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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

Policy Goal: Continue to practice the fiscal discipline necessary to make Indiana the state that

works by balancing budgets, maintaining adequate reserves, and using the next dollar for tax

relief.

Vision Plan Goals Served:

Goal #1: Increasing private sector employment

Goal #2: Attracting new investment in Indiana, with emphasis on manufacturing, agriculture,

life sciences and logistics

Policy Steps:

Pass structurally balanced budgets without gimmicks or tax increases.

Maintain reserves equal to at least 12.5 percent of appropriations.

Allocate the structural budget surplus to enact a 10 percent, across the board income tax

reduction for every Hoosier and to further enhance our savings.

Task the Office of Management and Budget to perform a new government performance

review called PACE (Program Accountability Comprehensive Evaluation) that will focus

on government operations and develop a plan to utilize performance-based budgeting to

fund core government functions.

Practice the fiscal and debt management necessary for Indiana to maintain a top credit

rating.

Enhance taxpayer transparency with a robust commitment to public disclosure at the state

and local level.

Rationale:

Every Hoosier should be grateful for the fiscal stewardship of Governor Daniels. His leadership

has left the state with more than $2 billion in reserves and a $500 million structural surplus in the

state budget. He has instilled a culture of performance management in state agencies, reduced

government debt, built our reserves and promoted transparency in government funds. All this is

reflected in the fact that Indiana has a top credit rating from all three major credit rating agencies.

We can never forget the fiscal situation that Governor Daniels inherited in 2005. The state had a

structural deficit of $820 million.1 Our universities and local governments, including schools,

1 See Indiana’s Fiscal Condition: A Different Set of Policy Choices, p.3, Indiana Fiscal Policy Institute (July 12,

2012), located at http://www.indianafiscal.org/pdf/IFPI-Report-on-Indianas-Fiscal-Condition.pdf.

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

were owed over $700 million by

the state due to payment delays.2

Our reserves were functionally

non-existent, equaling only 0.2

percent of operating revenue in

FY2005.3 State government

agencies and programs were not

consistently measuring their

results.4 Finally and

unsurprisingly given the fiscal

mess that Indiana was in, the

state had seen its credit rating

lowered twice between 2002 and

2004.5

To make Indiana the state that

works, we must reject the

practices of borrowing, taxing

and spending that left Indiana broke before Governor Daniels took office, and embrace fiscal

discipline, living within our means, and performance-based budgeting and management, and

return the fruits of these efforts to the taxpayers who earned the money in the first place.

Indiana must continue to pass balanced budgets without gimmicks or tax increases. Each budget

must be structurally balanced, meaning that our annual expenses should not exceed the annual

revenue collected by the state. We cannot return to the practices of the past, where lawmakers

used tactics like raiding teacher pension funds or delaying payments to schools in order to

support spending that was unsustainable based on current receipts. Finally, tax increases to

balance the budget should absolutely be off the table. Government should live within its means,

just like Hoosier families.

2 Id.

3 Id at 4.

4 In 2006, when OMB issued their first report on performance management, they found that only 38 percent of state

programs had any performance measures in place. See Interim Report: Budgetary and Functional Review of

Executive Branch Agencies, p.4, Indiana Office of Management and Budget (January 2006), located at

http://www.in.gov/omb/files/OMB_Interim_Report.pdf. 5 http://www.in.gov/tos/files/BondRate.insideindianabusiness.com.pdf.

Source: Calculations based on data from the Indiana Budget Agency

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

The next governor will work with the General Assembly to produce a budget for FY 2014 and

2015. Assuming that revenue grows by 2.5 percent6 and appropriations grow by 1.5 percent,

7 and

that funding for full day kindergarten is included in the next budget, the structural surplus will be

$516 million in FY 2014 and $667 million in FY 2015 (see Table 1 and Chart 1). Structural

surpluses are a sign of fiscal health and put Indiana in a position of strength nearly unheard of in

other states.

Table 1: FY 2014/2015 Surplus Projection (amounts in millions)

FY 2013 (projected) FY 2014 (projected) FY 2015 (projected)

General Fund Revenue $14,432 $14,793 $15,163

Projected Growth Rate n/a 2.5% 2.5%

Other Revenue8 $205 $223 $223

Total Revenue $14,637 $15,016 $15,386

General Fund

Appropriations

$14,318 $14,532 $14,750

Projected Growth Rate n/a 1.5% 1.5%

Other Spending9 ($107) ($31) ($31)

Total Spending $14,211 $14,501 $14,719

Structural Budget

Surplus

$426 $516 $667

Source: Calculations based on data from Indiana Budget Agency. Totals do not add due to rounding.

