COMMENTARY: Capital Comments: Indiana’s state budget in the coronavirus recession

How will Indiana’s state budget do in the corona-recession? We don’t know how deep the recession will be, or how long it will last, so there’s not much point to predictions. But we can ask what sort of recession the budget can handle, and what sort would cause trouble.

Here are three questions. One, can we fully fund appropriations in the 2020-21 biennial budget? The budget passed in April 2019 set appropriations based on a revenue forecast. If actual revenues fall too far below that forecast, spending will have to be cut. Spending cuts revert to balances, so they’re called reversions.

Two, can we keep balances above 5 percent of the budget? We had $2.3 billion in the bank last July, which was about 14 percent of the budget. We need at least 5 percent so the state can pay its bills on time. In the past 45 years balances have dipped below 5 percent only once—to 4.9 percent in 2004.

Three, for the next biennium, can we continue to provide the same services we’re providing now? The General Assembly will pass a budget next spring for the 2022-23 biennium. Inflation has been about 2 percent per year. Appropriations need to rise 2 percent to match this rise in prices.

No reversions, maintaining minimum balances, matching inflation. If the budget can do that, it has handled the recession. If not, we’ve got trouble.

Let’s consider a severe V-shaped recession. That’s a quick, deep downturn—like right now—with a quick, sharp recovery. Suppose revenues fall short of forecast by 25 percent in the last quarter of this fiscal year, April through June 2020. Revenues fall short of forecast by $1.3 billion, but we have balances to cover that and still fund the budget’s appropriations.

Suppose we climb out of the hole quickly, with 9% revenue growth in fiscal 2021. Revenues still fall 2 percent short of forecast, but balances remain at 5 percent by June 2021 with no reversions. If revenues grow by 4 percent per year in the next biennium, appropriations can rise 2 percent to cover inflation. Our budget can handle a V-shaped recession like that.

Now consider a severe U-shaped recession. Start with the same 25 percent shortfall in the second quarter, but let revenues in 2021 grow slowly out of the deep hole, by only 3 percent. Balances would drop below the 5 percent minimum. Spending would have to be cut, with reversions of $1 billion.

That happened in 2011 after the Great Recession. Reversions were $928 million. A billion dollar cut in spending would be about 6 percent. Some of it would have to come from K-12 education, since state aid to schools is almost half of the general fund budget. If revenues grew 4 percent per year in the next biennium, that billion dollar cut would remain in place for two more years. The budget can’t handle a severe U-shaped recession.

We can tweak these two scenarios all we want. How about a mild U-shaped recession? If the three-month shortfall is only 12 percent, instead of 25, and revenues recover by 3 percent, we’re OK. No reversions needed, and appropriations could cover inflation in the next budget.

How about an L-shaped recession, with a 3-month 25 percent drop, then a continued 13 percent shortfall in 2021? We’d need more than $3 billion in reversions, and appropriations would remain low by $3 billion through 2023. That’s a 19% budget cut three years in a row. A long, sustained recession would be a budget disaster.

The wild card is federal aid. During the Great Recession the federal government sent Indiana $2.2 billion over three years, and that helped a lot. The CARES act provided money to states for virus costs, but not to offset revenue losses. Perhaps that’s still to come.

The balances in the bank can sustain us in a mild recession, or a deep recession with a quick recovery. But a more severe recession will mean cuts for education aid and other state services.

Watch the revenue shortfall numbers from the budget agency in coming months. And if you know anybody in Congress, you might want to give them a call.

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