The Outlook for the Indiana State Budget

Updated February 2011

Contents
Introduction
A Checking Account Statement
Fiscal Year 2010
Fiscal Year 2011
Balances
The Outlook for the Budget in the New Biennium

Introduction
Indiana’s General Assembly passed a budget in the evening of June 30, 2009. It took a special session, and the pressure of an end-of-fiscal-year deadline that had not been missed for more than a century, for legislators to agree on a spending plan for 2010 and 2011. The problem was revenues.

Indiana's state budget experienced some of its worst years ever in fiscal years 2009, 2010 and 2011 (fiscal years run from July to June). The economy plunged into recession. Revenues fell short of appropriations by almost $5 billion. Appropriations were flat-lined, then spending was cut below those levels. Balances were reduced to the bare minimum.

In the 2011 long session the Indiana General Assembly will write a budget for fiscal years 2012 and 2013. Revenues are predicted to grow at normal rates in these two years. But more-than-normal growth would be needed for the state to deliver services at pre-recession levels. The legislature may be faced with the difficult task of down-sizing Indiana's state government.

A Checking Account Statement
Here are eleven years of past Indiana revenues, spending and balances, and projections for 2011, arranged to look like a checking account statement. It's useful for understanding what's happened to Indiana's finances since 2000.

The state budget agency provides plenty of information about the budget’s appropriations, revenues and balances. Unfortunately, it’s all in separate documents, which can make the big picture difficult to understand. The table below draws this information together in checking account form.

Like any household, the state starts the year with balances, which is money in the bank. The state had $1.4 billion at the start of fiscal 2010. The state received income from taxes and other revenue sources, but not nearly as much as was expected. It writes checks to pay for public services, based on appropriations planned in the budget. Indiana's rich but indebted uncle slips it some cash to help out, in the form of American Recovery and Reinvestment Act funds--the Federal stimulus money. Some money was shifted around with fund transfers, and some previously planned spending was cancelled with reversions. And at the end of the year, there was some money left over, in balances in the bank.

The table shows eleven years of actual results, from fiscal year 2000 to fiscal year 2010. Fiscal year 2010 ended on June 30, 2010. The 2011 fiscal year figures are based on the December 2010 revenue projections, on the budget passed on June 30, 2009, and on a January reserve balance statement.

Fiscal Year 2010
Revenues. Revenues were the problem for the 2010-11 budget. The checking account table shows total revenues down $735 million from 2009 to 2010. This was the second straight year-to-year drop.

The reason, of course, was the recession which began in December 2007, and intensified in the Fall of 2008. This revenue drop understates the recession’s effect on the budget. Sales tax revenues increased $467 million because of the hike in the sales tax rate from 6% to 7% in April 2008. The higher rate was used during the last three months of fiscal 2008, but for all of fiscal 2009. Without this rate increase, sales tax revenue would have fallen by nearly $200 million, and the revenue reduction in 2009 would have been much larger.

More important for budgeting is the shortfall of actual revenues below projected revenues. In fiscal years 2009, 2010 and 2011, revenues fell about $3 billion short of projections. Budgets were made based on revenue projections, so when revenues fell short the state had to find other revenues, use up balances, or cut spending.

Appropriations. The General Assembly enacted a very conservative budget for the 2010-11 biennium, as a result of falling revenues. Appropriations in 2010 were less than in 2009. Such a reduction had not happened in the previous ten years (and for many years before that). Appropriations in 2011 were only slightly larger than in 2009, meaning that appropriations were effectively flat-lined for the biennium. Again, this was unusual.

Total appropriations were unchanged. The composition of these appropriations changed significantly, however, due to the 2008 property tax reform. In calendar 2009 the state took over the school corporation general funds, county welfare funds, and several smaller local government funds. These had been paid for with property taxes; now they are financed out of the state budget.

State appropriations for K-12 education increased more than $2.6 billion as a result of this tax policy change. This does not mean that local school corporations were awash in new money. Each dollar of added state aid replaced a lost dollar of property tax revenue for the schools. Likewise, health and social services spending rose $400 million because of the takeover of county welfare funding. The changes were effective in calendar year 2009, so they show up in fiscal year 2009 (which includes the first half of calendar 2009) and fiscal year 2010 (which includes the second half).

These spending increases were partially offset by the near-elimination of state property tax relief appropriations. By 2012 property tax relief will be zero. At its peak, property tax relief was the second largest item in the state's budget, at $2.3 billion. This is also the result of the 2008 tax reform. The old methods of providing tax relief—called property tax replacement credits and homestead credits—were phased out. These were credits that reduced the tax bills of property taxpayers. The state compensated local governments for this lost revenue with payments from its budget. Now, tax relief will be provided by eliminating school operating costs and local welfare costs from the property tax. The credits will disappear, and the property tax relief money will help pay for the added state spending on schools and welfare. The sales tax increase also funds these new expenditures.

