The State Budget: Where the money goes, and how to cut spending

As state governments across the country grapple with the economic shutdown and sharp reductions in revenue, North Carolina is better positioned than most states to weather the fiscal storm.

Thanks to a decade of prudent spending restraint combined with a sensible, long-term approach to spending, state government has built up a significant rainy-day fund and additional savings to help bridge the coming budget gap.

The comparison between today’s fiscal preparedness and that of the state a decade ago is striking.

In 2010, the state budget was out of control, having ballooned by 40 percent over the previous eight years (not adjusted for inflation). In contrast, the FY 2019-20 budget was scheduled to mark just a 16 percent growth rate in eight years.

Also in 2010, state debt was exploding, growing by 230 percent between 2001 to 2013. Since then, conservative legislators have steadily reduced state debt. Over the period 2013-2019, state debt declined from $6.5 billion to $4.2 billion, a reduction of 35 percent.

Finally, budget surpluses – not budget deficits – have become the norm. Responsible budgeting decisions led to five consecutive state budget surpluses, each totaling in the hundreds of millions of dollars. The state budget was on pace for a sixth straight surplus when Gov. Cooper ordered the shuttering of all “non-essential” businesses earlier this year in response to Coronavirus.

Remarkable progress has been made, but North Carolina remains just one election away from returning to the unsustainable and irresponsible spending growth of decades past.

Of course, the natural question that follows calls for spending restraint is: How? What should be cut?

Where the money goes

To begin to evaluate how to limit or reduce state budget spending, one needs to examine where the money goes.

Below is a chart breaking down state General Fund expenditures by state department from the FY 2018-19 budget (the last year the Legislature passed and governor approved a state budget):

The biggest slice of the pie is the 58 percent (roughly $13.8 billion) spent on education. The education category includes K-12, community colleges and the UNC System. Of total state education spending, $9.5 billion is on K-12, $1.2 billion goes to community colleges, and $3 billion to the UNC system.

Health and Human Services comes in second with $5.3 billion in spending, good for 22 percent of the General Fund appropriations. The majority of HHS spending is on the state’s Medicaid program ($3.8 billion).

(Keep in mind, this is the state’s General Fund expenditures. The federal government supplements several of these programs to the tune of tens of billions of dollars, and state highway/transportation spending are handled seperately.)

This chart is what is typically discussed and analyzed by researchers, the media and legislators.

But I would argue it paints an incomplete picture.

Where the money really goes

The chart below reveals where the majority of state tax money really goes: paying people.

Any serious discussion about curbing or cutting state spending must look at the cost of state salaries, benefits, retirees and Medicaid reimbursements. Combined, the cost of state employees, retirees and Medicaid payments make up roughly 83 cents of every General Fund dollar spent.

More specifically, roughly $12.5 billion in General Fund spending is for state employee salaries, another $1.5 billion for the state health plan for active employees, another $2 billion for retiree benefits (pension and health care) and $3.8 billion in Medicaid reimbursements.[i]

Backing out Medicaid reimbursements still reveals that a full two-thirds of the state budget is devoted to paying active and retired state employee salary and benefits.

Several years ago I did an in-depth analysis of most of these budget expenses and offered recommendations for reform. While the figures may be dated (for example, the unfunded liabilities are much larger now), the need for reform is as urgent as ever and the recommendations are just as relevant.

Pension reforms

With a pension liability exceeding $10 billion and growing fast, the annual cost to taxpayers of state retiree pension benefits is nearly $1.3 billion.

The best solution would be to transition state employees from the current defined-benefit plan to a 401K-style defined contribution plan. This would empower state employees with ownership of their own retirement accounts while shifting the financial liability for the benefits off the backs of taxpayers.

Financing for the 401K funds could come from a combination of employee contributions and taxpayer funds. The state could provide, say, a contribution rate of 5 percent of employee salary and save millions compared to the required contributions now.

For state employees on a 401(k)-retirement plan, there is no unfunded liability. Over the long-term, cost savings to taxpayers from this transition will be substantial. For instance, a research paper[ii] suggests that the state of Michigan’s measure to enroll state employees hired after March 1997 into a 401(k) plan spared the state from $3.3 billion in unfunded liabilities in the first four years alone.

