NC is prepared for a possible recession

John Hood

Just a few months ago, the housing market was scorching hot. Now average prices are falling, even in states like North Carolina that continue to attract new residents. The Federal Reserve isn’t done raising interest rates to fight inflation. Consumers react to higher prices by cutting spending.

Are we facing a major recession? Most economists polled by The Wall Street Journal last month said yes. I hope they are wrong. But I’m also glad to live in North Carolina, where the Legislature has made it a priority to hedge against worst-case scenarios.

As of September, the state had $5 billion in unreserved balances from the General Fund. The special savings reserve, our “rainy day fund,” contained $3.6 billion. Another $309 million was in two Medicaid reserves. Aside from other state savings accounts, these three categories alone represent nearly $9 billion in readily accessible funds — or about one-third of North Carolina’s General Fund budget for fiscal year 2022-23.

Never in the history of the state have we been so well prepared for fiscal turmoil. Most recessions result in budget deficits because of a combination of factors: lower-than-expected revenues from struggling homes and businesses, and higher-than-expected demand for public assistance programs like Medicaid.

Because North Carolina is required by law to balance its operating budget, previous governments and legislative majorities have responded to recessionary deficits by raising taxes, cutting spending, draining borrowed federal funds, and imposing more fiscal obligations on local governments — which then raise taxes and cut spending must or both.

I’m not a Keynesian. I don’t think government should at any level try to optimize the economy by artificially stimulating demand during recessions or artificially dampening demand during booms. Such measures usually fail to achieve their goals. Political actors inevitably lack the information to make the “right” decisions about all of this, and the impact of policies takes too long to manifest.

In fact, precisely because they are political actors, they rarely stick to the theoretical script anyway. They favor some sectors over others. And they shy away from difficult decisions that might benefit the common good but would anger a vocal political constituency.

That being said, leaders rarely make good decisions in the midst of a crisis. I’m all for austerity in government, but in the past governors and lawmakers have resorted to blanket cuts or gimmicks to fill budget gaps rather than making prudent, long-term decisions about what to fund and what not to fund and why.

On the revenue side of the equation, raising taxes during a recession makes neither economic nor political sense. And grabbing more federal money to cover budget gaps isn’t a solution either. Public debt has become so large that it is fueling inflation and stifling growth. Projected federal spending already exceeds projected federal revenue by many trillions of dollars, primarily due to unfunded liabilities for Social Security, Medicare, and other claims.

The best way to avoid making these catastrophic decisions is to build up savings. When recessions come, lawmakers should still set firm budget priorities and be prepared to scrap programs or positions that are inconsistent. But with $9 billion in savings, North Carolina leaders can do so without cutting core services — and without raising taxes. You can even increase the salaries of public servants to offset inflation or to compensate them for taking on additional responsibilities.

Here’s another underappreciated benefit of rainy day funds: They reduce government corruption! In a recent study published in Public Administration Review, economist Wenchi Wei found a strong negative relationship between the level of a state’s savings reserves and the rate at which officials are convicted on public corruption charges.

The policy “limits officials’ discretion, reduces uncertainty in tax utilization management, and ultimately curbs embezzlement and abuse,” Wei concluded.

Could the precautionary saving of the General Assembly over the past decade prove unnecessary? Yes. But the old maxim still applies: hope for the best, be prepared for the worst.

John Hood is a board member of the John Locke Foundation. His most recent books, Mountain Folk and Forest Folk, combine epic fantasy with early American history.

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