Why Does Indiana Keep Balances, and How Much is Enough?

The Indiana State Budget Agency wrapped up the fiscal 2019 budget on July 11, with its annual closeout statement. There was good news. Revenues came in $267 million above forecast, and that meant that Indiana ended the year with more money in the bank than expected. State balances were almost $2.3 billion, which was 13.6 percent of the budget. That’s above the Budget Agency’s “prudent range,” which tops out at 12 percent.

Balances are like a savings account, and a nice healthy savings account makes us feel good. Except, that’s our tax money, which we paid so the state could deliver public services like education and health care. Instead, it’s sitting in the bank. Maybe we should use that tax money for what it was intended. Or if we’re not going to use it, give it back to the taxpayers.

The questions are, why do we keep balances, and how much is enough?

Revenues arrive on one schedule. Expenditures go out on another. It’s prudent to have some money in the bank to cover those months when expenditures exceed revenues, to be made up later in months when revenues are higher.

Here’s an experiment to guess at how much the state might need to handle cash flow shortfalls. Suppose general fund expenditures are paid steadily, at one-twelfth of the year’s total each month. Suppose the state expects to exactly balance its budget, spending every dollar it collects during the year. In July 2018, which was the first month of fiscal 2019, revenues fell $195 million short of that steady monthly spending amount. Without balances, the state would have been in the hole.

Collections in February and March 2019 were particularly low. By the end of March, after three quarters of the fiscal year, the state had collected $1.3 billion less than it would have needed for constant monthly spending. As you might expect, April was a great month for income tax collections. Revenues were well above expenditures. By the end of June, the flush months had balanced the lean months so that total revenues matched total spending in our experiment.

That $1.3 billion shortfall through March was about 8 percent of total spending. The public finance biz often recommends 5 percent as the minimum balance needed to cover cash flow shortfalls. Indiana has adhered to that during the past several decades. But 5 percent may be a little low.

Cash flow is one reason to keep balances. Recessions are another. The state can draw on balances when revenues fall short during recessions, so we don’t have to cut spending or raise taxes right away.

Indiana designates a large part of its balances for just this reason. There’s the rainy-day fund, officially called the Counter-Cyclical Revenue and Economic Stabilization Fund (which is why we call it the rainy-day fund). Revenue flows into the fund in good times, to be used in bad times, and there are rules in the law defining good and bad times. If necessary the General Assembly can override the rules and use the money.

Then there’s the tuition reserve and Medicaid reserve funds, one to support state aid to schools, the other to make sure Medicaid payments are met. The law says that these balances can be used to support spending when state revenues are insufficient, though there isn’t a formula defining when that is.

These three funds totaled $1.4 billion as of June 2019, which is 8.7 percent of the budget. How much is enough when a recession hits? Unfortunately, the worst years are worse than that. The 2001 recession caused a 10 percent revenue shortfall below forecast in fiscal 2003. The Great Recession caused another 10 percent shortfall in fiscal 2009. And there were smaller shortfalls in the years before and after as well.

These cash flow and recession shortfall numbers imply a need for balances that are larger than what we have. At 13.6 percent, we have enough to cover cash flow, plus enough for about half a year of bad recession.

There’s no way we would keep enough balances to meet recession shortfalls in full. But whenever the next recession hits, we’ll be happy to have all the balances we can get.

Author: Larry Deboer
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