Economic Outlook - March 2005

Taxpayer's bill of rights could fix fiscal wrongs

The state faces a projected billion-dollar budget deficit for the fiscal year that starts in July. A report by Barry Poulson argues that a taxpayer’s bill of rights would prevent such shortfalls. Poulson is an economics professor at the University of Colorado at Boulder and wrote the report for the Washington, D.C.-based Americans for Prosperity Foundation, a conservative think tank with a North Carolina office.

BNC: Characterize 2004 and the year ahead.

Poulson: It is an amendment to a state constitution that limits the growth in state revenue and spending to the growth of population plus inflation, ensures revenue above this amount is returned to taxpayers and requires voter approval for tax increases or weakening of the amendment’s limits.

How would it limit spending?

In 2003-2004, North Carolina had 1.2% population growth and 1.7% inflation, which adds up to 2.9%. That’s the rate of growth permitted for revenue and spending in that year. If the actual revenue goes over the limit, refund the difference to taxpayers.

Why not a statutory limit on spending?

When you have a statutory limit, legislators can repeal it or change it because they passed it. A constitutional amendment is more binding because it requires legislators to go to a vote of the people if they want to spend more than the limit. That’s a pretty high hurdle.

What about economic fluctuations?

The criticism of the amendment as it exists in Colorado is that it ratchets down revenue the state can spend in a recession. When you start recovering from a recession, growth in revenue will exceed the limit, so the state will have to rebate surplus revenue to taxpayers even though revenue hasn’t recovered to pre-recession levels.

What’s the solution?

I link the taxpayer bill of rights to an emergency fund and a budget-stabilization fund. If you go through a period of prosperity like North Carolina did in the 1990s and you have this limit in place, you’re generating surplus revenue. Instead of returning the surplus to taxpayers, you allocate a portion to an emergency fund and a budget-stabilization fund. An emergency would be something unforeseen in the way of natural disasters or terrorist attacks. The legislature would have to declare an emergency, then spend the money for a specific event. The budget-stabilization fund is to help the state stabilize the budget over the business cycle. When you have a recession and a revenue shortfall, you can transfer money from that budget-stabilization fund into the general fund to offset the revenue shortfall.

What happens during a long recession?

When you have a revenue shortfall, the state should cut some of the budget, just as in the private sector you have to have budget cuts, but offset at least some of the revenue shortfall by using this budget-stabilization fund.

Why do we need such an amendment?

In the 1990s, revenue and spending ratcheted up very rapidly. And then when you had the recession and a revenue shortfall, there was tremendous pressure on the state to increase taxes to boost revenue to that higher level of spending. The income tax and some other taxes were raised, and the legislature borrowed money to try to keep spending levels up.

What’s wrong with how North Carolina generates revenue?

North Carolina relies heavily on income tax. You have a graduated income-tax structure from 6% to 8.25%. In Colorado we have a flat income-tax rate of 4.63%. The problems with North Carolina’s high, graduated income-tax structure are that, one, you’re very dependent on income-tax revenue and, also, income-tax revenue is very volatile when you have a graduated rate structure.

How so?

Your income-tax revenue increases more rapidly than personal income because of that graduated rate structure. Conversely, when you’re in a recession and income is falling, your income-tax revenue is going to fall more rapidly than the fall in personal income.

What’s wrong with the state’s spending?

The main expenditure items in North Carolina’s budget are education, Medicaid and debt service. Higher education in North Carolina has been on a gravy train for decades. Tuition is among the lowest in the country, but this is possible only by massive state subsidies. North Carolina’s Medicaid spending increased 224% over the last decade, more than any other component of state spending. North Carolina spends significantly more per person than comparable states in the Southeast. Most states have debt service, but what’s surprising about North Carolina is how much debt it has and how fast it has increased. Current projections show total state debt service doubling from $296 million in 2003 to $587 million in 2006.

Which budget items would suffer?

In many states, the legislature doesn’t have discretion over much of the budget. There may be federal mandates for programs like Medicaid and state mandates for items like K-12 education. Discretionary parts of the budget may include higher education, health and welfare programs. These discretionary budget items are the programs substantially cut. The amendment forces legislators to make the decisions we elected them to make, which is to set priorities.