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.
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.
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.