This morning the NC Employment Security Commission released state employment numbers for the month of August. The seasonally-adjusted unemployment rate was 10.8% in August, meaning that 488,974 North Carolina’s workers were unable to find jobs. Since the recession began in December 2007 North Carolina has shed 255,400 jobs. The latest unemployment rate represents a decrease of 0.1 percentage point from the previous month. This is in part due to the fact that 7,000 jobs were added (thanks primarily to expansion in local government employment) and to workers dropping out of the labor market entirely. The private sector continued to shed jobs, with manufacturing and construction eliminating the most jobs in the past year (73,500 and 38,200). At 10.8% North Carolina is tied with Ohio and Tennessee for the 9th highest rate of unemployment.

While it’s good news that the unemployment rate in the state has not increased in the past few months since it peaked at 11% in May, the current unemployment rate is still much higher than any time during the previous two recessions of early 1990’s and the early 2000’s. This many months after the beginning of the past two recessions the state unemployment rate was 6.4% and 6.5% respectively.

The extended unemployment benefits made possible by the federal recovery package earlier this year are set to expire in December by which time an estimated 32,171 North Carolinians will see their benefits expire. Keep in mind that only about 38% of jobless workers in North Carolina are eligible for unemployment benefits and that the average benefit payment is approximately $300 per week.

The National Employment Law Project and others are calling on Congress to extend benefits for an additional 10-20 weeks. Given that during this recession approximately half of unemployed workers cannot find jobs after six months of looking extending benefits once again may be a good idea – both for maintaining spending in local economies and keeping working families from falling into poverty.

Earlier this week budget negotiators announced that they had come to agreement on a revenue plan that would raise $990 million. Most of the revenue would come from a 1% increase in the state sales tax with lesser amounts coming from increases in taxes on purchases of cigarettes and alcohol and a 2% income tax surcharge.

Shortly after this plan was announced the Governor voiced her opposition to it, citing her desire not balance the budget “on the backs of working families.” While I’m all for focusing on working families when it comes to making choices about tax policy, in this instance the Governor’s math is way off.

The fact is that the sales and excise tax increases in the plan would have a far greater impact on working families than the proposed income tax surcharge. In fact the proposal to increase the sales tax by 1% would have cost the middle 20% of income earners ($37,000 annual income) nearly six times more than the proposed income tax surcharge. The sales tax would cost them an estimated $130 in FY 1009-10 compared to a $23 increase in income taxes because of the surcharge.

Since her press conference announcing her budget proposal earlier this year the Governor has continued to imply that somehow taxes on consumption have less impact on taxpayers, insinuating that they are somehow voluntary. Tell that to the “working family” whose washing machine breaks down. The sales tax on that one purchase alone (roughly $39 on a $500 purchase) would eclipse the additional burden from the 2% income tax surcharge (roughly $23) on middle-income families.

Here’s the great thing about income taxes on working families during tough times – when their income drops so does their tax liability. This is not necessarily the case with sales taxes because families still have to make basic purchases and they typically rely on savings, debt and government assistance to in order to support themselves until their income level recovers.

If budget-negotiators are truly starting over from scratch to craft a tax package let’s hope they seek to understand how different types of taxes affect taxpayers of different income levels and act accordingly.

Earlier today Governor Perdue told legislative leadership that she opposes the recent proposal to include a 2% income tax surcharge on all taxpayers as one piece of the final tax plan. One alternative to to the surcharge would be to add two additional top income tax rates that only apply to higher-income taxpayers. Case in point is the plan put forward by the House in its budget proposal that would have raised an additional $256.7 million in FY 2009-10 (roughly $50 million more than the 2% surcharge raises) by adding two top income tax brackets (8.25% for married filing jointly incomes above $200,000 and 8.5% for incomes above $500,000). Raising an equivalent amount of revenue from higher income taxpayers is better economic policy during recessions because higher income taxpayers are more likely to be able to sustain their spending levels despite the additional tax responsibility. And if good policy isn’t reason enough, consider the recent polling results from Public Policy Polling in which 60% of voters favored raising income taxes on those earning over $200,000.

In an ideal world many of the more reform-minded proposals that have been discussed this year would be part of the overall package which would actually allow for nominal tax rates to be lowered while still raising substantial revenue. But in absence of such reforms, targeting any income tax increases to those that are most able to afford such an increase is the wisest course.

Statement from Elaine Mejia, Director of the North Carolina Budget & Tax Center regarding the latest tax package negotiations (recommendations in bold)

The latest, and possibly near-final, revenue package being considered by the legislature would reportedly raise approximately $1 billion, an amount that will allow lawmakers to avoid very deep cuts to state services that would otherwise have to be made. Unfortunately, the revenue package currently under consideration will disproportionately impact low- and moderate-income taxpayers and will do nothing to close the state’s long-term structural budget gaps. State lawmakers should consider making a few minor changes to the plan that would make it fairer and improve long-term stability.

Published media reports from the past few days indicate that the final revenue package under consideration by the General Assembly relies primarily on a substantial increase in the state sales tax, moderate increases in sales and excise taxes on purchases of cigarettes and alcohol, and a temporary surcharge on state income tax payments.