ARRA: Federal Stimulus Money. ARRA is the American Recovery and Reinvestment Act, the Federal stimulus money passed by Congress in February 2009, and augmented in mid-2010. Two features within the stimulus program were meant to shore up state budgets.

Medicaid is a joint Federal-state program that provides health care for low income people. Each state is expected to finance a fraction of the cost, and the Federal government picks up the rest. In 2009, 2010 and 2011 the Federal government increased its share of Medicaid costs. This reduced the state’s spending on Medicaid. Since Medicaid is an entitlement program, this added Federal money did not increase Medicaid spending. Instead, it freed up for other purposes funds that Indiana would have used for Medicaid.

The stimulus bill also included fiscal stabilization funds. In 2009 Indiana used this money to make state aid payments to local school corporations, which were owed under the school funding formula. This reduced the state’s spending on K-12 education. Indiana used a total of $992 million in Federal stimulus money in its budget in 2009. In 2010 and 2011 fiscal stabilization money funded the remaining homestead property tax credits. The amount totaled $683 million in 2010.

The ARRA money could have been counted under reversions, which are appropriations that are budgeted but not spent, and so revert to the general fund budget. That would have made “adjustments” bigger. That’s how the state budget agency counted ARRA money for fiscal 2009 (but not for 2010 and 2011).

Adjustments. When budgets are stressed the state often resorts to extraordinary adjustments. Fund transfers are one such adjustment. In fiscal 2010, $165 million was transferred to the General Fund from other funds.

Reversions were by far the biggest adjustment, at $630 million. These were the Governor's spending cuts. State agencies, universities and school corporations spent less than their original appropriations. When this happens the money reverts to the General Fund.

Payment delays are adjustments that were used in the past two recessions, but the Governor has pledged not to use this "fiscal gimmick." These are delays in payments from the state to local governments, from one fiscal year to the next. This works because the state is on a July to June fiscal year, while local governments are on a calendar fiscal year. If the state delays a property tax relief payment from June to July, the locals get their money during their budget year (just a little late), but the state reduces its recorded spending in the earlier year. This helps maintain balances while reducing the need for spending cuts or tax increases.

Payment delays are an accounting trick, a “fiscal gimmick”, but they have been useful in the past. Delays were used after the 1990-91 recession and after the 2001 recession. In each case they were reversed during the expansions that followed the recessions. Reversals add to a budget’s spending. The last payment reversal from the 2001 recession was made in 2009—that’s the negative $31 million shown in the table.

End-of-Year Balances. Start-of-year balances, plus revenues, less appropriations, plus ARRA money, plus adjustments, equal end-of-year balances. The state ended the fiscal year with $831 million in balances in fiscal 2010, almost $600 million less than the $1.4 billion it had at the year's start. Using balances is one way to maintain spending when revenues fall short of projections. Total balances are composed of several sub-categories, but all but general fund balances had been zeroed out by the end of 2010.

In 2009, more than $500 million was shifted from the general fund balance to the education balance. This was done as a result of the 2008 tax reform. School corporations are now almost totally dependent on state aid to finance their general funds, which are mostly teacher pay and benefits. It is sensible to build a fund to support these aid payments in the event of revenue shortfalls. Unfortunately, the new school funding policy started in the very year that the enormous revenue shortfalls began. In 2010 the education fund balance was used to shore up the general fund, and to support K-12 education spending.

The famous Rainy Day Fund was also transferred and used 2010. These are balances that are accumulated in good times, to be used when revenues fall short. It's saving for a rainy day, and 2009-11 saw a downpour. Balances also include a small reserve to cover potential shortfalls in revenue for Medicaid entitlement payments. Those balances were used too

Appropriations less Reversions. Budget cuts got big in 2009-2011, so much so that appropriations no longer provide a very good measure of what Indiana's state government spends. The last rows in the table show appropriations less reversions, which approximate total spending. The big increase in 2009 is the result of the 2008 property tax reform. The declines in 2010 and 2011 show the effect of the recession.

Fiscal Year 2011

Revenues are expected to begin a recovery in fiscal 2011. The forecast increase is over $700 million, or 5.9%. In fact, through the first half of the fiscal year revenue growth is exceeding this projection, rising by 8.6% in July 2010-January 2011, compared to the same months in 2009-10. The current year deficit is still very large, however, at $1.4 billion. This is because 2011 revenue is still well below what was projected when the budget was written in June 2009. Revenues are ahead of the very diminished revised forecast; they are behind what is needed to fully fund budget appropriations.

The 2011 current year deficit is about $650 million smaller than the 2010 deficit, however. This is partly because of revenue growth, but also because of nearly flat-lined appropriations. The $67 million growth in appropriations is very small compared to past years.

