November 9, 2001
Indiana's Fiscal Crisis Was Predictable
State governments across the United States are in trouble. Some have seen as much as a 17 percent drop in tax revenues as a result of the economic downturn that has snowballed into what appears now to be a full blown recession. In many states, including Indiana, healthy surpluses built up over the boom years of the late 1990's have helped cushion the blow. But governors and legislatures now face the kind of dilemma that all politicians dread. They can either walk away from the commitments they have made to support programs and services, or they can send higher tax bills to their cash-strapped electorate to make ends meet.
It’s a situation that all have faced before, and will almost certainly face again. Indeed, if we were to look coldly and rationally at how the economy impacts the fiscal solvency of state government, we might conclude that swallowing the occasional tax increase or expenditure cut is better than any other alternative.
But you're not likely to hear much rational discussion on this issue in the coming months. The opportunism practiced in state politics can instead be counted on to produce a host of pious statements about "living within our means" that fail to address the complexity of the situation. And, of course, those who have the courage to actually vote for a tax increase will run an imposing gauntlet next November.
When it comes to financing government during good and bad times, there are really only three choices. One is to use a tax instrument that doesn't vary with the cycle of the economy. That's exactly what local governments in Indiana have in place with the levy system employed as part of the property tax. When farmers, retailers, or individual homeowners have a bad year, their tax bill stays the same, and school teachers and firefighters still get paid.
Since local governments are allowed to annually raise their tax levies by as much as 5 percent of their base, the effect of business closures or a deterioration in housing is typically borne by other taxpayers, not the government. Which is a big reason why the property tax is the most loathed tax in the state.
Another alternative is to allow governments to run deficits. That's exactly what the federal government has done, and its ability to spend into the teeth of a fiscal storm has proven to be an important counter-weight to the forces that tend to pull a struggling economy further downward. But deficit spending can be disastrous for smaller government entities, as the experience of New York and Cleveland has shown. And no state has the spending power to meaningfully impact its own economy.
What we have in Indiana largely represents the third alternative. We rely heavily on tax instruments, like the sales and income tax, whose collections vary with the pulse of the economy. We enjoy the higher revenue streams when times are good, and we face hard decisions when times are bad.
To most people's thinking, taxes that vary with our ability to pay are fairer than those that do not. But something has to give when they do not cover the cost of government.
Unfortunately, in Indiana we have made the inevitable recession-related crunch on state finances even worse than it has to be. Most impartial observers recognize that the rosy assumptions underlying the biennial budget passed last session were unlikely to be met. The legislature will not make everyone happy when it meets to bring the budget back into balance next year, as it must. Let us hope that the decisions they make are best for the state, and not simply for the incumbents.
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