Indiana’s Revenue Rebound (and Post-COVID Challenges)

There’s growing — if cautious — optimism about Indiana revenues as lawmakers craft the next state budget. As we wait for the Senate’s take on HB1001, we also approach the one-year mark for COVID restrictions hitting our economy and tax collections. But early fears of an extended period of pandemic-induced austerity have eased — and the past week brought more reason for guarded relief about the scale of Indiana’s fiscal challenges (at least over the next two-year budget cycle).

The February state revenue report released Friday exceeded monthly expectations by nearly $150 million, based on the December ‘20 revenue forecast. Individual income taxes beat projections by $90 million, though explained by a later-than-usual start to federal tax season (the state paid out fewer tax refunds than a typical February for a better bottom line total).

The more significant positive news is that sales taxes, Indiana’s largest source of general fund revenue, beat the latest forecast by $62 million. That’s also 10% higher than February 2020, our last “normal” (pre-COVID) month. Indeed, Indiana’s reliance on the sales tax has been a fiscal strength through this crisis.

After steep declines last April and May, sales taxes largely rebounded by summer as consumer spending stabilized. This was in part thanks to the first wave of stimulus checks and federal action to extend and enhance unemployment benefits. (Indiana personal income is likely to show growth in 2020, primarily due to this influx of federal relief.)

That means Congressional action on the $1.9 trillion American Rescue Plan could deliver another boost to Indiana’s budget prospects. Even though our unemployment rate has improved significantly since last summer, more direct stimulus and the extension of enhanced unemployment through Labor Day will help sustain Hoosier buying power (and sales tax revenues) as we continue to rebuild from COVID.

What does this mean for Indiana’s next budget?

April’s revised revenue forecast could improve on the December estimates, which anticipated about $2 billion in growth over the current COVID- biennium to arrive at $34.95 billion in general fund revenues for FY2022 and 2023.

The April update is an important guidepost for legislators in the homestretch of budget negotiations, a final check on predicted resources against spending priorities. A stronger outlook isn’t likely to significantly reshape current proposals or add momentum for costly new programs in the waning days of the session. But it could help bridge some of the modest differences among the Governor, House and Senate — accommodating a funding increase for higher education in both years of the biennium, or easing limits on K-12 support for students in poverty while expanding school choice scholarships.

If recent developments do point towards a more robust revenue forecast, the added spending flexibility could help build quicker consensus among budget conferees to close out this socially-distant session.

But wait — a cautionary note about deeper economic challenges:

There are still clouds beyond this silver lining.

Indiana also avoided a tougher fiscal climate for a few structural reasons: Public health restrictions affected spending on services more dramatically than tangible goods, the reverse of a typical recession. Indiana is a manufacturing-heavy state that levies sales taxes on goods but not services — so both the dominant sector of our economy and our largest state revenue stream escaped the worst effects of the pandemic.

But taking a closer look at February revenues reveals pre-existing economic challenges compounded by COVID: Taking away the unusual timing of tax refunds noted above, individual income tax withholdings were actually below forecast by $37 million. Indeed, most of the state’s revenue shortfall through the pandemic was attributable to income tax losses (in contrast to most states).

A recent report from the Brookings Institution notes that Indiana’s economy produces too few high-quality, family-supporting jobs, especially as the state has lost ground in ‘advanced industries’ over the last decade (despite bright spots like the high-tech boom in Indianapolis). A longer-term view reveals that we were also slow to recover in employment and earnings from the 2001 and 2008 recessions.

Much of the hardship of the COVID downturn has also fallen on lower-skill, lower-wage employees. The economic outlook presentation to the State Budget Committee in December confirms that high-wage jobs had fully rebounded from the economic shock by October, while low-paying positions were stalled 14% below January 2020 levels. Federal relief masked the full fiscal impact of payroll losses.

A lower unemployment rate is one barometer of Indiana’s recovery. Just as important are average incomes, creating higher-wage, higher-skilled jobs through advanced industry investment. That’s Indiana’s deeper fiscal challenge: Not just restoring the state budget to its pre-COVID trajectory, but making sufficient investments in education, workforce and economic development, local quality of life and regional competitiveness to build a stronger economy and more resilient revenue structure against future crises.

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