State Health Plan for employees and retirees

The expense to taxpayers to cover the costs of state health insurance plan premiums for active state employees is roughly $1.5 billion and growing.

Moreover, according to the 2019 Comprehensive Annual Financial Report, the unfunded liability for retiree health benefits now stands at $31.6 billion. That’s up relatively modestly from $27.8 billion at the end of 2008.

Unfunded liability represents the present value of the amount of estimated premium subsidies for retirees’ health insurance the state will be responsible for over the next 30 years. What this means, in short, is that as more and more state employees retire and live longer, it will be increasingly difficult for state taxpayers to cover the costs of rapidly escalating premiums.

These retirement benefits are paid for on a pay-as-you go basis, so every year taxpayers are paying the health care premiums for more than 200,000 retirees.

Taxpayers paid $775 million for these benefits last year alone. Just like pension benefit payments, every tax dollar devoted to retiree health coverage means one less dollar to pay active employees or programs.

A provision included in the 2017 state budget, however, will eliminate this problem in the long term. State workers hired after Jan. 1, 2021 will no longer be eligible for the subsidized state health insurance when they retire.

But that still leaves the next 30-60 years of retiree health obligations to contend with. And given the sheer magnitude of the liability, legislators need to act now to rein in these obligations.

To rein in these costs, a new policy could require state employees and retirees to contribute more to monthly premiums, perhaps $100 per month for the 80/20 plan, and $50 for enrollment in the 70/30 plan.

Roughly 70 percent of other states require retirees to contribute a significant share towards their health insurance premiums, and 14 states contribute nothing for retiree enrollment into their state health plan. Most state and local governments across the southeast require employees contribute a larger share of the premium than does North Carolina.

Another cost-saving reform would be to introduce a Health Savings Account (HSA) option for state employees. Such a plan allows employees to pay much lower premiums while setting aside tax- free money in the savings account for use for out-of-pocket healthcare expenses. The introduction of HSA plans for state workers has worked to save taxpayer dollars in states like Indiana, which began offering the plans in 2006 and by 2010, experienced an 11 percent drop in total health coverage costs.

Medicaid reform 

Regarding Medicaid, the first rule is to continue to block Medicaid expansion. We’ve gone into great detail on why expansion would be bad for North Carolina’s budget and even worse for the state’s neediest population who would be at risk of being crowded- out from access to care. There’s no need to rehash the arguments here.

Moreover, North Carolina has already paved the way with legislation passed in 2015 to reform the existing Medicaid program, by transitioning it from a fee-for-service program to a managed care arrangement. Unfortunately, the transformation, which was originally slated to be complete by Feb. 1, 2020, has gotten off track. The legislature needs to make this a priority again, as transformation will make Medicaid expenditures far more predictable and also produce savings – in the first  years alone   estimated in the hundreds of millions of dollars.

Salaries – transition to more contractors

As noted above, employee salary is the largest component of the state General Fund budget. More than $12.5 billion is now spent annually on active state employee salaries, 52 percent of total General Fund spending.

To reduce this massive annual cost, there are several simple – but not necessarily easy – steps to take:

* Eliminate ‘lapsed’ positions. At any given time, the number of unfilled state government positions can number in the thousands. The salary for these positions that were budgeted for but not paid out are called “lapsed salary.” The state can closely monitor these unfilled positions, and any that go unfilled for 12 months or more without any disruption to the agency’s mission should be eliminated. This would be a way to regularly trim non-essential worker positions.
* Slow or reverse growth of state government. Between 1989 and 2019, the North Carolina state General Fund budget grew by a whopping 265 percent. At the same time, the state’s population grew by 62 percent, less than one-fourth the rate of the state budget. Inflation-adjusted per capita spending grew by 27 percent; which means in real dollar terms, on a per person basis, the state budget grew by a fourth since 1989. This needs to stop. Reducing the size of state government also means reducing the state workforce, which will naturally lead to a reduction in state salary obligations.
Transition to more contract workers Thanks to the deep-pocketed lobbying groups for state employees, salaries for government workers often become a politicized issue. Transitioning to more contract workers can depoliticize a larger share of the work performed to carry out state agency missions. This will serve to reduce public pressure on politicians to increase salaries and benefits, while also allowing state government to solicit competing offers from firms willing to perform the needed work at more competitive rates, saving taxpayer dollars. Utilizing contract workers also eliminates the long-term retiree obligations taxpayers are on the hook for, as state agencies could just pay an annual flat fee for work performed by the contracting companies without having to hire the workers and take on expensive long-term retiree commitments.

