY 1973-74 and FY 1983-84. The level of per-person appropriations is in the range last seen in the early 1990s. There is nothing to suggest that this is an ideal level of appropriations, but it clearly is not a crisis.

State Appropriations Per Person in N.C. (Adjusted For Inflation)

The Senate has a more realistic second year than Gov. Cooper. He proposed a 5.0 percent increase in FY 2017-18 (from July 1, 2017 to June 30, 2018) followed by a 1.5 percent increase in FY 2018-19, though these figures ignore earmarks of $60 million over two years from lottery funds, $350 million in new debt incurred without taxpayer approval, and $4 billion in higher Medicaid spending financed, in part, by an off-budget tax on hospitals. The Senate would increase appropriations by roughly 2.5 percent each year, in line with appropriation increases over the past five years.

The Senate expands the availability of early childhood education for families on wait lists, raises teacher pay by an average of 3.7 percent, boosts state employee pay by the greater of $750 or 1.5 percent of salary, adds funding for apprenticeships and moves the program to the Community College System, raises the age at which a person can be tried as an adult, funds new computer systems to track spending and performance of state government, and provides cash or tax incentives to film production companies and tire manufacturers. While Gov. Cooper’s budget included similar funding priorities, the difference is that the Senate spends less than the governor.

The cumulative effect of those reductions is a spending increase half the size of what Gov. Cooper sought. Under the Senate plan, spending for the fiscal year ending June 30, 2019 would be less in the second year of the biennium than the governor would in the first.

Budget restraint makes it possible for the Senate to set aside $50 million more in the Savings Reserve Account, the state’s “rainy day fund.” The Senate is also able to provide more tax relief to North Carolinians than Gov. Cooper offered.

The Senate’s Proposed $1 Billion Tax Cut

The plan  cuts taxes by $1 billion over the biennium. It expands the standard deduction and reduces taxes by a larger percentage  for taxpayer s at the lower end of the income spectrum, including those who have no tax liability, than for those at the higher end.

Personal Income Tax

  • Reduces the personal income tax rate from 5.499 percent to 5.35 percent, a 2.7 percent reduction
  • increases the Standard Deduction from $8,750/$14,000/$17,500 to nice, round numbers: $10,000/$15,000/$20,000
  • changes the child tax credit to a phased tax deduction that results in higher tax savings for those in the lowest income tiers
  • adjusts the cap on the mortgage interest and property tax deduction to a tiered deduction based on income with a  maximum allowable deduction of $22,000, instead of $20,000. My back-of-the-envelope calculation suggests that, at the average property tax rate of $1.08 per $100 valuation, an owner with a 5 percent interest rate would  need an average outstanding principal more tha n $325,000 over a year to exceed the $20,000 cap

Business Tax

  • Reduces corporate income tax rate from 3 percent to 2.75 percent in 2018 and 2.5 percent in 2019
  • institute s a flat $200 franchise tax on the first $1,000,000 of a business’ net worth and then $1.50 per $1,000 of net worth above that

Market-Based Sourcing

  • Charges multistate companies an income tax based on the amount of goods and services consumed in North Carolina, which removes a penalty for companies that locate in the state

percentage-savings-NC-tax

Policy Changes to Watch

The Senate budget plan incorporates some major policy changes with its spending and tax plan. It provides opportunities to make health care more available by phasing out Certificate of Need over the next eight years. It ends the promise of State Health Plan coverage in retirement for state employees hired after June 30, 2018, so the state can better ensure those benefits already promised, but makes no structural changes to the pension promises for teachers and state employees.  It also expands educational options by funding the Opportunity Scholarship and Disability Grant programs and laying the groundwork for an innovative education savings account (ESA) program.

As the House takes up its budget, its members will provide the final point to triangulate outcomes for the coming year on taxes, Medicaid, juvenile justice, educational options, health care freedom, and daily operations in state government.

Joe Coletti is a senior fellow at the John Locke Foundation focused on fiscal policy issues. He previously headed the North Carolina Government Efficiency and Reform initiative within the Office of State Budget and Management, which led to… ...

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