Declining tax collections eat away at state’s fiscal footing

Indiana's fiscal picture is looking good roughly one year after former Gov. Mitch Daniels left office with about $2 billion in cash reserves and a strong credit rating, but the next few years could leave the state in a fiscal pinch nonetheless.

The state is continuing to crawl out of the recession, with depressed earnings by many residents and an improving, but persistently high unemployment rate. The State Budget Committee had to downgrade expectations last week, after state budget and tax forecasters came back with an expectation the state will collect $298 million less than expected over the next two years.

The pinch will likely weigh most on Republican Gov. Mike Pence, who is heading into his second year with a potentially pricey legislative agenda. The governor's plan to expand the state's school voucher program to preschool-age children and teachers carries an unstated price tag. And eliminating the personal property tax, which accounts for about $1 billion in local revenues each year, would require some sort of backfilling of money, either by the state, local governments or some mix of the two.

In particular, the personal property tax, which is levied on business equipment, has depressed economic growth in Indiana, he said.

"It discourages companies from investing in new technology and the expansion of their businesses. As the most manufacturing-intensive state in the nation, we are holding back new capital investment because of our business personal property tax," Pence said in prepared remarks last week, laying out his case for the tax cut.

The state's fiscal footing is one of the best in the nation. Indiana has maintained a top credit rating from the major bond-rating companies, the state still has a cash reserve of close to $2 billion and lawmakers found money in the most recent budget to retire old debt and pay for some new capital projects without accruing new debt.

But those tax cuts, combined with declining tax collections, are squeezing the pot of money leaders have to work with. If the business tax cut goes through, it will be the third consecutive session featuring a significant tax cut. Lawmakers started to phase out the state's inheritance tax in 2012 and they signed off on further cuts this past session, including a portion of the income tax cut Pence asked for.

Shortly before lawmakers received the grim budget news last week, the economist kept on contract by the state said Indiana should expect to see steady growth over the next few years. The state's unemployment rate has continued a steady decline and auto parts makers have the potential to spur more growth.

All of it could keep lawmakers cautious during the upcoming session, say Indiana budget observers.

"Although the economic forecast is optimistic, the state expects less revenue than when the budget was written last May," said John Ketzenberger, president of the Indiana Fiscal Policy Institute, which tracks the state budget and other fiscal issues. "The improving economy's just not producing as much tax revenue at this point and the conservative revenue forecast reflects that. It'll be difficult for lawmakers to rationalize additional spending or even budget cuts given the new revenue forecast."

Pence has continued the tightfisted budgeting Daniels established, but unexpected downturns have still hampered some goals. He responded to news that monthly tax collections had dipped $141 million by selling the state plane and cutting agency and higher education budgets. And the state lost $63 million a year from the national tobacco settlement after a federal arbitrator determined the state had not done enough to collect settlement proceeds from small tobacco manufacturers.

Winning new programs and tax cuts from the Legislature may have to wait another year, until lawmakers begin work on their next budget and have a better idea of the long-term fiscal trends.