Commentary, NC Budget and Tax Center

Short-changing the recovery

The ballooning cost of recent state tax cuts is one of the key stories of 2014. While state leaders argued over how to pay for increasing teacher salaries, it was easy to forget that the 2013 tax cut package was a huge part of the reason that funds were so hard to come by. The 2013 tax cuts, which largely went to the wealthiest North Carolinians, are forcing us to make unnecessary choices between funding schools or roads, healthcare or economic development, local governments or state services. It didn’t have to be this way and, as the charts presented here clearly show, the costs of the 2013 tax cuts are becoming increasingly clear.

Many proponents argued that the 2013 tax cuts would stimulate new economic growth and, as a result, the cost of reducing rates would be largely offset because there would be more economic activity to tax. The idea that tax cuts will actually increase revenue is based on a simple intuition popularized by Art Laffer. Laffer’s thought experiment holds that lowering the cost of doing business will cause people to invest and spend more, so the total economy will grow, which will ultimately result in government collecting more revenue. Like many exercises in theoretical economics, the “Laffer Curve” is just a mathematical equation. It looks nice on a napkin, and has an pleasantly simple logic, but the real world is often allergic to this kind of treatment and refuses to behave as theorists’ models expect. Unfortunately, the consequences of putting faith in the Laffer Curve are anything but theoretical. As this economic experiment on North Carolina continues, the results are not looking good for the subject.

2014 End of Year Charts_tax cuts dig a hole

While sober analysis always showed that the 2013 tax cuts would reduce revenues, the hole keeps getting deeper every time we look at it. As can be seen in the chart above, initial estimates projected a roughly $500 million reduction in state tax revenues for the 2014-15 fiscal year. Estimates released this month have the cost rising to almost $900 million and, according to our analysis, the bill could top $1 billion. Thus far this fiscal year, actual tax collections have been lower than was expected even with the cost of the tax cut included. The December state revenue update shows that we are $190 million short of projections. We will know the real fiscal impact after sales taxes from the Christmas shopping season known and income tax returns are filed next year, but all indications to date are that the 2013 cuts will blow an enormous hole in current and future state budgets.

2014 End of Year Charts_underfund the recovery

The result of the ballooning revenue shortfall, is that state spending has not recovered to pre-recession levels. When the economy collapsed in 2008, it dramatically undermined state revenues, forcing a series of unusual measures to try to fill the gap. Under normal conditions, the return to positive economic growth brings in more revenue, allowing departments and divisions in state government to address needs they had put off during the squeeze. As can be seen above, this is the pattern for each of the last three recessions dating back to the early 1980’s. Each recession initially forced North Carolina to spend less than was anticipated when revenues fell, but spending bounced back within a few years allowing North Carolina to get back to business. Policy choices in the recent recovery are a departure from previous budgetary practice. We have usually seen reduced state spending during the initial downturn, followed by accelerated investing during the recovery to make up for lost ground and restore the state’s public service infrastructure. We are seven years removed from the onset of the Great Recession and, because of the 2013 tax cuts, state revenues remain roughly 10 percent below their pre-recession levels.

All of this means undercutting the future of North Carolina. The state still has a backlog of expenditures that were put off during the recession, positions unfilled, buildings overdue for repair, roads and bridges that need fixing or expanding, local governments who have lost state support for key services, and much more. We also face an increasingly competitive global marketplace. Many of the people who lost their jobs during the recession still need help retooling their skills and the challenge of preparing children to survive in the 21st century economy keeps getting more complex. As the legislative session gets started in 2015, remember that the choice to reduce taxes on the most fortunate among us is a major reason that key investments for the rest of North Carolina are not being made.

6 Comments


  1. LayintheSmakDown

    December 29, 2014 at 9:23 pm

    I agree, we really need to get a handle on the forecasting problem that is out there. It is obvious we are projecting too much in tax collections and should on the front end compile a more reasonable budget that is more conservative, and thus lower than projections, so that we will more likely fit into the likely tax confiscations that take place. That way we could go ahead and make the needed cuts at the original budget time.

  2. LayintheSmakDown

    December 29, 2014 at 9:29 pm

    Oh, and I forgot the most important thing. There needs to be some serious belt tightening in the state government. When you continually out spend what the people of the state are willing to fund, then there is something seriously amiss. Much more so than the obvious forecasting problem.

  3. ML

    December 30, 2014 at 9:33 am

    There is no forecasting problem here, only from the republicans that wrote in the tax cuts. Any rational person knows that human nature doesn’t comply with theoretical economics as is the case with supply-side economics. People/corporations do not reinvest as they should not do they have any incentive to, they simply pocket the profits and pay their shareholders. There is a reason business is so against competition from the government and it isn’t because the government will be wasteful and inefficient it is precisely the opposite.

  4. LayintheSmakDown

    December 31, 2014 at 5:44 pm

    You are mistaken, it is certainly a forecasting problem when they cannot forecast how much will be confiscated in taxes.

  5. Alan

    January 1, 2015 at 11:50 am

    LSD, you are the one mistaken, it is not a forecasting problem, many people clearly knew what would happen as a result of the unfunded tax-cuts. Remember, these were to be “revenue neutral” according to “The Guv”, but the cuts were implemented knowing full well they would result in a shortfall. Your use of the word “confiscated” clearly sums up the GOP attitutude to taxation. Nothing is free, and the GOP need to learn that.

  6. LayintheSmakDown

    January 1, 2015 at 3:19 pm

    It is definitely a forecasting problem, but actually even more a spending problem as the forecasts were too optimistic and spending was budgeted based on the forecasts. I do concede the point as over spending is the crux of the matter and hopefully the NCGA will come in with the scissors to make some drastic cuts.

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