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Raise taxes or cut spending to deal with $4.6B budget shortfall?

The updated state budget shortfall projection for FY 2009-10 is $4.6 billion, so said fiscal analysts at a joint meeting of the legislature’s appropriations committee this morning. In other words, there is a projected gap of $4.6 billion between the cost of maintaining the current quality and quantity of state services and the amount of revenue that the tax system is able to generate in the current economic climate. Revenue collections for the current year are 11% lower than last year! The state has never recorded such a large drop in year-to-year tax revenues.

The $4.6 billion projected shortfall represents more than 20% of the current budget. The new revenue forecast and the governor’s plan to use some additional federal recovery dollars this year that the state had planned on using next year means that the House must find $1.5 billion more in spending cuts and/ or new revenues than did the Governor or the Senate. For the House to balance its budget with cuts alone it would need to DOUBLE the level of spending cuts proposed by the Senate and the Governor! You may recall that the Senate’s cuts were none to pleasant – increasing class sizes, slashing early childhood education, etc.

During the hearing Senator Rucho asked the legislature’s chief economist whether or not raising taxes is a good idea. The response was that states must balance their budgets and are therefore are cutting spending and raising taxes, both of which are counter-cyclical (i.e. not ideal for the economy). I’ll tell you what’s best for the economy, Senator Rucho. Split the difference. Fill half of the budget gap with spending cuts and half with new revenues. Yes it sounds simple and unsophisticated but in fact research shows that to be the best course of action for the economy. Earlier this week the Center for Economic Policy Research released a paper that showed that the most economically sound course of action is for states to fill their budget gaps with equal parts spending cuts and tax increases. For North Carolina that means that the House needs to find roughly $200 million in additional spending cuts on top of the Senate’s proposed cuts and an additional $900 million in additional tax revenues.

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