The State Budget Passed. What Does It Mean?

Table of Contents

Introduction to the Budget and the Series

Tax Cuts

Individual Income Tax

Corporate Income Tax

Other Taxes

Why Does This Matter?

Introduction to the Budget and the Series

On October 3rd, House Bill 259 became North Carolina law without Governor Roy Cooper’s signature. You may have heard about the long-expected bill, more commonly known as “the budget,” from the headliner items that made it in (ie: serious tax cuts, Medicaid expansion, or private school vouchers), or items that did not (such as the controversial casinos that caused a small standoff between the House and Senate leaders). But aside from making catchy headlines, do North Carolinians need to care? Is the budget not just obscure financial jargon?

Throughout this series, I aim to convince you that even though this is how the sausage gets made, North Carolinians do have a reason to care—no matter their proximity to the state government. H.B. 259 directly impacts personal finances, access to social services, and the economy and opportunities of the state. But, H.B. 259 is also an omnibus bill with broad policy changes in healthcare, education, government operations, environmental regulation, and more that directly impact all North Carolinians. H.B. 259 sets the guardrails for what the state can and cannot do for the next two years. Being informed will help residents understand and react to what is coming.

NC’s budget is unusual in scope. As The News and Observer’s Capitol Bureau Chief, Dawn Vaughan, points out, “North Carolina is kind of an outlier in putting policy in a budget.” Indeed, other states such as New Jersey have budgets less than half the length and are focused exclusively on budgetary items such as appropriations to schools and government agencies. On top of this oddity, NC’s budget is biennial as opposed to annual, making it one of only 20 states that appropriates two fiscal years of spending per budget. Together, the sweeping policy changes and two-year timeline make the North Carolina budget a particularly important piece of legislation.

Even by NC’s standards, 2023’s H.B. 259 was a doozy. The bill took five days to read aloud and came out to 1,411 pages including the addendum which is necessary to read if you want the specifics of the bill. It was nearly twice as long as the state budget just 12 years ago, as an analysis by the Capitol Broadcasting Company shows. The same analysis also states that the state legislature has passed over three times fewer bills in 2023 than in 2011. These results suggest that modern bills have broader scopes and more provisions, making each one more important.

H.B. 259 has a whopping 43 parts, only two of which (plus the addendum) limit themselves to exclusively fiscal policy changes. And it does not mince words. The bill includes historic provisions–making North Carolina the 40th state to expand Medicaid, implementing more stringent voter ID requirements, and speeding up yearly income tax cuts. The bill also adds automatic revenue triggers that, if hit, would bring NC to the lowest income tax level in the country within a decade barring changes in other states. These changes are just the tip of the iceberg of the important and eyebrow-raising changes packed into H.B. 259.

In this series, I aim to distill 1,411 pages of information into a practical summary that proves useful to anyone living in or interested in North Carolina. I will present a data-driven analysis of how the budget affects our state’s economy and opportunities, as well as how it impacts our citizens personally.

In this first part of the series, I will dive into the tax changes in the bill. I aim to fit these changes within the dramatic story of NC fiscal policy over the past 15 years. Far from the dull topic this may seem at first blush, NC fiscal policy undergirds most headline-grabbing topics and lays the groundwork for our state’s economic future.

H.B. 259 - The Tax Cuts

Generally, the state budget is made of three sources; federal dollars, state funds, and reserves. H.B. 259 affects the latter two, which together form a larger share of total state expenditures than federal funds for most states, including NC. The main source of state funds is the General Fund, or the primary pool of state dollars which overwhelmingly comes from state taxes. H.B. 259 projects that it will hold $31.4 billion in FY 2023-2024, an increase from previous years. This follows a consistent rise over the past decade or so. However, this rise masks tax cuts that have decreased the size of the general fund as a percent of NC’s economy since the cuts began in 2013, as an analysis by the NC Budget and Tax Center shows. The steady rise in North Carolina’s economy has hidden this decrease. According to the Bureau of Economic Analysis, NC’s GDP has risen 30% since 2017, causing state revenues to rise in absolute terms which masks their proportional fall.

The strong economy is no doubt good news for North Carolinians today, but the budget does not concern itself with today. It sets the state’s ability to spend for the next two years, no matter which way the economy turns. So we must ask, does a transient rise in the economy warrant permanent cuts in state revenue? The state legislature seems to think so. H.B. 259 continues and accelerates the trend of tax cuts that the legislature has pursued since at least 2013. Here is a quick recap of these recent changes, a pivotal moment in NC history, and how H.B. 259 continues them.

