Have NC tax cuts boosted economy? Not so much, economists say

Mark Barrett | The Citizen-Times

State legislators who say tax cuts adopted this decade have dramatically boosted North Carolina's economy might have slept through a few sessions of Economics 101, comments from some who teach the subject suggest.

Income tax cuts have failed to fuel growth over the long haul nationally, and it's even trickier to tie them to short- or long-term economic benefits on the state level, said Steve DeLoach, an economics professor in the Love School of Business at Elon University.

Tax cut supporters will dispute that, but there is little debate the issue is an important one, especially now.

North Carolina legislators over the next month will piece together a 2017-18 budget bill to send to Gov. Roy Cooper. On taxes, the question most legislators are wrestling with is not whether to cut them, but by how much.

A recent analysis by legislative staffers says tax cuts approved by the Senate would result in budget deficits topping $600 million a year in two years' time.

That's equivalent to 2.4 percent of projected state spending for the 2019-20 fiscal year, and the shortfall would be even larger if the economy slows between now and then.

House leaders have endorsed a more modest cut, but its cost and other details won't be known until that chamber approves its proposed state budget, expected this week.

After that, House and Senate negotiators will work out a compromise to be approved by both chambers and submitted to Cooper.

Since Republicans took control of the General Assembly in 2011, legislators have cut the state's personal and corporate income tax rates, eliminated the estate tax paid on assets handed down by a few wealthy people, and reduced or eliminated other taxes paid by businesses.

Before the cuts started, North Carolinians paid income tax rates of 6 to 7.75 percent, with the higher rates falling on wealthier taxpayers. Now there is one flat rate, 5.499 percent. The corporate tax rate has dropped from 6.9 percent to 3 percent.

Those changes were accompanied by elimination of some deductions or tax credits. Legislators also expanded the state sales tax to cover services like car repairs.

Tallying the reduction in state revenue resulting from the cuts gets complicated. The N.C. Budget and Tax Center, a liberal-leaning organization, says projections by legislative staffers at the time the cuts were approved put their impact at about $2 billion.

But the impact of the cuts increases with time. The center says North Carolina would have about $3 billion more to spend this year had the taxes not occurred.

By way of comparison, Cooper's budget proposal this year called for about $23.5 billion in general fund spending.

But liberal critics say the state is neglecting programs that help working- and middle-class families and lowering taxes would make funding them adequately even harder.

The Great Recession forced dramatic cuts in services and that state has yet to make up for the losses, including those in education funding, said Rep. Susan Fisher, D-Buncombe.

"The basic needs of the classroom have been cut short for the last six years, and they need to be caught up," she said.

Even one of the more prominent allies of the General Assembly's Republican majority on budgetary issues says legislators should guard against going too far with tax cuts.

"I think that our economy is not percolating the way it was a year ago. I think that we want to be very careful with our budget to make sure we're not overly optimistic," said John Hood, chairman of the conservative John Locke Foundation.

"I do think there is room in the current fiscal situation for a substantial tax cut," Hood said. However, "the most important priority is to save, because there is at least some risk of a recession."

Breathing room

After dreary days that began during the recession last decade, some bright spots in the state's financial condition have emerged while Republicans have ruled the roost in Raleigh.

The General Assembly in recent years has made generous appropriations – some critics say too generous – to its rainy day fund.

Figures from the Pew Charitable Trusts say North Carolina's reserve fund stood at 23rd largest, as measured by how long the fund could keep state government running, among the states for the 2015-16 fiscal year. The legislature has added to the fund since then.

State government revenues in North Carolina have generally come in ahead of projections while almost half of states began 2017 expecting revenue shortfalls.

Critics say the surpluses are the product of conservative revenue estimates and cuts to needed services that will have long-term impacts, but they are surpluses nonetheless.

After a five-year period in which teachers got one annual raise, the General Assembly has approved average pay raises that outpaced inflation in each of the past three fiscal years.

Economic activity in the state and nation has picked up over the same period.

House Speaker Tim Moore wrote on Forbes.com recently that the General Assembly "has kept its promises to North Carolinians by passing historic income tax cuts this decade, growing the economy and benefiting the bottom lines of average and low-income working families across the state."

At a news conference to discuss the Senate's budget plan, chamber leader Phil Berger said he and his colleagues have decided to "leave (more) money in the hands of the people, in the economy. We think that’s been a successful strategy over the past few years."