Earlier this year, the NC Budget & Tax Center (BTC) put forth a General Fund revenue plan that would have raised $1 billion and would have improved the fairness, stability and long-term adequacy of the state’s revenue system. Unfortunately, the latest version of the tax package under consideration by the General Assembly does not include any of the reforms recommended by the BTC. At this point it is understandably too late in the process to reach agreement on sweeping reforms; however, the plan under consideration could be improved considerably by making a few modest changes.

The vast majority of the revenue generated from the plan under consideration would be from the proposed sales tax increase. A hypothetical 1% increase in the state sales tax rate would mean that the lowest income taxpayers (bottom 20% of income-earners whose average annual income is $10,000) would pay an additional 0.65% of their incomes in additional sales tax over the course of one year. In contrast, the state’s top 1% of income-earners whose average annual income is $1.015 million would pay only 0.13% of their income in additional taxes from this change. In other words, the proposed sales tax increase will hit the lowest-income taxpayers six times harder than the state’s highest-income taxpayers. To blunt the impact of this regressive change, lawmakers should consider increasing the state Earned Income Tax credit to at least 15% of the federal credit which would completely offset the impact of these changes on the bottom 20% of income-earners.

In addition to the highly regressive nature of the primary component of the plan – the sales tax – , it is also unfortunate that the final plan abandons many of the reform-minded elements that had been previously part of the negotiations. These include changes such as broadening the sales to base to include more services, broadening the income tax base to to Adjusted Gross Income rather than the more narrowly-defined Federal Taxable Income, and closing corporate tax loopholes by requiring Combined Reporting for all corporations. At the very least, lawmakers should revisit including the reform-minded elements that were included in both of the legislative plans. These include applying the Franchise Tax to businesses that are structured as LLC’s, a small expansion of the sales tax base by broadening the tax to include warranties, installations and repairs, and digital downloads and converting the privilege tax on movies to a sales tax on entertainment purchases.

Finally, the proposed temporary 2% across-the-board surcharge on income tax payments is likely to be moderately progressive because the state income tax is moderately progressive. However, to more fairly distribute the additional tax responsibility of the plan overall, lawmakers should consider restructuring the surcharge such that the rate applied to the income tax payments of higher-income taxpayers is greater than it is on low- and moderate-income taxpayers.

By raising $1 billion in additional tax revenues state leaders will avoid having to take steps such as laying off thousands of teachers and other state workers or making deep reductions to critical state services, both of which would further compromise the economic prospects of families already struggling to make ends meet during the recession. Moreover, making modest improvements to the final tax plan would also lessen the impact of the current recession on these families by lowering their additional tax responsibility and improving the stability of the General Fund’s revenues for the next few years.

On Tuesday morning state Rep. Paul Stam and state Senator Phil Berger held their weekly press briefing at the capitol. Not surprisingly they focused on the budget debate.

After challenging the governor to two weeks of debates around the state (an invitation the governor’s office has already declined), Rep. Stam went on to once again deny that the state’s books are in a state of crisis. He did this by comparing last year’s estimated general fund expenditures ($20.3 billion by his count) with next year’s baseline revenue availability ($19.2 including stimulus dollars), thereby declaring a budget gap of only $1.2 billion. These numbers are not necessarily inaccurate but they are as misleading as a diet pill infomercial. Here are 4 reasons why:

1. The Stam-n-Berger “methodology” includes the revenue from transferring .25 cent of local sales tax to the state as part of the Medicaid swap in the state’s baseline revenue forecast but then they neglects to mention that this new revenue comes with an even larger spending mandate. So add at least $270 million to the Stam-n-Berger shortfall to account for this mistake.
2. There is also no recognition of the 6-month state health plan patch of roughly $250 million that was paid out of reserves in 2008-09 that must be paid out of general fund tax revenues in 2009-10. So add another $132 million (required 2009-10 expansion) to the Stam-n-Berger budget shortfall to account for this omission.
3. There is no acknowledgement that the budget for 2008-09 was cut by a billion dollars (and that’s after accounting for stimulus funds) and that those cuts have already taken their toll on state government via hiring freezes, state employee pay cuts, and cuts to programs like the home and community care block grant program just to name a few examples.
4. Finally, there is no recognition of what is known as the “continuation budget” or “current services” budget – the budget that the agency administrators craft that details what funding they will need to operate their agencies at current levels. This budget accounts for the real world – the world in which there are such things as health care inflation, population growth, enrollment growth in health insurance programs and community colleges and more and more prisoners that must be “housed.” Ignoring these real world pressures is like pretending that North Carolina is in suspended animation. The gap between this real world budget (i.e. the continuation budget) and the baseline revenue forecast remains $4.5 billion of which $1.4 billion can be covered by stimulus dollars leaving budget gap of over $3 billion.

Unfortunately, the Stam-n-Berger definition of a budget shortfall crept into this mainstream newspaper article as if it were legitimate. If reporters opt to use the Stam-n-Berger shortfall estimates they should at least attempt to explain the difference between the competing definitions.

One last thing. Stam-n-Berger reiterated their preference for the level of spending contained in the continuing resolution but once again failed to recognize that the baseline revenue forecast even after adding in stimulus dollars still falls several hundred million dollars short of being able to support that spending level!