State revamps its revenue forecasting after big miss

Growing ranks of dropout workers have nagged the economy throughout its recovery, and now Indiana’s budget forecasters feel they can’t ignore the trend.

They recently revised their outlook on state revenue downward, partly because so many Hoosiers stopped looking for jobs.

Revenue fell far short of the November target, prompting Gov. Mike Pence to make midstream budget cuts. So the forecast team decided to replace the unemployment rate—where Indiana made big strides last year—with the labor-force participation rate—where things aren’t so rosy—in the model for predicting sales-tax revenue.

Now, sales tax, the state’s largest source of income, is expected to generate $6.9 billion in the year that ends June 30, down 2.5 percent from the April prediction. The forecast for total revenue was similarly revised, to $14.4 billion. The forecast for the fiscal year 2015 also was revised downward, by 2.7 percent, to $14.9 billion.

Ketzenberger Ketzenberger

“This is the first time I’ve seen the economic forecast and the revenue forecast seem a little bit at odds,” said John Ketzenberger, president of the Indiana Fiscal Policy Institute.

The Indiana unemployment rate dropped by more than one percentage point over the year to 7.3 percent in November, the most recently reported figure. Also in November, Indiana added 25,000 jobs and recorded the fastest pace of job growth in the nation.

Despite the apparent growth, revenue came up short of forecast in November by $141 million, or 3 percent. Pence cut state agency and university budgets and said he would sell a state airplane.

tax-revenue-table.gifThat certainly was not the first time revenue has been off-target. However, “We get particularly nervous when the error is above 2 percent or so,” said John Mikesell, an Indiana University economist who is the non-partisan adviser on a six-person technical team that includes Republican and Democrat appointees. The technical team produces the forecasts for the State Budget Committee, which is made up of Republican and Democrat lawmakers.

The technical team believes discouraged workers are one factor. The unemployment rate only captures people who are seeking work. So when that pool shrinks, the rate improves, even if jobs aren’t widely available.

“We think the unemployment rate is not as effective at capturing the impact on household spending,” Mikesell said.

Indiana’s labor-force participation rate was 60.2 percent in 2013, four and a half points lower than in 1991. The long-term trend is rooted in an aging work force, but since the Great Recession it includes people who aren’t really old enough to retire, Ball State economist Mike Hicks said.

“It’s very hard when you’ve been out to easily re-enter the labor force. That’s what you’re seeing,” Hicks said. Even though manufacturing jobs are rebounding, a lot of Hoosiers with outdated skills are being left behind, he said.

The upshot for state coffers, Mikesell said, is that work force dropouts also ratchet down their household spending, generating less sales-tax revenue. He declined to predict whether many of the so-called discouraged workers will look for jobs again, but he said participation stats will be part of the forecast model unless that model stops working.

kenley-luke-mug Kenley

The budget forecasters tweaked their other tax-revenue models, as they often do, in December, and that appears to have improved their accuracy. But the revised revenue figures left Sen. Luke Kenley, chairman of the State Budget Committee, feeling less confident about cutting taxes and spending more on programs.

“I’m very skittish about this whole exercise,” Kenley said.

Nevertheless, he’s backing a tax-cut bill, Senate Bill 1, which would serve as a proxy for eliminating the business personal property tax, Gov. Mike Pence’s top priority for the short legislative session.

The Senate proposal hopes to avoid a $1 billion hit to local-government coffers by eliminating the tax, which is essentially an equipment tax only on those businesses claiming $25,000 or less a year. At the same time, the state would drop its corporate income-tax rate even lower.

The rate is scheduled to go from 8 percent to 6.5 percent by July 1, 2015, and the Senate proposal would push it down to 4.9 percent by 2019.

Kenley said lowering the corporate tax rate will help companies like U.S. Steel and Eli Lilly and Co., which also have some of the biggest equipment-tax bills.

The full impact of the corporate income-tax cut in 2019 would be $135 million a year, and at this point, the Senate does not have a way to offset that revenue. Kenley hopes the tax cut will pay for itself, as it attracts more big businesses to the state.

Ketzenberger said the state could probably absorb another corporate income-tax cut over several years, but it would come on top of other cuts already in motion. The Legislature last year eliminated the estate tax and began ratcheting down the state’s personal income tax rate, which is 3.4 percent, by 5 percent.

“I’ve said for a while now, it’s probably a good idea to step back and see what the effect of all these changes has been,” Ketzenberger said.•

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