But four economists interviewed for this story generally say it is unlikely much of the growth in the state's economy this decade was caused by tax cuts approved in Raleigh or that they spurred enough economic growth to offset losses to the state treasury.

The economists work at Elon University, N.C. State University, UNC Asheville and UNC Chapel Hill.

Politicians favoring a tax cut sometimes argue it could "pay for itself" by encouraging more economic activity that ultimately brings an equivalent amount or more into government coffers.

The theory frequently pops up in discussions of state and federal budgets, but it is difficult to say how much of a role that sort of thinking has played in legislators' decisions.

But most economists dismiss the idea, said Robert Tatum, an associate professor of economics at UNC Asheville.

He said of politicians who claim otherwise, "I feel like they've had the Economics 101 class and just taken certain things away from it" and ignored others.

Tax cuts simply don’t pay for themselves, DeLoach said.

Hood said he generally supports the tax reductions legislators have approved this decade, but said people should not oversell their benefits.

"If you claim that North Carolina cut taxes and got more revenue out of it, you're looking at the wrong math," he said.

Alexandra Forter Sirota, head of the N.C. Budget and Tax Center at the N.C. Justice Center, said many legislators seem to have bought into an ideology that values tax cuts over almost any other use of government funds.

"There hasn't been a real engagement with the research and data about what works and what doesn't," she said.

Instead, lowering taxes "continues to be used a solution to every broad economic challenge we face," Sirota said.

Not so fast

Economists see at least four problems with closely linking the state's tax cuts to improvements in the North Carolina economy this decade or to the state's relatively healthy balance sheet:

It takes time for the results of such changes to become apparent, they say.

There may be offsetting effects from cuts to state programs that contribute to economic growth.

The state of the national and global economies and the state's existing economic advantages and disadvantages can overwhelm impacts of decisions made in Raleigh.

There isn't even agreement on whether the state's economy has been doing appreciably better than that of the nation's.

It would be a good research project for someone to attempt to tease out the impacts of lower taxes on the state over the past few years and the future, said Douglas Shackelford, dean of UNC Chapel Hill's Kenan-Flagler School of Business and a professor of taxation there.

Experts are skeptical about the idea that lower taxes can have a major impact on a state's economy in short order, he said.

"You want to be really careful about drawing inferences about immediate tax policy and immediate revenue flows," said Shackelford, who neither criticized nor endorsed steps legislators have taken.

"The vast, vast majority" of state government's revenue growth is probably due to improvement in the national economy that has seen North Carolina's economy rise as well, he said.

Hood said he expects lower taxes to benefit the state's economy, but says most benefits won't be seen for years.

"It's not like you're manipulating a car engine: You push the accelerator and the car takes off," he said. "That's not a helpful way to think about it."

Tax changes put more money in the hands of people and some of that will be invested in businesses that will yield dividends in the state for years to come, he said.

"It is demonstrable that the private sector invests more efficiently than the public sector," Hood said.

However, he said, "It's simply too early to have observed most of the effect."

State government's taxes are dwarfed by the size of North Carolina's economy, Tatum said.

"We're talking about a big economy that state government is not going to have a lot of short-term impact on," he said.

Few will complain if state government leaves more money in their pockets at tax time.

But DeLoach said the direct, short-term impact from those dollars can be spread over a wide area, much of it outside the state's borders.

Some people will put tax savings in the bank or perhaps buy stock in a company with operations halfway across the globe. Others, he said, "will buy goods and services produced in other states."

The road not taken, the textbook not purchased

Then there's the question of what the state will not spend money on because it has cut taxes instead.

Cuts in infrastructure and school funding – the biggest parts of the budget – can prove harmful, DeLoach said.

Investments made decades ago in the state's roads, public schools, university system and projects like Research Triangle Park are an economic advantage for the state today, he said.

"What I worry about is what's going to happen 20 years from now. Are the cuts we're making right now going to lead to a less educated workforce?" DeLoach said.

Research Triangle Park, located between Raleigh, Durham and Chapel Hill, was founded by state government in the 1950s and now is the focus of a boom in information technology and health sciences companies.

DeLoach called that an excellent example of public investment.

“We've kind of stopped doing that in recent years,” he said.