How will this $1.4 billion shortfall be covered? About $600 million in balances were used in 2010, so only about $150 million is available in 2011. This will bring end-of-year balances down to $678 million, near the 5% effective minimum (see below). They really cannot go lower.

The state will receive $501 million in remaining Federal ARRA stimulus aid, mostly to meet Medicaid entitlement payments. The extra Federal Medicaid payments had been scheduled to run out at the end of December, 2010. This part of ARRA aid was extended to the end of June, 2011, in a bill passed by Congress in mid-2010.

There are $747 million in budget cuts in the 2011 budget. These are "reversions," meaning that spending is less than budget appropriations.

Add it up. The $1.4 billion shortfall is smaller than the year before because of new revenue growth and appropriations restraint. The shortfall will be covered with about $150 million in balances, about $500 million in Federal aid, and about $750 million in budget cuts. After these cuts, total spending will be smaller in 2011 than it was in 2010 and 2009.

Balances
The state keeps balances to help it pay its bills on time, and to guard against unexpected revenue shortfalls. Payments go out on one schedule, revenues come in on another. The state needs money in its checking account to cover bills in months when revenues merely trickle in. The rule of thumb is that a state needs a minimum of 5% of its budget in balances for this "cash flow" reason.

Balances also help when recessions hit. The state can maintain services and avoid tax hikes by drawing on balances. Having almost $2 billion in the bank at the start of the 2001 recession meant that spending cuts and tax hikes were delayed, and were smaller when they did occur. Having $1.4 billion in the bank in the midst of the 2007-09 recession helped support spending and fend off tax increases as well. The State Budget Agency would like to see balances at ten to twelve percent of the budget to cover potential revenue shortfalls. They define this as the "prudent range." The graph below shows the history of Indiana state balances as a share of operating revenues, a measure of the size of the budget.

The state's balance is like a balance in a checking account.  If you spend more than you deposit, your balance shrinks. That's what happens during recessions, when revenues fall short of appropriations. There are four recessions shown in this chart, 1979-82, 1990-91, 2001 and 2007-09. In each case balances fell as a share of the budget. Indiana adheres to the 5% rule-of-thumb minimum. Three times during this period balances approached this minimum, and only in 2004--slightly--did balances dip below this level.

If you deposit more than you spend, your balance grows.  That’s what happened during the second half of the 2000's in Indiana.  Spending was restrained, and for four years revenues came in above predictions.  The state took in more than it spent.  State balances recovered, and topped 10% of the budget by the end of fiscal 2007.

Indiana's balances have rarely been within the prudent range during the past 35 years. During most expansions balances grew well above this range; after recessions, balances dropped below it. Balances in the recent 2001-2007 expansion stand out because they did not rise above the prudent range. One reason was that the 2000's expansion was shorter than the 1980's and 1990's expansions, so there was less time to accumulate balances. Another reason was the severe effect that the 2001 recession had on state balances. It took a long time to recover from those revenue shortfalls. Still, this means that Indiana's budget was in a less healthy position coming into this recession, than it was entering the past three recessions (1980-82, 1990-91 and 2001).

The Outlook for the Budget in the New Biennium
The December 2010 revenue forecast revised expected revenues for fiscal 2011, and provided a first look at revenues for fiscal 2012 and 2013.  Revenues are expected to grow strongly in 2011, at 6.3% over 2010.  Growth then is expected to drop to typical levels from past expansion years, 3.5% in 2012 and 4.1% in 2013.  Despite this growth, the 2012-13 biennium budget is likely to be at least as tight as in 2010-11.

The revenue shortfall in the 2010-11 biennium was severe.  The state balanced its budget with limited appropriations growth, spending cuts, Federal stimulus aid, and by using available balances.  In 2012-13 revenues will grow.  But Federal stimulus aid will disappear, and available balances have been used up.  Appropriations again will be limited.

The table below shows the 2010 and 2011 columns from the summary table.  These budgets were passed in 2009.  It also shows the revenue forecasts for 2012 and 2013 from the December 2010 forecast, the appropriations from the Governor’s proposed budget from January 2011, and the balances from the Budget Agency’s statement that accompanied the budget proposal.

Revenues are forecast to grow 3.7% on average over the next two fiscal years.  This is similar to the average annual growth during the last expansion.  In a sense, though, it’s a conservative forecast.  If revenues are to grow out of the recession, and return to their former path, they would have to accelerate for a time, that is, grow faster than during normal expansion years.  This appears to be happening in fiscal 2011.  Revenues are up 8.6% through the first seven months of the 2011 fiscal year.  The state’s revenue forecasters do not expect this acceleration to continue.  (This is hardly surprising.  Revenues have fallen far below forecasts in recent years, so revenue forecasters might well be cautious, if not pessimistic.) 

