Perdue’s Budget Raises Taxes, Avoids Meaningful Reform and Sets Stage for Next Budget Crisis

Gov. Bev Perdue unveiled her first biennial budget proposal for fiscal years 2009-11 earlier this week. The proposal relies heavily on federal money and sin taxes to plug the estimated $6.4 billion hole for the coming two budget years.

Focusing on fiscal year 2009-10, observations include:

• General Fund appropriations would total $20.98 billion – down from the budgeted $21.36 billion from the current fiscal year, but up from the actual projected current year expenditure of $20.38 billion
  • The $600 million rise over actual expenditures represents a 3 percent increase
• The $20.98 billion in budgeted appropriations is slightly higher than the fiscal year 2007-08 budget ($20.7 billion)
• The Governor’s budget office estimated the continuation budget requirements to be $22.28 billion for 2009-10. The continuation budget is the calculated spending commitments if the state budget merely continued at its current levels, adjusting only for enrollment increases in education and Medicaid, state retirement contribution changes, teacher salary step increases and extra funding for the state health plan. Revenue is forecast at $18.86 billion for 2009-10, meaning a deficit of $3.4 billion for the coming fiscal year
  • The difference will be made up with $1.3 billion in spending reductions, $1.7 billion in federal “stimulus” funds and $580 million in extra revenue (mostly from increases in sin taxes)
• Significant spending reductions come from
  • “Truth in budgeting” regarding lapsed salaries: $238 million
  • “Flexibility” and “operation accounts” reductions: $297 million (these are non-specific reductions left to the discretion of agency and department heads)

Lapsed Salaries a Major Target
Traditionally, agencies budgeted for a full year of 100 percent staffing needs – even knowing they won’t need the full allotment. For example, a department that normally has 20 staff members may have a vacancy open for a few months, or an open position for the entire year. The agency would receive funding, however, as if it were paying 20 employees for the entire year. The extra revenue for salary needs that are not used is commonly referred to as “lapsed salary,” and agencies would routinely take the extra money and spend it on other agency items. The practice became so commonplace, in fact, that agencies would purposely underfund specific items knowing that they would have extra lapsed salary funds to make up the difference.

Gov. Perdue’s budget proposal seeks to eliminate this practice and fund agency salaries closer to their actual needs. Referring to this new approach as “truth in budgeting,” the Governor estimates $238 million in saving for 2009-10 from this reform.

Tax, Fee Increases of More than Half a Billion
Also part of Perdue’s approach to balancing the budget is significant tax and fee increases. The hikes are projected to total more than $525 million in FY 2009-10 alone. Perdue’s proposal would:

• Increase cigarette taxes from 35 cents to $1.35 per pack
• Raise the tax on other tobacco products from 10 percent to 28 percent
• Add a 5 percent surcharge to all alcohol purchases
• Increase the annual state license fee on professionals from $50 to $200

Targeted Tax Cuts and Handouts of Little Consequence
The Governor also proposes some tax relief in the budget, but they are quite minor.

• Small businesses with profits below $100,000 will be able to exempt the first $25,000 from their net income. Companies with profits between $100,000 and $200,000 will be allowed to exempt the first $15,000 of income. This is expected to save small businesses about $24 million annually. Spread out over the thousands of small businesses across the state, however, this credit will likely be fairly trivial to most recipients and provide little incentive for business expansion.
• The state’s earned income tax credit (EITC) would be increased from 5 percent of the federal credit to 6.5 percent. Because North Carolina’s EITC is refundable, much of this increase may well amount to larger handouts. Moreover, the increase would amount to only a few dollars a month for the average recipient.

State Employees Receive Extra Paid Leave In Place of Pay Raise. Teachers Get Small, Experience-based Pay Increase Instead of Across-the-Board Raises, and no ABC bonus

• In lieu of pay raises, bonuses, or longevity pay, state employees would receive extra paid leave in the upcoming year based on years of service
• Teachers don’t receive a pay raise, but certain salaries will be bolstered by an experience-based step increase in their pay schedule (totaling $64 million)
• No ABC bonuses are included in the Governor’s proposal

Rosy Revenue Projections, Empty Rainy Day Fund May Cause More Panic
The Governor has already emptied the state’s rainy day fund in order to help fill the current year’s budget hole. With that in mind, one would think that revenue projections would be overly cautious to avoid another deficit this coming year.

• The Governor’s office, however, projects an increase for 2009-10 for state income, sales and corporate tax collections compared to current fiscal year revenue.
  • North Carolina’s average unemployment rate for the first six months of the current fiscal year was 7.1 percent. As of January, unemployment was 9.7 percent and more than likely will be double-digits as we enter the new fiscal year this summer. Hoping for such a rapid rebound in revenue given the likely high unemployment the first half of FY2009-10 compared to the first half of the current fiscal year seems overly optimistic.
• The governor has already drained the state’s rainy day fund, so there will be no reserves available to balance next year’s budget if the revenue increases fail to materialize
  • The state budget office has been overly optimistic of late. For instance, in last year’s governor’s budget proposal, they predicted a 5.5 percent unemployment rate in North Carolina for 2009

What Happens When the Federal Funds Dry Up?
The Governor’s budget proposal relies on $2.9 billion in federal funds over the next two years to help balance the state’s budget. But what will happen when state lawmakers attempt to craft a budget for 2011-12?

• According to the governor’s budget, appropriations in the 2010-11 will exceed state revenue by more than a billion dollars. This hole will be plugged by federal money.
• This produces, however, a structural deficit of at least a billion dollars going into 2011-12. Where will the state come up with this money?