 Don’t forget the pork and corporate welfare

While addressing the above spending reforms are needed to generate any meaningful budget cuts and limits, further reductions can be found by rooting out pork and corporate welfare spending.

The pork and corporate welfare may be smaller in dollar amounts than salaries, benefits and retirement obligations, but that doesn’t mean we should ignore the low-hanging fruit. Every dollar state government spends is a dollar taken from hard-working North Carolina taxpayers.

For starters, state legislators can eliminate corporate welfare spending that directs taxpayer dollars to specific, politically favored corporations. Civitas has been advocating to replace North Carolina’s current web of crony handout programs with the elimination of the state corporate income tax. Doing so would create a fairer business environment and encourage more sustainable economic growth and job opportunities.

In the FY 2019-20 state budget vetoed by Gov. Roy Cooper, the state’s largest corporate giveaway program, the Job Development Investment Grant (JDIG) fund, was slated to receive $67 million in taxpayer dollars. Another giveaway program, the One NC fund was scheduled to receive $6.5 million. Meanwhile, the film industry grant program has more than $23 million in taxpayer funds. The NC Biotech Center, High Point Furniture Market and more than a dozen non-state local ‘economic development’ groups combine to receive just over $20 million in taxpayer dollars. Cutting these programs would generate savings and help to offset lost revenue from the elimination of the corporate tax.

And there is still plenty of pork spending to be trimmed as well. While not an exhaustive list, following are several budget items included in the 2019-20 budget bill that should be defunded. Many of these items are “niceties,” not necessities. In other words, nice things to have, but not necessary and certainly outside the core functions of government. Other items are line items for local projects that should be funded locally, if at all. The total comes to more than $123 million:

$10.2 million on state historic sites
$2.8 million on Tryon Palace
$9.4 million on the Museum of Art
$9.9 million on the Arts Council
$16.3 million on statewide library programs and grants for local libraries
$16 million on the Museum of Natural Science
$7.2 million on the Museum of History
$11.5 million on the state zoo
$7.7 million on state aquariums
$6.7 million on 12 different local fairgrounds, festivals and farmer’s markets
$2.6 million on welcome centers
$8.1 million on 60 various local town or city projects, like ‘revitalization’ projects, buildings or sewer systems
$1.2 million on 16 local “historic” parks & buildings
$2.3 million on the NC Symphony
$1 million to local children’s museums and attractions
$1.75 million on funding 27 various local parks
$8.8 million on 20 line-items for local buildings, rec centers and charities

 Conclusion

Most citizens agree that they’d like lower taxes and smaller government. But when it comes to specific ways to cut the budget, there is little will to identify specific functions or agencies that should be reduced or cut.

A review of how state government money is actually spent, however, lends guidance as to how meaningful budget reform can be accomplished. The overwhelming majority of state taxpayer dollars go to pay workers as well as retirees. So, it comes as no surprise that state budget writers must address state worker salaries and retiree benefits, while seeking ways to control costs by transitioning more state work to private contractors.

Pork spending makes headlines and should not be ignored. But it needs to be remembered that the low-hanging fruit is just a beginning. The heavy lifting of real budget reductions must confront personnel costs.

[i] Payroll and benefit for employees and retiree’s data obtained in Email correspondence from Office of State Budget & Management, other data from Joint Conference Committee on Base and Expansion Budget for Senate Bill 99, North Carolina General Assembly. Available online at: https://www.ncleg.gov/Sessions/2017/Budget/2018/conference_committee_report_2018_05_28.pdf

[ii] Dreyfuss, Richard C. “Estimated Savings From Michigan’s 1997 State Employees Pension Plan Reform.” Mackinac Center for Public Policy, Policy Brief, June 23. 2011. Available online at: http://www.mackinac.org/15284