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Executive
summary of the budget
Below
are major extracts from the executive summary of the budget
document that governor Easley submitted to the General
Assembly:
The total recommended biennial state budget of $54,126.3
billion is supported from four primary sources of revenue
which include: general funds ($29,952.1 billion), highway
funds ($5,042.4 billion), federal funds ($14,784.0 billion)
and other receipts which are generated by agencies ($4,347.8
billion).
In terms of total availability, the support is distributed as
General Fund tax and non-tax revenue 55.4%; highway fund tax
and non-tax revenue 9.3%; federal funds 27.3%; and agency
receipts 8.0%. General fund availability is determined from:
(1) the fiscal year ending credit balance, which is comprised
of unexpended funds in agency budgets and overrealized
revenues; (2) tax revenue, which is generated from payments
made by taxpayers consistent with the various tax laws of
North Carolina; and (3) non-tax revenue, which includes
earnings from investment of state funds during the course of
the fiscal year.
Accordingly, the Highway Fund and Highway Trust Fund are
supported from tax and non-tax revenues available under law.
The Highway Fund receives funding from three basic sources
including: (1) three-fourths of the motor fuels tax collected;
(2) licenses and fees; and (3) earnings on investment of the
fund balance. The Highway Trust Fund is supported from four
primary sources including: (1) one-fourth of the motor fuels
tax collected; (2) sales and use tax on the sales of motor
vehicles (currently in excess of $170 million); (3) title fees
and registration fees; and (4) earnings on investment of cash
balances. The use of the Highway Fund and Highway Trust Fund
revenue is currently limited to transportation related
activities, and the budgets of each are reflected in this
document.
Contained in this document is Governor Easley’s proposal to
balance the continuation budget for the 2001-2003 biennium
while continuing to move North Carolina forward by focusing on
education programs. The recommended continuation budget
includes: enrollment growth for public schools and average
annual salary adjustments totaling $65.5 million in 2001-2002
and $162.8 million in 2002-2003; funds to make payments as
earned by public school teachers and staff under the ABCs
Program estimated at $93.1 million in each year of the
biennium; continued funding of the Clean Water Trust Fund at
the current service level of $30 million in 2001-2002 and
$70.0 million in 2002-2003; current spending levels for Smart
Start at $256.7 million in each year of the biennium; $450
million in 2001-02 and $694 million in 2002-03 to address the
increased cost of the Medicaid program for the biennium; and
$150 million in 2001-02 and $200 million in 2002-03 to support
increased costs in the State Health Plan for teachers and
state employees.
The North Carolina Economy
As the nation’s leading industrial state, the North Carolina
economy has been impacted by the recession in the
manufacturing and technology sectors. Over the twelve months
ending January 2001, manufacturing employment has declined by
a net 15,300 jobs. The State’s traditional industries
continued their long-term slide, with textiles, apparel, and
furniture losing 7,000, 3,500, and 500 jobs respectively.
However, the year 2000 national slowdown in manufacturing has
further disbursed the employment declines to most of North
Carolina’s emerging industries. Over the past year,
transportation equipment employment fell by 2,800, while
industrial machinery payrolls lost 700 jobs.
As has been the case for many years, the engine for new job
creation in North Carolina continues to be the
nonmanufacturing sector. After increasing by a healthy 3.5% in
1999, the growth rate in total nonmanufacturing jobs held
steady at 3.6% during the past year. Since January 2000, over
110,000 new jobs were created in the nonmanufacturing sector,
with two-thirds residing in services and government.
Despite the slowdown in housing activity, construction
employment remains strong, increasing by 14,600 jobs, or 6.6%.
Mergers and consolidations, along with the growing weakness in
the U.S. economy, are hurting financial service providers in
North Carolina. Employment growth in the Finance, Insurance,
and Real Estate sectors has slowed to 2.8% from the 7.5% range
experienced in the 1996 – 1998 period.
Another indicator of the relative harm imposed on the North
Carolina economy by the national slowdown in industrial output
has been the rapid rise in unemployment. After standing at
3.2% in January 2000, the State unemployment rate rose to 4.2%
one year later, and now equals the U.S. average.