If this moderate growth projection is accurate, it means that revenue will never return to its former growth path.  Suppose, for example, that revenue had grown 3.7% per year from 2008, the last year before revenue started falling.  This is the forecast growth rate from 2011 to 2013.  Revenue for 2008 is adjusted upward to approximate a full year with a 7% sales tax rate.  At 3.7% growth, revenues would have been $16.7 billion by 2013, about $2.7 billion higher than the forecast for 2013.  Revenues would have to accelerate over the next several years to close this gap.

This is a measure of the structural deficit.  At current tax rates, revenues are too small to support the state services that have been provided in the past.  The task of the 2011 General Assembly is to down-size the state government to match the smaller tax revenues.

The Governor established several goals for the 2012-13 biennial budget, which he outlined in the state of the state address on January 11, 2011.  He said, “No tax increases. Can I get an “amen” to that?”  He got his “amen” for the legislators.  At this writing (early February 2011) both parties and both houses of the General Assembly are opposed to tax increases.  It seems most unlikely that a major tax will be raised.  Revenue forecasts reflect current tax rates.

The Governor said “No gimmicks. We put an end to practices like raiding teacher pension funds, and shifting state deficits to our schools and universities by making them wait until the state had the cash to pay them.”  This administration has not used payment delays as a method for balancing the budget, as was done in the last two recessions.  Payment delays will not be used in this coming biennium either. 

The proposed budget does use a sizable one-time fund transfer in 2012.  This is primarily a transfer of balances from the Public Deposit Insurance Fund.  This is a fund that insures the deposits of Indiana governments at private financial institutions, above the insurance provided by the Federal Deposit Insurance Corporation.  Remaining funds are thought to be more than sufficient to cover potential losses.

The Governor said “We must stay in the black at all times, with positive reserves at a prudent level throughout the time period.”  In light of Indiana’s history and the Governor’s budget proposals, “prudent” appears to mean balances equal to at least 5% of the general fund budget.  This is achieved by the proposed budget.  Balances are projected to be 4.7% of operating revenues after fiscal 2012, and 5.2% after fiscal 2013.  This shows that Indiana continues to honor the traditional 5% minimum on balances.  It also shows that the approximately $700 million that the state will have “in the bank” cannot be used for added appropriations.  Balances helped cover revenue shortfalls in the 2010-11 biennium.  They will not be available in this coming biennium.

And, the Governor said, “The budget must come into structural balance, meaning that no later than its second year, annual revenues must exceed annual spending, with no need for any use of our savings account.”  Actually, this last goal is a necessary result of the first three.  If there are no tax increases, no payment delays, and balances are at a minimum, then appropriations must come into line with expected revenues.  This is achieved in the 2013 budget.  The current year surplus proposed for 2013 is $31 million.  For the first time since 2008, current revenue would exceed current appropriations.

The figure plots revenues and appropriations for 2000-2010, the budget and forecasts for 2011, and the budget proposal and forecasts for 2012-13.  The thick blue line shows Indiana revenues plus Federal stimulus revenue.  The blue dotted line shows Indiana revenues without the stimulus.  The solid red line shows appropriations, and the red dashed line shows appropriations less reversions, which is a measure of actual spending.

The figure shows the extent of the drop in Indiana revenues.  By fiscal 2010 own revenues had dropped below their 2006 levels—even with a one point sales tax increase.  Without the added sales tax, revenues would have dropped to their 2005 levels.  The recession cost the state five years worth of revenue growth.  The decline was lessened by the Federal stimulus revenue, but not fully offset.  Total revenues in 2010 were still less than they were in 2008. 

A measure of the budget deficit is the difference between appropriations and own revenues.  In 2010 about one-third of this deficit was covered by Federal stimulus revenue.  Another third was covered by reversions—spending cuts.  Fund balances and transfers covered the remaining third. 

In the coming biennium balances and Federal stimulus money will not be available.  The Governor’s budget uses a one-time transfer in 2012.  Other than that, appropriations are brought into line with revenues.  The proposed budget cuts appropriations by 4.7% in 2012, and increases them only 1.6% in 2013 (mostly due to Medicaid entitlements).  On the chart, the appropriations line drops to the spending line, then converges with Indiana revenues.   The structural deficit is eliminated by downsizing state appropriations.

Revenues are accelerating in 2011, up 8.6% in the first seven months.  The revenue forecast predicts that this will not continue.  If acceleration does not continue, and tax rates are not increased, the downsizing of Indiana state government could be permanent.

If the acceleration does continue, the biennial budget passed in 2011 is unlikely to be much affected.  There will be a forecast revision in April.  It seems unlikely that there will be enough growth before then to convince forecasters to significantly increase the revenue forecast.  If the economy and revenues accelerate, the forecast probably won’t be affected until December 2011.  If it occurs, revenue acceleration could affect appropriations in a budget adjustment in the General Assembly’s short session of 2012.