In addition to a healthy structural surplus, it’s important that the state continue to maintain

adequate reserves. Good kitchen table budgeting provides a strong savings account for

unexpected emergencies. Reserves also serve as a last line of defense for taxpayers in an

economic downturn. Currently, the state has very healthy reserve levels, exceeding $2.1 billion

in FY 2012 and projected to exceed $2 billion at the end of FY 2013.10

These levels exceed 14

percent of appropriations in each of those fiscal years (see Chart 2). Moving forward, the state

should maintain reserves at a minimum of 12.5 percent of appropriations, to adequately protect

taxpayers in a downturn or emergency situation.

6 The current state revenue forecast predicts 2.5 percent general fund revenue growth in FY 2013.

http://www.in.gov/sba/files/rev_forecast_20111214_revenue_forecast.pdf 7 Appropriations growth in the current biennium (FY 12/13) is 0.7 percent. Given Indiana’s fiscal health, it’s

reasonable to assume that appropriations growth will roughly double in the FY 14/15 biennium. 8 Includes, most significantly, revenue collected from the Quality Assessment Fee (QAF) and the Hospital

Assessment Fee (HAF). 9 Includes full day kindergarten augmentation and reversions.

10 http://www.in.gov/sba/files/FY_2012_Surplus_Statement.pdf.

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

Source: Indiana Budget Agency

With adequate reserves in place and a strong budget surplus, the state will need to determine how

to allocate the surplus. Surplus

funds are the result of years of

careful, prudent management

of state resources, and they

must be managed with the

same level of care. Therefore,

they should be allocated to

further enhancement of broad-

based tax relief for Hoosiers

and further enhancement of our

reserve accounts.

The state should first allocate

the surplus to phase in a 10

percent, across-the-board

reduction in the state’s

individual income tax rate (see

Table 2). The rate would be

reduced by 5 percent in FY 2014 and another 5 percent in FY 2015.11

This would reduce

Indiana’s state income tax rate from 3.4 to 3.06 percent.

Table 2: Proposed Allocation of Projected Budget Surplus

FY 2014 FY 2015

Projected Budget Surplus $516 million $667 million

Phased in 10 percent reduction

in individual income tax rate

$261 million $534 million

Transfer to Reserves $255 million $133 million Source: Calculations based on data from the Indiana Budget Agency

While Indiana has relatively low tax rates and a competitive tax system overall,12

Indiana has an

“all of the above” tax system as shown by our middle of the pack ranking on state and local tax

11

The current revenue forecast projects that Indiana will collect a little over $5 billion in individual income tax

revenue in FY 2013. See http://www.in.gov/sba/files/rev_forecast_20111214_revenue_forecast.pdf. 12

Indiana ranks 11th

best on the Tax Foundation’s State Business Tax Climate Index.

http://taxfoundation.org/article/2012-state-business-tax-climate-index.

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

burden paid by Hoosiers.

13 Furthermore, neighboring states like Illinois are raising taxes due to

their inability to control spending, while states like Michigan and Ohio are looking at tax

reductions. An across the board tax cut for all Hoosiers would send a strong signal that we are

managing our funds wisely and also reducing the tax burden on our taxpayers and businesses.

For a family of four in Indiana, the tax cut will be more than $228.14

For a small business with

net income of $300,000, the tax cut will be more than $1,000. In total, this will deliver a tax cut

to approximately 92 percent of all business establishments in the state which pay through the

individual income tax, providing a direct jolt to the Indiana economy by allowing them to hire

more and invest more.15

A 10 percent, across the board income tax cut would also give Indiana the lowest tax burden in

the Midwest. According to the Tax Foundation, Indiana’s state and local tax burden is currently

second lowest in the Midwest (see Table 3). Reducing income taxes by $533 million per year

would give us the lowest overall tax burden in the Midwest. Achieving the lowest tax burden in

the Midwest would be a major improvement in our state’s overall business climate and even

better position Indiana to grow private sector jobs and attract new investment.

Table 3: Income Tax Cut Gives Indiana Lowest Taxes in the Midwest

13

Indiana ranks 25th

(1st is highest) on tax burden as a percentage of personal income.

http://taxfoundation.org/article/indianas-state-and-local-tax-burden-1977-2009. 14

Median income for a family of four in Indiana in 2010 was $67,296. See State Median Family Income by Family

Size (1-Year), available for download at http://www.census.gov/hhes/www/income/data/statemedian/.

15 According to an analysis by Robert Carroll and Gerald Prante, 92 percent of Indiana business establishments are

non C-corporations, which means their business income is taxed via the individual income tax system. http://www.s-

corp.org/wp-content/uploads/2011/04/Flow-Through-Report-Final-2011-04-08.pdf.

