Will N.C. Learn From Past Mistakes?

Economic Slowdown of 2008: North Carolina Should Learn from Past Mistakes

While it is up for debate whether a full-blown recession will hit North Carolina, early signs of slowing tax revenue have already surfaced. For instance, data released in January showed that sales tax revenue collections for the first half of the fiscal year grew by 3.9 percent, compared to the recent average growth rate of 5.8 percent.

What is worse is that current budget commitments have increased by 40 percent over the past four years, making it more likely that slumping tax revenue could lead to a budget shortfall. If this does happen, North Carolinians would be wise to remember how our state leaders reacted the last time a recession occurred in 2000-2001, and ask themselves, “Is history about to repeat itself?”

Last Recession Poorly Handled

Some important facts to consider when pondering the similarities between now and 2001:

• Largely due to annual spending increases of nearly 10 percent in the late 1990s, North Carolina faced a budget shortfall in 2001 of $820 million, one of the largest in the country.
• In a desperate move to obtain more revenue, Governor Mike Easley (D) appeared on statewide television to plea for more taxes. Subsequently, lawmakers implemented the “temporary” taxes – which remained in effect well past the initially promised sunset date of 2003, and part of which (the ¼ cent state sales tax) was made permanent in 2007.
• Thanks to the FY2002-03 budget, North Carolina became the only state in the Union to raise income taxes (and one of only a handful to raise taxes at all) during the 2001 recession. Raising taxes during a recession goes against sound economic principles, as UNC economist James Smith declared in September 2001: “It’s one of the all-time stupidest things done by a legislature anywhere. You don’t raise taxes in a recession, or even in a dismal economic environment.” North Carolina paid for this poor policy decision by recovering more slowly from the 2001 recession than most other states:
  

   – North Carolina’s average personal income fell further behind the national average.  In 2000, North Carolina’s per capita income was 98.1 percent of the national  average; by 2006 it had fallen to 96.3 percent.
   – Real personal income growth from 2000-2006 in North Carolina was 7.3 percent, well  below other Southeast states such as Florida (15.1 percent), Virginia (13.2 percent)  and Tennessee (10.5 percent); as well as the national average of 9.3 percent.
   – North Carolina’s annual unemployment rate exceeded the national average for seven  straight years. Prior to 2000, that had only happened once in the previous 25 years.
   – 2006 per capita income growth was tied for third lowest in the nation.

The More Things Change …

Unfortunately, it seems the General Assembly is repeating the same mistakes it made in the late 1990s – embarking on a spending spree during a period of strong economic growth while not adequately preparing for a rainy day. Consider the following:

• Spending Trends are Quite Similar to the late 1990s
  

   – The four years leading up to the FY2000-01 slowdown saw average annual spending  increases of 9.2 percent. Likewise, during the last four years (counting FY2007-08)  annual spending has increased on average by 8.64 percent.
   – Spending increases for the four final years of the 1990s totaled 34.3 percent.  Spending increases over the last four years totaled 30 percent.
   – The average annual dollar spending increase for the four years prior to the 2000- 2001 recession was roughly $1.05 billion; over the last four years, it has been just  under $1.45 billion (in nominal dollars).

•  “Rainy Day Fund” is Still Underfunded
  

   – In FY2000-01, the Savings Reserve Account was only about 1.3 percent of the previous year’s operating budget.
   – For FY2007-2008, the account’s balance is roughly 4.2 percent of last year’s operating budget, higher than it was in 2001 but well short – by nearly $711  million – of the General Assembly’s stated goal of 8 percent (cf. § 143C-4-2).

Responsible Measures Needed Now

State lawmakers would be wise to learn from past mistakes and prepare for the upcoming economic downturn by implementing the following strategies:

• Limit spending increases for next year to population growth plus inflation.
• Adhere to state law by setting aside 8 percent of last year’s operating budget into the rainy day fund.Avoid the temptation to raise taxes to “make up” for declining revenues.
• Raising taxes in a recession will simply prolong the stagnation and stifle the state’s ability to grow itself out of the slowdown.

  For more information, contact Brian Balfour, Policy Analyst, at brianb@nccivitas.org or 919-834-2099