Weekly Briefing

How budget negotiators can resolve their differences

Quick take: North Carolina's elected officials are on the verge of completing work on a new biennial budget. The major stumbling block is the revenue package - with the House and Senate putting forth two very different, but strong proposals. With help from the experts at the N.C. Budget and Tax Center, this edition of the Weekly Briefing outlines a "best of both plans" compromise that would serve the state well for years to come.  

It's "crunch time" again. As happens almost every year, North Carolina lawmakers have arrived at the moment at which the end of the fiscal year coincides with final budget negotiations to produce a series of urgent, down-to-the-wire talks between the House, Senate and Governor. At issue: what state government will spend and what it will tax over the next two years - or, in other words, the single most important bill that the General Assembly will adopt this year.

In many ways, this year's talks feel a bit anti-climactic. After months of reluctant wavering, the key players have all finally faced up to reality and committed themselves to meaningful tax increases. Confronted with an increasingly obsolete revenue system, unprecedented budget shortfalls, and the prospect of devastating cuts to a host of essential state services, elected leaders have stepped up to the plate and committed to doing the responsible thing.

Though far from perfect in their performance, officials have, at least, mustered the courage to head off the worst of what the economic downturn could have inflicted on the state. While North Carolina's current leaders may not be the slickest politicians, they deserve credit for listening and caring. Things will be very tough in the new biennium, but at least we're not South Carolina or California - states paralyzed by political gridlock and blundering elected leaders with outsized ambitions and egos.

Competing plans

Of course, general agreement on the concept of raising new revenues to make the coming budget cuts somewhat less severe is one thing, getting final agreement on exactly what should be in the final tax plan is quite another. Though all key players acknowledge the fact that more money must be raised, there is less agreement on exactly how much to raise and how to do it.

Here are some key components of the two plans - both of which have much to recommend them:

On the personal income tax-

The Senate would broaden the income tax by changing the starting point for calculating state income taxes from the current system, which uses "federal taxable income" (i.e. after deductions), to one that uses "adjusted gross income" (i.e. before deductions). It would also create a new zero-percent tax bracket for first $10,000 of adjusted gross income for married couples filing jointly ($5,000 for single filers).

The House, in contrast, would create two new upper-income tax brackets: 8.25% and 8.5% on taxpayers with high incomes. The current top rate maxes out at 7.75%.

On the sales tax-

The Senate would broaden the base of the sales tax by adding a number of currently untaxed services and lowering the overall rate by as much as .75%. According to recent reports, it would also raise the sales tax on electricity sales from 3% to 6%.

While the House would broaden the base a little by adding a few services, most of its new revenue comes from an old-fashioned, across-the-board rate increase of 0.25%.

On business taxes 

The Senate would generate additional revenue by eliminating some ineffective business credits, limiting the farm sales tax exemption to smaller farms and expanding the franchise tax to so-called "limited liability" business entities. It would also cut business taxes by eliminating state and local privilege taxes, and lowering the corporate income (i.e. corporate profits) tax.

The House would close a giant loophole exploited by many large, multi-state businesses to the detriment of smaller, in-state companies by enacting "combined reporting," It would also adopt some smaller, but very important measures to improve the corporate income tax including closing the so-called "nowhere income" loophole. It would also follow the Senate's plan to expand the franchise tax.

Sealing the deal

Neither plan is perfect. Each includes regressive components and neither raises as much money as is truly necessary. With respect to the latter flaw, Governor Perdue is much more on target when she calls for new revenues of around $1.5 billion in order to produce a truly balanced package of service cuts, tax hikes and federal recovery funds.

Still, in light of the political realities that they confront, both houses deserve significant credit for having produced serious proposals that raise real revenue while paying genuine attention to the issue of tax fairness. In comparison to efforts of many past General Assemblies, each displays a much higher level of sophistication and attention to the long-term that bodes well for the state's future.

At this point, the only real question is how to craft a deal that takes the best of both proposals. How can lawmakers construct a final revenue package that maximizes the revenue available to minimize services cuts, while making sure that those with the greatest ability to contribute pay their fair share?

As usual, the best resource for such advice is the North Carolina Budget and Tax Center. After examining both proposals and, of critical importance, running the "incidence" numbers for the competing plans to see how they would impact various income groups, BTC experts urge the following "best of both plans" compromise:

• On the personal income tax, adopt the Senate's base broadening reform, but graft on one of the House's new proposed upper income brackets. Net revenue benefit: $161 million next year and more than $400 million in '10-11.
• On the sales tax, again go with the Senate's base broadening and expansion of the sales tax on electricity - this will be fairer and better for the long-term revenue health. Net benefit: As much as $500 million next year.
• On business taxes, enact all of the changes proposed by the two houses. Net benefit: $183 million next year and $354 million in '10-11.
• To lessen the regressive impacts of some of the changes on people of modest income, lawmakers should supplement the compromise by doubling the state earned income tax credit (EITC) and considering adoption of an alternative refundable credit for older residents on fixed incomes who do not benefit from the EITC.

Going forward

In a period of extremely tough economic and political times, state elected leaders have done yeoman's work to get to this point. Now is the time to finish the job. With a little more hard work and imagination, the final product can be something to be proud of for years to come.

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This entry was posted on Tuesday, June 30th, 2009 at 10:14 am and is filed under Weekly Briefing. You can follow any responses to this entry through the RSS 2.0 feed.