The state budget hole is deep and getting deeper as the economy tanks. Message to policymakers from the progressive N.C. Budget & Tax Center: When cutting, spread the pain. Don’t just load it on low-income and working-class folks who struggled even when the economy was growing. And do take a hard look at all the loopholes in the state’s tax code.

“Generally, what we need is some comprehensive tax reform to broaden all the tax bases,” Elaine Mejia, the center’s director, told listeners at the budget briefing Nov. 14 in Durham, “and reduce tax rates.”

Mejia made headlines last week when she forecast, at an earlier briefing in Wilmington, that the hole in the 2009-10 state budget could exceed $3 billion, or more than 15 percent of annual state spending. That would come on top of the developing shortfall in the current, 2008-09 budget, which state number crunchers caution may reach $1.6 billion by June 30, the end of the fiscal year.

What didn’t get much ink was Mejia’s recommendation that tax hikes be used alongside spending cuts to balance this year’s budget and next year’s. She pointed to the state Department of Revenue’s little-noticed reports on “tax expenditures”the special credits, exceptions and exclusions from ordinary taxes that shrink the state’s tax baseas a place to look for the former. Last year, the department listed 290 loopholes totaling $4.9 billion in lost revenue, annually.

Not all of the 290 were enacted to protect fat cats. The biggest item on the list exempts food from the sales tax at a cost of about $450 million a yeara loophole that curbs the regressive impact of the sales tax on low-income people.

But many have the opposite effect, shielding the well-off and profitable corporations from paying their fair share, to say nothing of paying at progressive rates. Measures such as excluding annuity payments from the personal income tax ($106 million) and excluding Social Security payments to high earners ($280 million if federal limits were applied) add up to significant revenue losses, as do loopholes for selected businessesno sales tax on “packaging items” for manufacturers and retailers ($62 million), for example, or for “telephone equipment” ($31 million).

The Budget & Tax Center, an arm of the nonprofit N.C. Justice Center, is also recommending that the General Assembly increase some motor vehicle-related taxes.

One is the sales tax on vehicles, now just 3 percent instead of the standard 6.75 percent. Increasing it to 4 percent would raise $170 million a year, the center said in a policy study. Eliminating the deduction for trade-ins would collect another $100 million.

Second, the center proposed increasing vehicle registration fees and basing them on weight, since heavier cars do more damage to road surfaces. Adding $10 to vehicles weighing less than 3,000 lbs. and $20-$25 to vehicles that weigh more would raise $150 million a year, the study said.

Justice Center leaders have previously pushed the idea of expanding the sales tax to cover serviceseverything from lawyers and accountants to plumbers and landscaperson grounds of practicality and fairness. Practically speaking, they argued, spending on services is increasing as a share of income while product purchases decline. Depending on what’s included, taxing services could add hundreds of millions of dollars to state coffers.

As for fairness, they say, rich folks pay somebody to mow their grass; others buy a lawnmower.

Absent tax moves, Mejia and her colleague, Justice Center senior policy advocate Louisa Warren, worry that the brunt of state budget cuts will fall on social services and the needy. Programs that subsidize childcare and children’s health insurance for the working poor, for example, are woefully underfunded now, they said, as are dropout-prevention efforts in the schools.

What’s particularly cruel, they added, is that the poverty rate in North Carolina actually increased between 2001 and 2007when the economy supposedly was expanding. In that period, median household income in the state fell about $1,200 a year after adjusting for inflation (to $43,513 in ’07), and the percentage of North Carolinians without health insurance increased to 17.2 percent in ’07, up from 15.1 percent in just two years.

The reason, Mejia said, is that following the 2000 recession, North Carolina experienced an essentially jobless recovery. Where the number of new jobs in the ’90s grew faster here (2.8 percent a year) than the workforce was growing, from 2001 on the opposite was truejob expansion averaged just 0.8 percent a year, below growth in the workforce.

Bottom line: “There was no trickle-down” from Bush economic policies, Mejia said, and with more workers seeking the same number of jobs, pay and benefits fell.

North Carolina isn’t alone in facing huge budget shortfalls. According to the Center on Budget and Policy Priorities in Washington, 40 other states are in the same boat, and in fact North Carolina’s in better shape than most of them.

Still, the state’s revenues were $250 million below projections in the first quarter of the current fiscal year, and with the economy worsening, it’s likely they’ll run more than $1 billion below for the full year, Mejia said.

Gov. Mike Easley (and Governor-elect Bev Perdue, when she takes office in January) can tap the state’s $800 million rainy-day fund, and Easley has called on state agencies to cut spending by 5 percent. That should allow them to get through June in the blackas the state constitution requiresbut at that point, Mejia said, the state “will be broke.”

She estimates that, starting the 2009-10 fiscal year, Perdue and the General Assembly could be looking at a $3.3 billion budget gap, the result of recession-starved revenues that fail to rebound, plus inflation in the cost of delivering programs at current levelssome $900 million more in a $20.8 billion budget.

An additional problem: Health care spending for state employees is already estimated to be $250 million over budget in this fiscal year, and will cost some $500 million more to sustain in the next budget unless benefits are curtailed, Mejia said. A 2 percent pay increase for state employees and teachers next year would cost $260 million.

A wildcard in the budget equation is what form a federal stimulus package might take. The Obama team has signaled that it wants a major boost in aid to the states for infrastructure programs (road-building, for example), renewable-energy initiatives and college aid.

Whatever the federal government sends North Carolina’s way, Warren urged state policymakers to expand five programs for the working poor:

  • The state’s Earned Income Tax Credit, now 3.5 percent of the federal credit, is a wage subsidy for low-income workers. It’s scheduled to increase to 5 percent in 2009-10, at a cost of $20 million.
  • Childcare vouchers for the working poor. Some 30,000 eligible children are on the waiting list, Warren said. This year the state created 1,100 new slots at a cost of $4.9 million.
  • The NC Kids Care health insurance program, which the General Assembly voted to expand next year to cover children of working families making between 200 and 300 percent of the federal poverty-income levelwhich is $17,160 for a family of three. Parents would contribute on a sliding scale. State costs are about $20 million, less if Congress adds funding.
  • Community college enrollments. They’re jumping as the unemployed seek training, but funding is on a rolling two-year average and lags the need, Warren said.
  • The state’s Housing Trust Fund, now $10 million a year. Advocates want $50 million for mortgage assistance, urgent repairs and new construction of low-income and supported housing for the mentally ill.

All five, Warren said, would help stimulate local economies. “They’d put the money into the hands of people who would be spending it immediately on groceries and other necessities,” she remarked. “They’re not going to be spending it on digital flat-screen TVs.”