Two weeks ago, the State Budget Committee received another dose of stunning news about the strength of Indiana’s finances: The latest revenue forecast adds $3.3 billion to earlier two-year projections, pushing the state surplus over $5 billion this year and $4 billion by the end of Fiscal Year 2023, even after subtracting $540 million in automatic income tax refunds, more than $3 billion to shore up public pension funds and $500 million in university construction projects.

Tax collections continue to climb even as we struggle to put COVID behind us. Public health challenges will continue to occupy the General Assembly in 2022, while the new forecast means renewed momentum for permanent tax reforms.

But it’s fair to ask whether the new numbers are too good to be true, and to question how quickly lawmakers should act on these projections outside the normal budget cycle.

Putting the forecast in perspective:

Indiana uses a consensus forecasting process, with a bipartisan team of budget analysts working alongside outside experts and professional economists to produce revenue estimates. There’s no reason to doubt their efforts, especially after adding some short- and longer-term context.

Adjusting for delayed income tax payments in 2020, annual revenue growth from FY2019 (pre-pandemic) through FY2021 was 6.5%. Impressive, but also just one percent higher than the 5.4% increase from FY2018 to 2019; the legislature acted that year to boost future revenues by authorizing online gambling and applying sales taxes to e-commerce facilitators like Amazon.

Now factor in the strength of Hoosier manufacturing as COVID pushed household spending towards goods from services, an unprecedented infusion of federal stimulus, and Indiana’s decision to tax enhanced federal unemployment benefits. The state’s current revenue performance is incredible, but not inexplicable given the circumstances.

The new forecast revises employment and earnings upward to continue sharp year-over-year growth in FY2022 (nearly 8%), slowing to 1.7% in FY2023 after the state’s job market fully recovers from COVID and federal aid filters out of the economy.

This averages out to 4.7% annual growth in FY2022 and FY2023. Let’s compare trends for our two biggest general fund contributors, sales and individual income taxes: From 2002 through 2018, Indiana consumer spending on durable goods grew at an annual pace of 4%. Removing the Great Recession years (2008-2009), state taxable income increased more than 3% per year over the same period.

So 4.7% revenue growth is still a testament to the strength of Indiana’s recovery, but doesn’t strain credulity for a rebounding economy (especially considering the lingering impact of CARES Act and American Rescue Plan spending).

Balancing future budget priorities:

The 1.7% revenue increase predicted for FY2023 signals a more ‘normal’ fiscal climate. Most notably, sales tax expectations cool as consumer spending shifts back to services. (There’s discussion around expanding Indiana’s sales tax base to include some services, but that’s a topic worth its own column.)

The $20.2 billion anticipated for 2023 nonetheless reflects higher economic confidence versus the April forecast, with smaller growth still coming against a baseline that would have seemed unrealistically optimistic just a year ago.

There’s no denying that this forecast is a blockbuster. How will policymakers respond?

There will be strong sentiment for permanent tax cuts from the largess, sending part of the historic surplus back to the taxpayers who built it with their earnings and spending. House Republicans seem to be more squarely in this camp.

There will also be arguments that tax and spending decisions should be made during a budget-writing session, waiting for next year’s forecast to clarify the revenue outlook for the next biennium. Some Senate leaders have adopted this more cautious stance.

After all, a number of current budget priorities – e.g. the Regional Economic Acceleration and Development (READI) grant program – are supported by federal COVID aid. Governor Holcomb has signaled his intention to seek additional funding for READI, and the expected budget surplus could act as a contingency for continuing these investments.

Preserving sufficient reserves to protect READI and other quality of life programs beyond 2023 while sustaining commitments to education and workforce development also heeds a key point from the economic analysis accompanying the forecast: “[Indiana’s] labor force must continue to grow in size and skill to allow existing businesses to expand and attract new business.” In other words, Indiana should focus on creating new taxpayers along with rewarding current ones.

Indiana has built a reputation for steady fiscal management, and the safest bet for next year’s session is a compromise that delivers modest tax relief while guarding a larger surplus to backstop the next budget. But unlike the revenue forecasting models, there’s no science to predicting the deliberations of the General Assembly – we’ll need to revisit the debate in 2022.

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