NC Budget and Tax Center

Lowering the income tax cap would come back to haunt N.C. when the next recession occurs

Among the proposed ballot initiatives hanging in the air as the 2018 legislative session draws near its end is a move to change the North Carolina Constitution to lower the income tax rate cap . While this proposal has not received a great deal of attention, it could have profound and long-lasting impacts on the fiscal health of state and local governments. The proposal would dramatically reduce our ability to respond to changing economic circumstances, a problem that will likely be felt most acutely whenever the next economic downturn occurs.

It is not clear when the next downturn will happen, but current risks and historical precedent indicate that the run of growth will not last forever. The current economic expansion is already one of the longest on record and, if there is one thing we know about economic conditions, it is that they are bound to change.

Prolonged periods of growth tend to create what economists call “irrational exuberance”, a collective forgetfulness that long-term decisions should be calibrated to deal with bad times as well as good. “It’s just the time when it feels like all is going fabulously that we make mistakes,” says Mark Zandi, chief economist of Moody’s Analytics.

Dramatically lowering the maximum income tax rate permitted under the North Carolina Constitution is a good example of irrational exuberance, because it is likely to come back to haunt us whenever this run of growth comes to an end. Lowering the income tax cap would tie our state’s fiscal hands when the next recession occurs, effectively forcing the state government to increase sales taxes, franchise taxes, fees, and other levies when the next recession creates a hole in public finances. Local governments could also be forced to increase property taxes if state funding dries up during the next recession.

It is devilishly tricky to predict when the next recession will begin, but there are enough warning signs that a panel of leading economists recently warned that the next downturn could hit as early as 2020. Beyond the historical evidence that a downturn is due in the not-too-distant future, economists are worried about several features of the current economic environment. Most prominently, the Trump administration’s escalating trade tensions with China and many of the United States’ traditional allies have economists worried that trade conflicts could push the global economy into recession. Worries over trade are compounded by increasing household debt, ongoing instability in the Middle East, rapidly escalating housing prices in many US markets, volatile energy markets, and a range of other economic uncertainties that could conspire to end the current economic expansion.

Even if we manage to avoid recession for the next few years, lowering the income tax cap will be a problem whenever the next downturn does come down the road. Flexibility in an uncertain world is a hallmark of wise fiscal policy, so we need to preserve that flexibility and end the legislative session without trying to impose new Constitutional limits on our system of raising public finances.

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