Personal Income Tax

In FY 2021-2022, the personal income tax made up 54.5% of General Fund tax revenues. Along with the sales tax, which sat at 31.6% of tax revenue in the same year, it is the largest and single most important source of state funds. Unlike the sales tax, which has not changed in the last decade, the income tax has seen a remarkable decline. In 2014, the legislature replaced the variable income tax rate with a flat tax rate, making NC one of only eleven states to do so. Over the next decade, the legislature continued to make cuts, and H.B. 259 accelerated the drop to a 3.99% tax rate in 2026 and beyond. What’s more, H.B. 259 added “rate reduction triggers” for each of the next ten years. These are set amounts that, if exceeded by general fund revenue in any year, automatically trigger a permanent 0.5% reduction in the income tax in that and all subsequent years, reaching a potential floor of a 2.49% income tax. The yellow line in the graph shows how the income tax rate would respond if all triggers were met beginning in FY 2025-2026.

*Source (2011-2023):* *NC Department of Revenue.* *Source (2023-2031):* *H.B. 259*

While the graph is revealing, it hides two important questions– what are the impacts of income tax rate decreases on the budget, and how likely are the triggers to be reached? In answer to the first question, a drop of just 0.1% below the planned income tax rate in FY 2023-2024 carries an expected price tag of $160 million, roughly the same cost as public school teacher wage increases in the same year, according to the addendum (p. B21). The 0.25% dip below the base budget in FY 2024-2025 carries an even bigger price tag–$620 million–or nearly half the appropriations to the community college system (A-3). These price tags come on top of the lost revenue from the scheduled annual tax cuts made in the last budget which are still in place, costing around $1.5 billion per year.

The second question, which is if the revenue triggers will be hit, is slightly more tricky to estimate given the unpredictability of the economy. However, they seem designed to be met. The bill’s first trigger, set for FY 2025-2026, is roughly $700 million lower than this year’s projected general fund revenues, according to the bill. Even with the income tax cuts, projecting forward the state’s 3.2% economic growth from 2022 and a roughly 3.5% inflation rate consistent with the past few months, it seems plausible that these triggers will soon be enacted.

Corporate Tax

In 2022, North Carolina had the third lowest corporate tax rate in the country at 2.5%. H.B. 259 continues to phase out the corporate tax entirely from 2025 to 2030 as enacted in the FY 2021-2023 budget. During the first year of the stepwise drops in the corporate tax, FY 2025-2026, the state expects a loss of 342 million dollars. This sum comes from a small drop from a 2.5% to a 2.25% tax rate. Following this math, by 2030 our 0% corporate tax will represent several billions of dollars in annual lost revenue, creating a hole in state funding. How big is this hole? As recently as 2013, the corporate tax represented 6.9% of the General Fund tax revenues. As we have seen, it is not true that other taxes have risen to compensate. In addition, cutting the corporate tax has a stronger impact on the distribution of the tax burden than cuts on individual income taxes. As a recent report by the Brookings Institute shows, the corporate tax is one of the most progressive taxes around, meaning the costs overwhelmingly fall on the wealthy. As a result, cutting the corporate tax benefits well-paid managers and executives more than working families.

*Source (2003-2023):* *Department of Revenue. Source 2023-2030: NC* *General Assembly*

Other Taxes

While the income tax and the corporate tax are larger pieces of the state pie and have changed most dramatically in the past decade, H.B. 259 acts on a few smaller taxes worth noting. The bill:

Sets a lower franchise tax on C-corporations–typically large, shareholder-owned companies. (p. 614).
Expands and extends tax exemption for jet fuel and aircraft parts (p. 616-617).
Creates a new tax on ride-sharing services such as Uber (p. 620-622).

While the pros and cons of each of these specific taxes can be debated, it is striking that the legislature consistently cuts taxes that have a greater burden on the wealthy while creating new taxes where the incidence falls on the working class–such as the tax on ride-sharing which will fall on Uber and Lyft drivers and riders.

The legislature, especially House Speaker Tim Moore who championed H.B 259, has been quick to celebrate the bill as part of ‘pro-growth’ economic policies. Supporters of the bill use terms like ‘tax-relief,’ and talk about how making NC business-friendly has caused the economic boom in our state. They are not wrong about the state being open for business. An analysis by EY, a leading accounting and consulting firm, finds that NC has the lowest total effective business tax rate in the country. While some may call these strong incentives, others call them immodest handouts to already wealthy companies. A 2018 analysis of previous NC corporate tax cuts found that the lion's share of benefits went to the top 20% of income earners. Moreover, 80% of the benefits went to people living out-of-state, challenging the narrative that these benefits trickle down to NC residents. A decade of these ‘pro-growth’ policies has not changed that the average personal income in North Carolina ranks 40th in the country. Moreover, if the costs of these ‘pro-growth’ policies are starving education budgets at a time when employers are looking for educated workers, then maybe NC needs to have a conversation about what ‘pro-growth’ actually means, and who it is for.

