Recession, budget shortfalls will have major impact on everything legislators debate

December 22, 2008
It's anybody's guess how long Indiana will endure recession. But state officials have an official prediction. They forecast a rough ride through the middle of next year. After that, they expect Indiana's economy to gain steam.

If they're correct, it'll mean a brutal session of the General Assembly.

Now expecting $935 million less in annual revenue than they did a year ago, legislators will spend the next four months arguing over budget cuts. After the State Budget Committee shared its forecast Dec. 11, Gov. Mitch Daniels announced a series of trims, but there's still a $763 million deficit to close.

"This is going to be the key priority, the major issue. This will be the thing that sets everything else to the side," said Indiana Legislative Insight Publisher Ed Feigenbaum. "There will have to be total attention to how to bring spending in line with revenue. It won't be an easy task."

The question is whether it'll be tough or Herculean. If the revenue forecast is incorrect, the state's deficit will be much, much bigger. And legislators won't be talking about mere belt-tightening. They'll wrestle over how to slash Indiana's budget to the bone.

"The picture they've drawn is of a fairly intense, but fairly short, recession," said David Bennett, executive director of the Community Foundation of Fort Wayne. "I hope they're right. But some people think we may be in for a longer haul."

In November, the nonpartisan Indiana Fiscal Policy Institute released a study Bennett co-authored titled, "Economic Hurricane Coming — Is Indiana Ready?" It lays out Indiana's challenges as it faces what many are calling the worst national recession since the Great Depression.

It notes the impact of Indiana's new property-tax caps and its increased reliance on sales tax, which declines in a recession. The IFPI study also points out that state government took on many local expenses when it approved the caps last year. And while Indiana has a $1.4 billion reserve, that might not last long as state pension assets drop along with the stock market, unemployment claims rise, and housing values fall.

Bennett isn't the only financial expert worried that the state's official forecast — grim as it may be — represents a best-case scenario.

"I think it's close to equal probability it will be worse than that," said Indiana University economist Bill Witte. "We have an alternate forecast with a worse first quarter, no improvement until the third quarter, and national unemployment close to 9 percent."

"That becomes a recession that's more than comparable to the early '80s," Witte said. "And I'm beginning to come to think it's a probable outcome. ... If the economy deviates, it's far more likely to be on the downside than the upside."

Indiana Manufacturers Association President Pat Kiely put it more simply:

"We're in a much better position to handle this [than most states]," he said. "The question is how much water comes over the levy here."

Gloomy forecast

Every December, the State Budget Committee offers its forecast of Indiana's future revenue. Each April, it updates the numbers just before the General Assembly concludes its business.

In December 2007, Indiana forecast $13.2 billion in revenue for fiscal 2009. On Dec. 11, the forecast had dropped to $12.5 billion. Counting shortfalls from the previous fiscal year, that's a $935 million reduction. On the day Indiana released it, Daniels stressed that he believed there's no reason to doubt the forecast.

But the governor left wiggle room, just in case it's overly optimistic.

"If this forecast is accurate, the state will have less money to spend in 2011, the second year of the budget we're about to write, than it believed it would have for 2009," Daniels said. "This means the budget to come will have to be put together with more care and more protection of taxpayers than probably any we've seen, including those that brought us to balance in the last four years."

Traditionally, the forecast process begins with a committee of volunteer financial experts who offer their prophecy on the economy's general direction. Then a technical committee within the State Budget Agency applies statistical equations to show how the broad economic forecast is likely to translate into tax revenue.

This year, for the first time, Indiana hired a private firm to make the economic estimate: Lexington, Mass.-based IHS Global Insight Inc. It retained the technical committee.

Jim Diffley, IHS Group managing director of U.S. Regional Services, said the state of the national economy was the primary basis of its forecast. He particularly noted the meltdown of the financial markets in New York and the deflation of the real estate bubble in the Sun Belt states.

Indiana's primary difference from the rest of the nation remains its relative exposure to the manufacturing sector, Diffley said. Still heavily reliant on the Big Three automakers in Detroit, Indiana's economic future is intertwined with the stalled auto bailout.

Fortunately, Hoosiers have done a great deal to modernize their economy since the last deep recession in the early 1980s.

"There's no reason to think Indiana will be slower on the uptick than the rest of the economy generally," Diffley said. "If you traditionally went back to the '80s, you'd lump Indiana with Ohio and Michigan. But there's no doubt Indiana [won't] have as tough a time because it has diversified away [from the U.S. auto industry] and has a nice technology sector in pharmaceuticals that will make the picture better going forward."

Witte was a member of Indiana's economic forecast committee for the last six years until retirements forced its dissolution. He said the national economy is dismal, and has been getting worse continuously and rapidly the last two months.

It's impossible to tell for certain when the tide will turn, Witte said. It's still quite possible that the IHS "baseline" forecast will play out, and the economy will begin growing again by the middle of 2009. But it's nearly as likely to go the other way. There's simply not enough historical data for economists to tell whether the worst downturn since World War II will be a particularly sour recession, Witte said, or a depression.

That means, in 2009, the April forecast update — always important — will be crucial.

"We're going to learn a lot about the economy over the next six months," Witte said. "If it turns out that something like the baseline that was laid out is playing out, by April we'll have a good bead."

Holding pattern

Since legislators aren't sure whether they're dealing with the bad or the worst-case scenario, the General Assembly will likely spend its first weeks, and perhaps months, of 2009, publicly avoiding all spending questions. Any bill that might have an impact on state expenses will be stuck indefinitely in a holding pattern.

But behind closed doors, horse trading over potential spending cuts will dominate legislative leaders' time, said Daniel Seitz, managing principal of locally based lobbying firm Bose Public Affairs Group.

"Essentially, the agenda will be driven by the idea there is no money," Seitz said. "The one thing I've learned is politicians are realists and flexible, when you get right down to it."

Caucus leaders are already reacting as Seitz predicted. House Speaker Pat Bauer, D-South Bend; Senate President Pro Tempore David Long, R-Fort Wayne; House Minority Leader Brian Bosma, R-Indianapolis; and Senate Minority Leader Vi Simpson, D-Bloomington, issued an unusual joint statement immediately after the state released its latest forecast.

"As evidenced by today's grim revenue projections, the state of Indiana is facing fiscal decisions that are critical to our future," the statement read. "As the state's legislative leaders, we are resolved to transcend party lines as we attempt to do our part in guiding the state through this economic storm."

As severe as the recession's impact will be, many folks who follow the General Assembly are already taking solace in the fact that other states are faring worse. Indiana Legislative Insight's Feigenbaum said many are already slashing up to 20 percent of their budgets.

"There are as many as 49 other states that would rather be in Indiana's position, with a less than $1 billion shortfall and a rainy day fund," he said. "Just like Bill Gates and Warren Buffet have taken significant hits to their portfolios, I'd much rather be in their shape."

Bottom line: It would have been unthinkable a year ago. But everyone connected to the General Assembly is currently crossing their fingers that a forecast predicting a nearly $1 billion decline in revenue is accurate.

Because nobody's prepared yet to face the alternative.

"I hope they're right, and what they predicted comes to pass, because it means six months from now, we'll see tangible signs of coming out of this recession," said Bennett, co-author of the IFPI study. "That'd be good news for everybody."
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