Despite the current gloominess, there are reasons for optimism
looking forward. Monetary stimulus and the prospect for
federal tax cuts (possibly retroactive), will spark an
acceleration in consumer spending and new business investment,
leading to robust economic growth in 2002.
As U.S. industrial production recovers, North Carolina will
outpace the nation in relative economic performance in 2002
– 2003. The recovery of the housing market, along with the
phased re-building from Hurricane Floyd, indicate a solid
rebound in residential construction.
Specifically, OSBPM is projecting State total personal income
(not adjusted for inflation) to grow by 5.5% in 2002 and 6.4%
in 2003. The following chart displays U.S. and North Carolina
personal income growth rates on a state fiscal year basis.
The factors underlying the General Fund tax revenue shortfall
are a combination of a weakening State economy, along with a
significant volume of unbudgeted tax refunds. Approximately
$120 million of fiscal year 1999-2000 individual and business
tax refunds were brought forward and paid in July and August
2001. Since these refunds were not budgeted in fiscal year
2000-01, the General Fund was put in an immediate deficit
position.
Tax revenue was below the budget target in September 2000 as
the first signs of a slowdown in the State economy were
observed. At September 30, 2000, General Fund tax revenue was
$166 below the forecast authorized by the 2000 Session of the
General Assembly.
A second round of unbudgeted tax refunds occurred in the
second quarter of 2000-01. On August 24, 2000, the North
Carolina State Supreme Court issued an order denying the North
Carolina Department of Revenue’s request for a review of a
lower court decision which found in favor of the Chrysler
Financial Corporation’s petition for a refund of protested
privilege license payments. Subsequently, the department
dropped its appeal of a similar lawsuit involving Ford Motor
Credit. Combined, the cases involved refunds of taxes and
interest of $58.7 million, which were paid in October and
November 2000.
December and January are important months for General Fund tax
collections since they include the sales tax receipts for the
Christmas season as well as the final quarterly estimated
payments by individuals and corporations. February is also
important from the standpoint of individual income tax (IIT)
refunds, which largely commence in February.
Focusing ahead this fiscal year, the expected flow of IIT
refunds will make it more difficult to monitor the tax revenue
shortfall situation during the remainder of 2000-01. Issuance
of IIT refunds was abnormally slow in 1999-2000, to the point
where approximately $100 million in refund liabilities were
carried over into 2000-01.
The pace of refund processing accelerated noticeably in
February 2001 compared to last year. One reason for this
acceleration is that more taxpayers are utilizing electronic
filing of the tax year 2000 returns. In February 2001,
reported refunds increased to $320 million, up significantly
from $208.5 million last year. Adjusted for the acceleration
in IIT refunds, 2000-01 General Fund tax revenue stands at
$373.5 million below the authorized forecast through the first
eight months.
Based on the economic forecast discussed in Section II, OSBPM
projects that the shortfall in tax revenue will increase to
$460.8 million at June 30, 2001. The largest negative
differences from the budget will occur in corporate income and
sales taxes. As employment and wage growth continue, IIT
withholding payments will not add to the overall shortfall.
OSBPM does not expect a major problem in IIT final payments,
although they are expected to fall below the authorized
budget.
Herein lies the largest element of uncertainty during the
remainder of 2000-01. Will IIT final payments decline in April
2001 as a result of declining stock prices in 2000 calendar
year (CY)? OSBPM subscribes to the theory outlined by
Dr. Mark M. Zandi of Economy.com. Dr. Zandi believes that the
volume of realized capital gains increased in tax year 2000
despite the stock market drop because many people took gains
on stocks they had held for many years.
Allowing for increased stock market losses, the net budgetary
impact in fiscal year 2000-01 may be positive. This opinion is
buttressed by the recently released estimates of the
Congressional Budget Office (CBO) showing 2000 CY capital
gains realizations increased by 18%, down only slightly from
the 22% increase estimated for 1999 CY. Offsetting for losses,
CBO estimates that federal fiscal 2001 (mainly April 2001)
receipts from capital gains will grow by 9%.