Economists say the state has benefited from a general move to the South by many Americans that followed the spread of air conditioning following World War II and a reputation as a more progressive state than some other Southeastern states.

"I think basically people like to come here because we've got a state, HB2 aside, that's considered fairly progressive," said Michael Walden, who teaches economics at N.C. State University.

"I do think taxes matter," Walden said, and he says corporate tax cuts the legislature approved are having a positive effect.

But he said it is only natural that North Carolina's economy has grown during a period when the national economy has grown, he said.

"This has just been an attractive state for a long time," Walden said.

Looking for clues

Economists and others disagreed over whether or how much North Carolina has performed better than the nation or other states in the Southeast. Some say they see little difference, others say the state's economy has been stronger since North Carolina starting cutting taxes.

The state’s unemployment rate was about a full percentage point above the national rate for the first quarter of 2013 and dipped below the U.S. rate for a couple of months in spring 2014.

However, the N.C. rate has been higher than the U.S. one each month since August 2014. The spread between the state and nation widened during the fall and winter and has narrowed this spring.

Hood said the jobless rate is an imprecise measure and he and Walden both say they see evidence of better performance by North Carolina on other indicators. Hood added, however, that the advantages he sees for the state were smaller in 2016 than in previous years.

"Economic performance in North Carolina has been better than benchmarks, but not radically better," he said. He also said that at a minimum, the figures show no short-term harm from tax cuts.

DeLoach and Tatum say indicators don't show North Carolina breaking away from the pack.

Hood said there are too many other factors at play to use economic indicators to make many definitive statements about the state's tax changes.

A look at which states are doing well across the country suggests that while decisions made in their statehouses are important, they are often outweighed by things legislators and governors have little control over, he said.

West Coast states and Southeastern states have had the best economic performance recently, Hood said. The first group is mostly governed by Democrats, the second mostly by Republicans.

"If you think about economic performance in purely political terms, this would mystify you," he said.

What’s been done so far

Major changes to North Carolina’s tax structure made since 2011 include:

Personal income tax. North Carolinians used to pay income tax rates ranging from 6 to 7.75 percent, with the higher rates paid by those with higher incomes. That changed in 2013, when the legislature went to one rate – 5.75 percent – for all taxpayers and eliminated a number of deductions and tax credits. The rate has dropped more since, and now stands at 5.499 percent. The standard deduction, which all taxpayers can take, has increased.

Corporate income tax. The rate used to be 6.9 percent and the General Assembly has lowered it as well. It now stands at 3 percent.

Sales tax. The state rate, 4.75 percent, has remained the same but the list of things it is applied to has expanded to include more services, like car repairs. Some caps on the amount of tax or exemptions from it have been changed with the general impact of increasing sales tax collections. (The state also authorizes local sales taxes that range up to 2.75 percent, depending on the county.)

Estate tax. The tax, which applied to exceptionally large inheritances, was repealed as of 2013.

Other business taxes. Several other taxes that apply to business have been altered with the net effect of lowering companies’ tax obligation.

What may lie ahead

Major tax changes contained in budget proposals now being considered in Raleigh:

Gov. Roy Cooper. The governor would keep the state’s tax structure basically as is, except that he would reinstate the tax credit for child care expenses the General Assembly eliminated in 2013. That would reduce state revenue by $52.5 million in the 2018-19 fiscal year.

Senate. Highlights of its plan include lowering the personal income tax rate from 5.499 percent to 5.35 percent and increasing the standard deduction, the amount of income exempt from tax. It would increase from $17,500 to $20,000 for a married couple and $8,750 to $10,000 for a single person. The corporate income tax rate would fall from 3 percent to 2.75 percent, then 2.5 percent in 2019.

The cost to the state treasury would be $323.7 million in the 2017-18 fiscal year and $709.5 million the following fiscal year.

House. Speaker Tim Moore says the House budget, to be voted on this week, will include tax cuts. Details are not yet available, but the cuts are expected to be significantly smaller than those proposed by the Senate.

What's the impact? Once the cuts proposed by the Senate take full effect in 2019-20, the state would be about $600 million per year short of the revenue it needs to continue to provide current services, an April 10 analysis by staffers for the General Assembly says.

The memo, first reported by Raleigh newsletter The Insider, takes into account factors like school and college enrollment growth and costs for state employee health insurance and the state retirement system. The latter two expenses are likely to rise faster than inflation, it says.