State State/Local Tax

Burden

Rank (1st is lowest) State/Local Tax

Burden (with

income tax cut)

Rank (1st is lowest)

Illinois 9.97% 6 9.97% 6

Indiana 9.49% 2 9.25% 1

Iowa 9.53% 3 9.53% 3

Kentucky 9.28% 1 9.28% 2

Michigan 9.67% 4 9.67% 4

Minnesota 10.29% 7 10.29% 7

Ohio 9.71% 5 9.71% 5

Wisconsin 10.98% 8 10.98% 8

Source: Calculations based on data from the Tax Foundation

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

Source: Calculations based on data from Indiana Budget Agency

It is also recommended that the state set aside $255M in budget surplus in FY 2014 and $133M

in FY 2015 to further augment the state’s reserve accounts. This is recommended not only as

cushion against a future downturn, but also to give the state additional flexibility to meet future

challenges or investment needs.

After allocating the surplus to a 10 percent income tax cut and further enhancement of our

reserve accounts, Indiana would remain in a strong fiscal position. Reserves would equal 14.3

percent of appropriations at the

end of FY 2014 and 15.0

percent of appropriations at the

end of FY 2015 (see Chart 3),

putting the state in an even

stronger position to address

future challenges.

This plan is responsible and

flexible, puts taxpayers first,

and will grow our economy

instead of growing government.

If economic circumstances

change before or after the

budget passes, we will have

additional flexibility in our

reserve accounts to manage the

changing circumstances. The

phased-in nature of the tax relief

will give us two years to monitor how it is impacting the bottom line. This plan puts taxpayers

first while also giving the state flexibility to meeting future challenges.

State government also should continue to manage taxpayer funds to deliver results for taxpayers

in a cost-effective, efficient manner. In 2005, Governor Daniels ordered OMB to review the

budgets and functions of each executive branch department, agency, and instrumentality for the

purpose of finding cost-saving efficiencies and establishing performance measures.16

This effort

was called the PROBE (Program Results: an Outcome Based Evaluation).

16

See Executive Order 05-02, located at http://www.in.gov/gov/files/EO_05-02_Creation_of_OMB.pdf.

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

A fresh comprehensive review should be undertaken, called PACE (Program Accountability

Comprehensive Evaluation). Under PACE, OMB should review all agency performance

measures, including an evaluation of program performance since the measures were adopted.

OMB should concentrate its review on those policy areas that are most crucial for job growth,

such as education, regulatory,17

tax, and transportation. In addition to efficiency review, each

program should be explicitly measured for its support of private sector job growth.

After this review is complete, OMB should prepare a plan to move from performance-informed

to performance-based budgeting, including the adoption of a performance-funding matrix that

will guide budget development and the budget management process.18

Taxpayers deserve to see

their hard-earned dollars flow toward programs that work and away from programs that don’t.

Programs that consistently fail to meet their measures should be re-evaluated. To support

performance-based budgeting, OMB should devote management resources to agencies and

programs that are not meeting their performance targets, to assist agencies with best performance

and financial management practices.

Indiana currently has a top credit rating from all three major credit rating agencies.19

A top credit

rating is more than just a tool for acquiring low-interest debt. It is a market signal of the state’s

fiscal health. Indiana’s underlying strengths in its balanced budget, sound fiscal management,

low debt per capita, and an ever-diversifying economic base provide the foundation for a top

credit rating. Conversely, losing a top credit rating would put Indiana at a competitive

disadvantage with other states and increase the State’s cost of doing business. Therefore,

maintaining a top credit rating should be a continued priority.

With billions of dollars running through the hands of state lawmakers, the public has the right to

know how their dollars are spent. Under the leadership of Governor Daniels, the state established

the Indiana Transparency Portal and the Gateway system for state and local governments and

developed the first tax expenditure reports for taxpayers. As technology changes and

information becomes increasingly easy to access, so too should government disclosure of its

financial condition be easier to access.

17

OMB’s new performance review will be integrated with the OMB regulatory review that Candidate Pence

announced earlier. 18

OMB’s 2006 report called for moving toward a performance-informed budgeting process. 19

INDIANA FINANCE AUTHORITY, INVESTOR RELATIONS, available at http://www.in.gov/ifa/2717.htm.

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THE STATE THAT WORKS: PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

Building on the success of Governor Daniels, there are several enhancements that can be pursued

to offer further transparency to taxpayers. First, the tax expenditure reports should be codified

and presented on an annual or biennial basis. Second, state government should begin processing

all contracts electronically to improve transparency for taxpayers and efficiency for government.

Third, we should ensure that all documents posted on the Indiana Transparency Portal are easily

searchable by the public. Fourth, OMB’s review of existing performance metrics should include

a review of how they are presented to the public on the Indiana Transparency Portal. Finally, a

gubernatorial commission should be established, consisting of local units of government, local

businesses, and concerned citizens, to review the Gateway project and begin to develop an

understanding of important financial metrics at the local level.