Morton J. Marcus, an economist formerly with the Kelley School of Business, Indiana University
If we are lucky, by the time you read these words the Indiana General Assembly will have passed a new budget. Democrats use tarot cards and Republicans chicken innards to determine how much to spend. There are alternatives.
In some states, changes in the level of the budget are driven by the percent change in personal income (PI). Two weeks ago, the U.S. Bureau of Economic Analysis released its latest estimates of quarterly state PI. Where U.S. PI grew by 0.8% from the first quarter of 2008 to the same quarter in 2009, Indiana advanced only 0.4%. There were 16 states that performed worse than we did.
If Indiana's budget was linked to PI, the legislature would have an easier time. The budget for next year would rise by 0.4%. The question would become: "Which agencies and functions of government should get how much of that small increase in funding?"
If we were going to hang state spending on some statistical star, PI is not the best choice. Look again at first quarter 2008 to 2009. PI in Indiana rose by 0.4% without adjustment for inflation. However, that figure doesn't tell the real story of Indiana's economic performance in the year.
When times are tough, many workers lose their jobs and collect unemployment compensation. As we know too well, that puts a strain on our state's finance. In the past year, unemployment compensation payments tripled in Indiana. If we exclude these payments, PI did not increase by 0.4% but declined by 0.3%.
Farm earnings are highly volatile; there can be wild swings depending on government subsidy payments and sudden speculative activities. In our year-over-year comparison for the first quarters of 2008 and 2009, Hoosier farm earnings declined by 23%. We do best to focus on the non-farm sector of the economy which is far larger and more stable.
While thousands of Hoosiers in the private sector were losing jobs or taking pay cuts, earnings in the public sector rose by 4.8%. (During this period, state government shrank by 2.1% -- a loss of 2,400 job, while local government employment increased by 1.8% or 5,230 jobs.) With the government and farm sectors excluded, PI in Indiana declined by 0.7%.
Included in PI are dividends, interest, and rent. This sector was down in the past year (-0.2%). You see dividends and interest credited to your retirement account statements. But you aren't able to spend that money and you don't pay taxes on those receipts until you cash in the account. It doesn't make sense to include those funds, whether they go up or down, in any consideration of this year's income.
The same applies to contributions made by employers to social security, health insurance and other benefits for their workers. They are not funds available for current spending.
What should be the guideline for government spending if we throw out all these components of PI? We could use wages and salaries paid to employees in the private sector, plus government transfers to individuals (Social Security, welfare, Medicare, Medicaid, and certain pensions), plus Non-farm proprietors' income (less their contributions to social insurance programs).
This nameless sum declined by 0.4% in the twelve months we have been discussing. If we linked state spending as outlined here, there would be no foundation for increasing the state budget beyond its previous level; unless a strong case could be made that existing services will be harmed seriously by operating without additional funds. And if such harm can be substantiated, we have a rainy day fund to help out.
I am not recommending this approach, but it would be better than seeing our representatives continue to sail without a rudder in stormy waters.