July 11, 2013

Hard Choices, and Some Smart Moves

Eileen Norcross

Senior Research Fellow
Summary

North Carolina lawmakers cut unemployment benefits by one-third. This disqualifies the state from receiving $700 million in federal funds for the long-term unemployed, affecting 170,000 jobless North Carolinians.

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The New York Times Room for Debate posted the question, "Can one state’s budget be a model for another?"

North Carolina’s Republican governor and Legislature are pushing a series of controversial steps, including reducing unemployment benefits, cutting income taxes for high earners and raising sales taxes. It is the kind of sweeping change that conservatives have championed nationwide.

Is North Carolina taking a responsible approach to its budget? Does another state offer a better model for fiscal management?

Eileen Norcross provided the following response:

It depends on the policy and economic realities facing individual governments.

North Carolina’s proposed $20 billion biennial budget proposes a few good measures for fiscal stability. First, it would double the state’s “rainy day” fund — which helps states maintain budgetary balance in downturns — to $813 million. It would also put an end to the estate tax, a beneficial step for small businesses and families. Finally, the commitment to ending budget gimmicks and new debt issuance is promising.

But there is controversy surrounding the proposed budget. This week, North Carolina lawmakers cut unemployment benefits by one-third. This disqualifies the state from receiving $700 million in federal funds for the long-term unemployed, affecting 170,000 jobless North Carolinians.

Although critics on the left are quick to fault the Republican lawmakers and governor behind this decision, the most important issue it highlights is not partisan: the continuing structural problems with the federal-state unemployment insurance program. Many state unemployment insurance trust funds — financed through payroll taxes — are depleted. The trust funds can be replenished by increasing the payroll tax, by expanding the taxable wage base or by cutting benefits. These are not good choices for a state like North Carolina, with an unemployment rate of 8.8 percent. Payroll tax increases are passed on to the work force in the form of less hiring or reduced wages.

Since 2008, the federal government has granted benefit extensions through the EUC program. States must pay back what they have previously borrowed from the federal government with interest, or face increases in payroll taxes. North Carolina owes $2.5 billion. With two bad options – higher payroll taxes or lower unemployment benefits – lawmakers decided to avoid going further into debt by ending the extended benefits. The only permanent fix is an overhaul to the current approach to social insurance.

North Carolina’s pension system is considered one of the best funded in the country, but lawmakers shouldn’t get too comfortable. By the state’s math, the pension system is facing a shortfall of $3.72 billion – seemingly manageable, compared with many other states. However, independent economists estimate the funding gap is several times that.

The longer this disconnect continues, the greater the risk of acute gaps in pension funding down the road – a dangerous prospect for employees and taxpayers.