Mid-year revenue shortfall grows, official revenue outlook filled with caution and uncertainty

State revenue collections are coming in $199.2 million below projections half way through the fiscal year, according to the legislature’s non-partisan Fiscal Research Division’s new revenue outlook report. This report provides an assessment of revenue collection performance for the state on a quarterly basis. The main culprit behind the mid-year shortfall is the 2013 tax plan that reduces revenue availability while primarily benefitting wealthy taxpayers and profitable corporations. The plan’s personal income tax cuts are costing more than previously expected.

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 and reposition itself to compete nationally and globally. North Carolinians are already dealing with the fallout of the current state budget that falls short of what’s needed for children, families, and communities to thrive. The inadequacy of the budget has been chronicled in the news, with many stories focusing on how there are too few textbooks (even toilet paper) as well as the local challenges that state budget and tax decisions are creating.

It is important to view this mid-year revenue shortfall in the context of the dollars that lawmakers already lost due to the tax plan. For the 2015 fiscal year, Fiscal Research Division originally estimated that the plan would cost $512.8 million but soon revised its revenue outlook to account for an additional loss of $191 million. This latest report of $199.2 million in under-collections comes on top of these already-accounted-for losses.  By the end of the fiscal year, the total cost of the tax plan could reach as high as $1.1 billion, according to the Institute on Taxation and Economic Policy’s estimates. That’s roughly equivalent to the state dollars that support the entire Community College System.

Highlights of the Revenue Outlook Report

The underperforming revenue picture occurred despite a stronger-than-expected performance in sales tax revenues, which came in $78 million above projections. Revenues from the corporate income tax were $57 million above projections. As the economy has slowly improved, sales tax collections are growing steadily as consumer confidence expands and corporate profits have been on an upward trend. Even in the face of growing corporate profits, policymakers decided to further cut corporate income tax rates—a move that allows corporations off the hook of paying their fair share of taxes that support the building blocks of a strong economy.

Gains in the sales and corporate income tax sources were dragged down by lower-than-expected franchise tax collections and personal income tax collections. Net withholding income on wages and salaries “dropped off dramatically from last year as a result of tax law changes,” according to the FRD report. Also, the boom in low-wage work that is defining the economic recovery in North Carolina and the nation is also being a drag on revenue collections. Once factoring for both withholding collections and payments, personal income tax revenue came in below target by $247 million, or 4.8 percent. This is nearly equivalent to the budget set aside for instructional supplies and equipment in addition to the state supplement given to low-wealth schools.

As I wrote during my analysis of the previous revenue outlook, the possibility that tax collections will rise and fully erase the shortfall by April 2015 when taxpayers make higher final payments and receive smaller refunds as a result of changes in the 2013 tax plan is slim. 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. This is because not only should withholding have already been accounted for in the new tax forms released last year but the value of various deductions and credits is a known quantity.

Finally, 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 continues to be relevant as we discuss this latest report on the shortfall in revenue.

Going Forward

Keeping a close eye on how revenue collections perform during the second half of the 2015 fiscal year should be a priority for state policymakers who are beginning to think about the next two-year budget. A revenue shortfall would throw the current budget into disarray, impacting the subsequent budget as well. To some extent, it appears that Governor McCrory is already concerned about next fiscal year. He instructed agencies to cut 2 percent from their budget when making requests for the next biennium (FY2015-17).The fact that lawmakers allowed the next round of costly income tax cuts to go into effect earlier this month—rather than pausing the plan and reassessing the damage—will do little to improve the revenue picture going forward.

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Mid-year revenue shortfall grows, official revenue outlook filled with caution and uncertainty