Debate over the Governor’s fund transfer to cover the cost of outgoing tax refund checks has focused public attention on a frequently overlooked problem involving state cash flow as well as the difficult financial decisions necessitated by the current economic climate.

When state taxpayers start filing returns, the Department of Revenue processes the returns and cuts checks to taxpayers who are owed refunds. Those refunds, which constitute a liability in accounting terms, are paid out of the state General Fund. Of course, tax refunds are just one of many things paid for out of the General Fund. In fact, the General Fund flirts with insolvency almost every year in March.

Source: NC Office of the State Controller, Monthly General Fund Reports

So why is this year any different? In short, because there isn’t enough cash in the state’s go-to savings accounts right now to cover the difference. Savings reserve funds, which are analogous to savings accounts, are key to making sure the General Fund stays in the black. These funds include the Savings Reserve Account, Job Development Investment Grant (JDIG) Reserve, Repairs & Renovations Reserve, Disproportionate Share Reserve, Disaster Relief Reserve, and the ONE NC Fund. Before the Great Recession, the state had between $800 and $900 million in cash in these accounts, most of it in the Savings Reserve Fund, to cover this year’s March shortfall. However, the impact of the Great Recession that brought a collapse in revenues and increased spending pressures depleted state reserves during FY2009. Compared to early in fiscal year 2009, when the state had over $900 million in total cash savings, funds available by the end of this January had fallen to roughly $200 million ($150 million in the Savings Reserve Account and about $50 million between the JDIG and Disaster Relief funds).

Source: NC Office of the State Controller, General Fund Monthly Reports

In this situation, the state has only two options: raise revenues, or borrow money. The governor’s proposal to borrow cash from the Savings Reserve Account is complicated by the fact that it has been dedicated as the sole source of funds to pay interest on the $2.6 billion federal loan for unemployment benefits. Debate on the legality of borrowing these funds is still being hotly debated, and the first interest payments on the federal loan are set to commence this November. In the meantime, the governor’s proposal to borrow from the Savings Reserve Account for several months at 0.9% with repayment in full before the close of the current fiscal year is low-risk, though not completely risk-free. Another borrowing option for the state is the issuance of a tax anticipation note, or TAN, which is basically a short-term municipal bond issued against the state’s promise to repay using a dedicated revenue source within the fiscal year. North Carolina issued TANs in 2004 and 2005, and other states, such as Colorado, regularly issue these bonds to meet short-term liquidity needs. While not as cheap as borrowing from existing funds, TANs issued by states with strong bond ratings like North Carolina’s are still affordable at  interest rates of 2 to 3 percent.

This cash flow situation is emblematic of the kinds of difficult decisions that will hound lawmakers as long as state revenues remain depressed and insufficient to cover obligations, let alone rebuild needed cash reserves. On one hand, promptly issuing tax refunds returns money to consumers who are then at liberty to spend it, is good for both individuals and the economy. On the other hand, debt – even short-term debt – is less politically appealing than ever before, which brings us back to the alternative: raising revenue. While temporary revenue measures would provide time-limited relief to the state’s cash flow shortage, comprehensive revenue reform is necessary to ensure the state’s capacity to support economic recovery and meet its continuing obligations to taxpayers.