Revenue continues to underperform projections, shortfall likely to grow larger

State revenues are coming in $62 million under projection for the first three months of the fiscal year, according to the Fiscal Research Division’s (FRD) new General Fund Revenue Report. This report provides an assessment of revenue collection performance for the state on a quarterly basis and is particularly important considering the state’s inadequate and unsustainable budget (a point that has been fleshed out in this Budget and Tax Center’s blog series). The growing cost of the 2013 tax plan further challenges state lawmakers ability to rebuild what was lost in the aftermath of the Great Recession.

Despite state revenues having not yet fully recovered from the downturn, lawmakers overhauled North Carolina’s tax code last year in a way that significantly reduced state revenue. In its first year of implementation, the tax plan is already costing far more than expected. Fiscal Research Division estimated that in FY2015, the plan would cost $512.8 million—but it is already costing $191 million more than that. By the end of the fiscal year, the revenue shortfall could reach as high as $600 million—for a total cost of the tax plan of more than $1.1 billion—according Institute on Taxation and Economic Policy estimates using up-to-date taxpayer data (see the chart below).

In other words, the $62 million revenue shortfall in the first quarter of the state’s fiscal year foreshadows what’s to come by the end of the fiscal year, assuming ITEP’s estimates turn out to be accurate.

Tax plan is growing, from budget report

The underperforming revenue picture occurred despite a stronger-than-expected performance in sales tax revenues, which came in $74.2 million above projections. Revenues from the corporate income tax were effectively on target. As the economy has slowly improved, sales tax collections have held steady and corporate profits have been on an upward trend.

Gains in the sales tax revenue were dragged down by lower-than-expected personal income tax collections. Net withholding income on wages and salaries “dropped off dramatically over the last year as a result of tax law changes,” according to the FRD report. Once factoring for both withholding collections and payments, personal income tax revenue came in below target by $102.3 million. This is nearly equivalent to the cut to the Teacher Assistant budget ($109 million) that lawmakers approved in August for the 2015 fiscal year.

The weakness in withholdings from wages and salaries remain a major cause for concern. Certainly the state’s persistent and deep jobs shortage, boom in low-wage jobs, and growing income inequality are three factors that aren’t making it any easier to meet revenue targets. Yet, tax revenue collections from the personal income tax will continue to be lower moving forward than otherwise would have been due to the income tax rate reductions that went into effect on January 1.

Fiscal Research Division notes that tax collections in April 2015 will “rise significantly as taxpayers make higher final payments and receive smaller refunds” as a result of changes in the 2013 tax plan. However, given what we know regarding who benefits from the tax changes—primarily wealthy taxpayers—the likelihood of such an outcome coming to fruition is difficult to imagine. Furthermore, an outcome in which taxpayers receive “smaller refunds” means that low- and middle-income families and individuals will not fare as well under tax plan as proponents claim.  My colleague explains in detail why the tax plan was likely the main driver of last year’s revenue shortfall—an explanation that extends into the current fiscal year shortfall.

Keeping a close eye on how revenue collections perform during the second quarter of the 2015 fiscal year should be a priority for state policymakers. A revenue shortfall would throw the budget into disarray. North Carolina’s state constitution requires a balanced budget, so lawmakers would be forced to deal with a shortfall before the end of the fiscal year by implementing damaging cuts to state services or by using substantial amounts of one-time money, such as the state’s Rainy Day Fund.

Fiscal Research Division’s latest revenue outlook further confirms that the state’s economic and fiscal outlooks are intertwined. The 2013 tax plan is undermining the state’s ability to collect revenue and invest in the foundations of a strong economy at a time when the economy continues to fail to deliver for hard-working individuals and families. An example of this reality is the fact that Governor McCrory is already instructing agencies to cut 2 percent from their budget when making requests for the next biennium (FY2015-17). Lawmakers should stop the next round of tax cuts that go into effect next January to put North Carolina on a more sustainable path.

This is the final post in the NC Budget and Tax Center’s Blog series on the final budget passed by North Carolina lawmakers during the 2014 legislative session. See the rest of the series here.

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