Why Does This Matter?

H.B. 259’s tax policy, following the lead of the legislature since 2013, functions something like tearing insulation out of a house during the summer. For many North Carolinians (especially the wealthy) the change has been unalarming or even encouraging since they spend less on taxes. The state’s decade of economic growth has increased state revenue even though revenue has fallen as a share of growth. In short, things seem fine. But what happens when winter comes?

In 2008, we learned never to mistake a healthy economy for a healthy economic policy. We should be careful not to let fifteen comfortable years erode that hard-earned lesson. At that time, the financial system ground to a halt because risky assets were built up unregulated, spooking lenders. This process was facilitated by decades of legal changes that slowly gutted the safety mechanisms put in place after the Great Depression, as Adam Tooze notes in his bestseller, Crashed. The decadence and comfort of the 1990s and early 2000s allowed for the lessons of the Great Depression to be forgotten. The financial crisis of 2008, which came fairly unexpectedly, was painful for North Carolina. On top of the financial crunch people were already experiencing, the state increased and expanded its sales tax, which caused an added squeeze. The legislature had little choice since, unlike the federal government, the state is constitutionally required to balance the budget. This means that when revenue underperforms, such as during a recession, either taxes go up or government spending goes down, or both, at a time when neither is a great option.

The way out of this spiral is fiscal responsibility. As the Center on Budget and Policy Priorities points out, state preparedness means a strong base to provide uninsurance benefits, Medicaid, education, and other key social services, as well as adequate reserves. These two things, the maintenance of a strong and fair tax base and appropriate handling of state reserves are the most fundamental areas where H.B. 259 falls short. The stakes are high in our state, where an aging population means that non-discretionary social spending will likely rise in coming decades, tightening the budget in other places.

While we need fiscal responsibility, H.B. 259 does the opposite. The legislature leaves North Carolinians, not least their constituents, vulnerable to a financial downturn. Should an economic shock hit–either global, national, or regional–North Carolina would either need to sharply raise taxes or garrote essential state services. Furthermore, it is not clear that these services will not suffer even if the economy continues to chug along. Geoff Coltrane, a senior state education advisor, stated, “The scale of these tax cuts would severely limit the state’s ability to fund public education moving into the future.”

But while the legislature would not balk at accusations of cutting taxes, they may at accusations of mishandling the reserves. However, the same national analysis of the importance of strong reserves highlights NC as an example of how to raise reserves the wrong way. NC has historically diverted funds into reserves to justify cutting the very services that the reserves would be needed to support in a crisis. A separate analysis finds that H.B. 259 diverts a huge amount of money to the reserves…only for it to be immediately spent on items that could have been paid for out of appropriations. By funneling money in this way, the legislature sidesteps some of the transparency and accountability requirements associated with General Fund appropriations. However, they do not provide the state with an adequate cushion to soften a hard blow to the economy. A better policy would be to use the surplus to build capacity within essential state services, then strategically funnel some into reserves in case of a crisis or downturn that was not planned for in our 2-year appropriation cycle.

Before we close the discussion of the state tax cuts, we need to talk about who benefits. Supporters of H.B. 259 would point to the general economy, saying that lowering taxes is a boon to all. But the evidence here is not so kind. A 2018 analysis by the Center on Budget and Policy Priorities found that the tax cuts from 2013-2017 did not result in more private sector jobs or larger GDP growth in NC compared to other states in the region without the cuts. So who has unambiguously benefited? The wealthy. By continuing the erasure of the corporate tax, capping the franchise tax, and raising new sales tax lookalikes (ie: the rideshare tax), the legislature has continued to shift the incidence of tax collection towards poorer North Carolinians. The figure below from the NC Budget and Tax Center shows just how little the average North Carolinian has benefitted.

*Chart: NC Budget & Tax Center Source: Institute for Taxation and Economic Policy analysis of impact of tax rate and standard deduction changes passed since 2013.*

H.B. 259 continues North Carolina down the road we have been on since 2013. Our legislature seems determined to make NC the national leader in small and regressive taxes. Where does this road lead? Time will tell (and maybe soon if reports of economic stagnation pan out) if the state will be able to weather the financial storm that sooner or later hits, but the state legislature has set us up for failure. With unstable reserves and annual revenue scheduled to drop year-on-year, but demand for state services increasing as our population grows and employers demand a more educated workforce, we are stuck between a rock and a hard place. When the economic winds shift, H.B. 259 ensures that the legislature will be constitutionally obligated to either raise taxes or slash services. Because raising taxes seems anathema under this legislature, they would likely do the second, potentially leading to massive cuts in state-sponsored education, healthcare, and other social services. As we will see next in this series, these services are already under severe strain, and H.B. 259 has done little to relieve this burden.