Still Recovering from Recession:

Indiana's Days of Reckoning

Executive Summary

The most recent recession has had greater implications for state government revenues and spending than any previous recession of the past 30 years.  In contrast to prior recessions, its economic impact, as measured by state and national statistics, indicated a short and mild recession.  However, the consequences for Indiana’s fiscal health were much more severe and long lasting.

In the years leading up to the 2001 recession, Indiana’s elected policymakers cut state and local taxes in 1997 and 1999 by an annual total of over $750 million.  Indiana was not alone; 44 states had cut taxes by a combined $33 billion from 1996 through 2000.  During the same period, the State increased spending commitments for education, property tax relief, Medicaid, correction, and other programs at greater than historical average rates.  The combination of the tax cuts, the revenue impact of the recession, and the State’s reluctance to cut core spending priorities resulted in a large structural deficit, now calculated at over $800 million.  The pattern was consistent across the states, with many of them also now facing structural deficits.

In each of the last three recessions, the decline in state revenues was not matched in magnitude by cuts in expenditures, although significant budget trimming took place in many areas.  Indiana attempted to manage through the latest downturn by drawing down reserves of several types and delaying expenditures and transfers.  Both the intent and the effect of the budget administration efforts, fiscal management policies, and a tax increase have been to hold the high priority, politically untouchable, or policy “unavoidable,” core obligations relatively harmless.  At the same time, many policymakers are hopeful that the upside of the economic cycle will provide revenue growth sufficient to restore budget balance, pay down the delayed obligations, and rebuild reserves, as it did in the 1990s.

The economic growth experienced and tax increases enacted in the aftermath of the 1980-1982 recession reversed the impact of that recession.  In the same fashion, the national economic growth of the 1990s enabled the State to “grow” its way out of the effects of the 1990-1991 recession. 

In stark contrast, however, the State has not yet fully recovered from the 2001 recession.  Nor has it taken the necessary steps to prepare for the next recession.  Nearly three years into recovery and expansion, it is imperative that the State look to the next budget and beyond to begin positioning itself for the inevitable next recession. 

While recessions vary in severity and impact—as we shall see as we examine the last three—there has always been “the next one.”  In fact, since 1945, the average length of time between recessions has been about five years.[1]  As we complete this comparison, the State of Indiana is three years removed from the end of the last recession and will be nearly four years removed by the end of this budget cycle, June 30, 2005.  The next budget enacted by the General Assembly will be for the period that ends June 30, 2007, nearly six years from the end of the last recession.

Key Findings

1. Fiscal policy decisions made during the economic “good times” between recessions can have consequences during recessions.  Focusing on short term, politically popular actions such as large tax cuts and abnormally large spending increases have contributed to the seriousness of the structural deficit now faced by Indiana and other states. 
2. Now three years from the end of the 2001 recession, the State has not restored structural balance to the budget.  The current estimate of that structural deficit is over $800 million.
3. The State has not returned budget management to normal by reversing the techniques, including payment delays, used during the last recession.
4. Reserve balances have not been rebuilt and are still being used, depleting the Rainy Day Fund and tapping into other dedicated funds. 

Recommendations

1.     The first priority of policymakers in the next session of the General Assembly should be to restore structural balance to the budget.  Only policymakers will be able to determine whether cutting core spending obligations, raising taxes, or some combination will be required to do so. 

2.     Budget management and administration must be restored to “normal.”  This includes reversing or discontinuing use of techniques such as freezing or delaying operating and capital expenditures, delaying payments to education or local governments, and relying upon balances in dedicated funds to shore up the budget.

3.     Refrain from tapping further into fund balances dedicated for other uses and begin to rebuild the Rainy Day Fund.  This is necessary not only to prepare for a future recession, but it also requires policy makers to justify any spending increases in their priorities.

The anxiety over spending cuts, tax increases, and depleting reserves needs to give way to recognition that time is running out.  Structural balance must be restored to Indiana’s budget and we must prepare for the next economic storm.  Hoosiers look to state government for stability in spite of economic volatility.  Our policymakers should pursue sound, long term fiscal and budget policies that will afford some measure of stability.