EYE ON THE PIE: Budget made by rudderless Legislature-WEB ONLY

In some states, changes in the level of the budget are driven by the percent change in personal income. Two weeks ago, the U.S. Bureau of Economic Analysis released its latest estimates of quarterly state PI. Where U.S. PI grew 0.8 percent from the first quarter of 2008 to the same quarter in 2009, Indiana advanced only 0.4 percent. There were 16 states that performed worse than we did.

If Indiana’s budget were linked to PI, the Legislature would have an easier time. The budget for next year would rise 0.4 percent. The question would become, “Which functions of government should get how much of that small increase in funding?”

If we were going to hang state spending on some statistical star, PI is not the best choice. Look again at first quarter 2008 to 2009. PI in Indiana rose 0.4 percent without adjustment for inflation. However, that figure doesn’t tell the real story of Indiana’s economic performance in the year.

When times are tough, many workers lose their jobs and collect unemployment compensation. That puts a strain on state finances. In the past year, unemployment compensation payments tripled in Indiana. If we exclude these payments, PI did not increase 0.4 percent, but declined 0.3 percent.

While thousands of Hoosiers in the private sector were losing jobs or taking pay cuts, earnings in the public sector rose 4.8 percent. (During this period, state government shrank 2.1 percent-a loss of 2,400 jobs, while local government employment increased 1.8 percent, or 5,230 jobs.) With the government and farm sectors excluded, PI in Indiana declined 0.7 percent.

Included in PI are dividends, interest and rent. This sector was down in the past year (0.2 percent). You see dividends and interest credited to your retirement account statements. But you aren’t able to spend that money and you don’t pay taxes on those receipts until you cash in the account. It doesn’t make sense to include those funds, whether they go up or down, in any consideration of this year’s income.

The same applies to contributions made by employers to Social Security, health insurance and other benefits for their workers. They are not funds available for current spending.

What should be the guideline for government spending if we throw out all these components of PI? We could use wages and salaries paid to employees in the private sector, plus government transfers to individuals (Social Security, welfare, Medicare, Medicaid and certain pensions), plus non-farm proprietors’ income (less their contributions to social insurance programs).

This nameless sum declined 0.4 percent in the 12 months we have been discussing. If we linked state spending as outlined here, there would be no foundation for increasing the state budget beyond its previous level, unless a strong case could be made that existing services will be harmed seriously by operating without additional funds. And if such harm can be substantiated, we have a rainy-day fund to help out.

I am not recommending this approach, but it would be better than seeing our representatives continue to sail without a rudder in stormy waters. •

Marcus taught economics for more than 30 years at Indiana University and is the former director of IU’s Business Research Center. His column appears weekly. He can be reached at mmarcus@IBJ.com.