SEEING RED.

• Author: Heatherly, Charles
• Position: North Carolina's economic situation

Special interests -- from Jim Hunt's pet projects to tax loopholes for business -- created the state budget crisis.

Heatherly retired in March after four years as a deputy state treasurer. Before that, he spent 10 years as a public-relations consultant whose clients included State Treasurer Harlan Boyles, Superintendent of Public Instruction Bob Etheridge and Agriculture Commissioner Jim Graham. He started working for the state in 1969 as a publications editor in the Commerce Department's Division of Travel & Tourism and was the division's director from 1981 to 1986.

The first Saturday in January, a new governor took office and proclaimed a new day for North Carolina. That was Mike Easley's theme as he became the state's first chief executive born after World War II. Before the sun set that unseasonably warm day, the new governor discovered that those who had gone before him had spent all the state's money.

North Carolina is facing a shortfall that, by some estimates, could reach nearly $1 billion by June 30, when -- by law -- the budget must be balanced. The seeds of this fiasco were sown nearly a decade ago. In 1992, Democrat Jim Hunt, who had served two terms as governor from 1977 to 1985, won a third term. He made expensive promises to two important constituencies: He promised poor people he would create state-funded day care and promised teachers he would raise their salaries to the national average by the end of the century. Those two promises would cost more than $1 billion a year in recurring expenditures. Phasing them in lessened the sticker shock, and the governor hoped economic growth would provide the money, which it did for a while.

In 1994, North Carolina experienced a political earthquake that threatened to topple Hunt's plan. Republicans won control of the state House for the first time in the 20th century. They weren't fans of Hunt's pet programs. Nor were they eager to do anything that would bolster his chances for re-election in 1996. So, each side made a pact with the devil. Or, as politicians do, they compromised: The Republicans got their tax cuts; the Democrats, spending for their new programs.

In 1995, the legislature increased the exemption on personal-income taxes, created a child credit and killed the intangibles tax. In 1996, it began a three-year phaseout of the sales tax on food. It also cut the corporate-income tax rate, which had been raised to close a $1 billion-plus budget gap in 1991. In 1998, the inheritance tax was repealed, and the Bailey court case did away with the income tax on state and federal pensions. By the 2000-01 budget year, tax cuts and other reductions totaled more than $1.4 billion a year (see chart on page 24).

Things didn't look so bad back in 1998. While the tax cuts had been passed, they all hadn't kicked in yet. State revenue was up nearly $1 billion, largely from an unexpected surge in taxable capital gains from the "irrationally exuberant" stock market. Intoxicated by their good fortune, state leaders believed what the Wall Street whiz kids were saying -- that this era of prosperity would last forever. State Treasurer Harlan Boyles, a child of the Great Depression, kept telling his colleagues that it wouldn't and that they should prepare for a rainy day.

While cutting taxes $1.4 billion, the General Assembly increased spending by $1 billion and authorized a bond referendum to borrow another $1 billion for grants to local government for water and sewer projects. Voters, assured that the new debt wouldn't require additional taxes and...