Economics is called the dismal science. I risk my reputation for dismal analysis by writing this, but Indiana's state budget is in pretty good shape. For the first time in years, the General Assembly will have money to work with in next year's budget session.
Here's why. We've filled in the budget hole created by the Great Recession. Revenue fell short of planned spending by $4.6 billion from 2009 to 2011. We covered that with about $2.2 billion in federal stimulus aid, $2 billion in budget cuts, $200 million in fund transfers and $200 million in reduced balances.
We froze appropriations at 2009 levels through 2013. That's five years with no increase in planned spending, not even to cover inflation or population growth. Revenues started growing in fiscal year 2011 as the economy began its tentative recovery. We ran a budget surplus in fiscal year 2012 (which ended in June), and we're expecting to run another surplus in fiscal 2013. The surpluses restored state balances, with enough left over to offer taxpayers a rebate in 2013 and add some to our underfunded pensions.
Revenues continue to grow. In 2012 they grew by 6.4 percent over 2011. Revenues are up 4.1 percent so far in fiscal 2013.
We back-filled the budget hole, balanced the current budget and expect revenues to keep growing. A budget in pretty good shape means that the General Assembly will have some choices to make for the next biennium. Let's do some calculations to put some numbers on these choices.
Suppose revenues grow 4.7 percent per year over the next two years, fiscal 2014 and 2015. That's the average growth rate projected for the biennium we're in now, so it's just an assumption that current growth continues. Let's also suppose that we aim for balances equal to 12.5 percent of the budget by the end of the biennium in mid 2015. State law says that balances higher than that must be distributed in tax rebates and used to build the pension funds.
Indiana population has been growing by about 0.6 percent per year for the past decade. Each year the state must provide services to about 40,000 more Hoosiers. And let's assume that inflation increases consumer prices by about 2 percent per year over the next two years. That's the Federal Reserve's target inflation rate.
Now, suppose we wanted to keep delivering the same services in the next biennium as in 2013. We would need to cover population growth and inflation, so appropriations would have to increase about 2.6 percent per year. With revenues growing 4.7 percent per year, we'd have about $800 million a year in leftover revenue.
We could let that money accumulate in balances. By the end of the biennium, balances would equal about 22.5 percent of the budget, way above the 12.5 percent target. The excess balance law would distribute about $800 million in tax rebates and add $800 million to the pension funds.
We could cut taxes to get balances down to 12.5 percent. We could cut the sales tax rate from 7 percent to about 6.25 percent or the income tax rate from 3.4 percent to about 2.9 percent.
Our state government probably provides fewer services now than it did in 2009. Appropriations have been frozen since then, yet population has grown, and inflation has increased prices. If appropriations had grown 2.6 percent per year after 2009, the 2013 budget would be $16 billion, not $14.5 billion. That's a $1.5 billion gap.
If we added all the extra revenue to appropriations, we'd spend $15.3 billion in 2014, and $16.1 billion in 2015. That would not be enough to restore the 2009 level of services per person, since population keeps growing and prices keep rising. But it would cut the gap in half.
What's our choice for the coming budget? We could decide that we like the smaller state government forced on us by the Great Recession and scale down taxes to match. Or we could decide to hold tax rates steady and start to restore state government to what it was before the recession. Or we could choose something in between.
Maybe that's how to save my dismal economist's name. More money is a good thing. But now we'll have to make choices. Making choices is hard.