However, OSBPM recognizes that there are alternative opinions
predicting much weaker outcomes for the nation in April 2001,
which can not be dismissed. Additionally, the capital gains
realizations and tax liabilities for North Carolina filers may
differ from the national average. Regrettably, we will have to
wait for a full accounting of the April 2001 State tax
receipts to answer this important question.
A shortfall in income from Treasurer’s investments added to
the overall revenue difficulties for 2000-01. Average monthly
cash balances have been diminished by the slowdown in tax
collections, along with the numerous settlements of lawsuits.
Additionally, the rate of return on State investments is
gradually falling with market interest rates. Currently, the
estimate of investment earnings for 2000-01 is $178.8 million,
or $35.2 million below the authorized budget. In total, the
overall shortfall of General Fund tax and nontax revenue for
2000-01 is projected at $497.9 million by OSBPM.
The economic recovery is now projected to commence in the
first quarter of 2001-02 and pick up speed during the year.
Typically, early in the recovery, consumers make big-ticket
purchases which were postponed during the economic slowdown.
The unemployment rate will recede as the manufacturing sector
improves. These are positive signs for General Fund tax
revenue growth.
Adjusted for refund anomalies, OSBPM projects a moderate 5.6%
rate of growth in tax revenue for 2001-02. By 2002-03, the
economic recovery phase is winding down and the State economy
is growing at a long-run trend rate. Bolstered by stronger
corporate profits in 2002 CY, the rate of tax revenue growth
accelerates to 6.2%.
Returning to the capital gains issue, CBO is currently
projecting that capital gains realizations and the resulting
tax receipts will become a less important source of federal
revenue compared to the late 1990s. In their January 2001
federal budget outlook, CBO projects that capital gains
realizations will be flat in 2001 CY and down by 5% in 2002
CY. The OSPBM General Fund forecast mirrors that projection.
Revenue Enhancements and Other Issues
On March 1, 2001, Governor Easley announced the formation of
the North Carolina Efficiency and Loophole Closing Commission,
which will be led by former Governors Jim Holshouser and Bob
Scott and former State Treasurer Harlan Boyles. As part of
their charge, the Commission will evaluate existing State tax
expenditures to identify those which cannot be justified under
our current economic condition. The Commission is expected to
report their recommendations for closing “loopholes” in
mid-April.
At present, it is assumed that the Commission’s
recommendations will increase General Fund tax revenue by at
least $150 million, beginning in 2001-02. A recent
analysis of accounts receivable by the Department of Revenue
indicates that collectibles total $120 million. The department
is currently increasing its efforts to collect these accounts
receivable. The recommended budget for 2001-02 and 2002-03
includes an expected $18.0 million in additional annual
revenue from these enhanced collections efforts.
Currently, the General Fund receives a $170 million annual
transfer from the Highway Trust Fund. This transfer was
established to compensate the General Fund for the loss in
sales tax revenue on motor vehicles following the creation of
Highway Use tax. In order to partially adjust the transfer for
past inflation, it is recommended that the Highway Trust Fund
transfer be permanently increased to $200 million in 2001-02.
The State Inheritance Tax was repealed effective January 1,
1999. However, the State Estate Tax, which is equal to the
state death tax credit allowed by the Federal Estate Tax Act,
remains in effect. President Bush is expected to offer federal
legislation which will phase-out the federal estate and gift
taxes. Alternative proposals exist which would maintain the
federal estate and gift taxes but increase the filing
threshold (one proposal, eliminates the estate tax on estates
below $4 million). Consequently, there is a strong likelihood
of a change in the federal estate tax which will negatively
impact North Carolina General Fund tax revenue. Until federal
legislation is enacted, it is not possible to accurately
determine the size or the timing of the effect on the State
budget. Fortunately though, any change should not have a
significant impact on the 2001-03 biennium. However,
recognizing the potential loss in the “Inheritance Tax”
(term still used by the Department of Revenue), OSBPM
forecasts actual collections at somewhat less than the base
line value. If significant changes in the federal wealth
transfer tax system are enacted, the impact on the State
General Fund (Inheritance as well as other taxes) will need to
be fully evaluated.
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