How Daniels Got His Budget Act Together

The lessons from Indiana’s playbook
By Christopher Ruhl

 

After more than six years in office, Indiana Gov. Mitch Daniels has earned a reputation for smart fiscal discipline. It’s easy to forget the problems he inherited when he took office in early 2005.

The state had an annual public expenditure growth rate of 6% during the previous decade. The state was consistently paying out more than it was collecting in annual revenue, and had been running a negative cash balance for years, with debts exceeding cash balances.

To pay its bills, the state had forcibly borrowed more than $700 million from local governments, schools and public universities. And it raided the teachers’ pension fund as well.

Today, Indiana has an AAA rating from all three credit rating agencies — one of only nine states to enjoy such a privileged status. What turned things around?

Gov. Daniels implemented a four-step plan to restore fiscal health when he took office: Balance the budget, pay back debts, build net worth, and cut taxes.

To balance the budget, the rate of spending growth had to be slowed. This was achieved through a combination of initiatives. We looked for ways to introduce competition into service delivery, consolidate overlapping services, implement health savings accounts and employ hawk-like discipline as we reviewed whether jobs that opened up through retirement and attrition needed to be filled.

As a result, the rate of spending growth slowed from 6% to 2%; indeed, Indiana’s spending between 2004 and 2008 increased at one-third the rate of most other states.

We turned around the budget situation and structurally balanced it four years running as a result of these reforms.

The governor also negotiated a deal that transferred a money-losing toll road to experienced private-sector operators — creating a nearly $4 billion pay-out that eliminated a multibillion-dollar infrastructure backlog without raising taxes or incurring new debt.

Gov. Daniels knew that we had to institutionalize sound budgeting practices. So he created an Office of Management and Budget (OMB) to oversee seven separate financial agencies that were previously uncoordinated.

Within OMB, he created a Government Efficiency Division to measure agency and program performance. Its job is to set clear performance standards and hold agencies accountable. No more business as usual. Accountability and performance became the cultural imperatives of the entire government.

States can get into deep trouble when they use borrowing to avoid difficult budget decisions. We took multiple debt-issuing authorities and combined them into a single agency (the Indiana Finance Authority), which is housed within OMB. Gov. Daniels made it a priority to increase oversight and coordination of state borrowing.

Accountability, performance, cost-benefit analysis, consolidation — this kind of discipline enables you to focus on other key priorities such as paying off debt and building reserves. We were able to pay off the $700 million forcibly borrowed from other governmental units in the governor’s first term and reduce total outstanding debt by $1.4 billion.

Indiana has now enjoyed five straight years of positive cash balances, reaching a high point of $1.3 billion in cash reserves and rainy day funds with no debts to other units of government.

We have been able to achieve these results during a debilitating recession because Gov. Daniels began implementing his reforms when it wasn’t popular to do so. Many states are now discovering this kind of discipline out of necessity. Indiana embraced it out of principle.

The reforms are critical to making sure taxpayer dollars are spent efficiently and effectively. When this is done, the benefits need to be directed into taxpayer savings that will support productivity and growth.

In the governor’s first term, we passed major business tax cuts, research and development initiatives, and a phase-in for property taxes on purchases of new equipment and machinery.

In 2008, we enacted a significant property tax reform package that was the largest tax cut in state history. It resulted in a net reduction of $600 million in Hoosier taxes in 2010 and capped homeowner taxes at no more than 1% of a home’s value.

Though we haven’t succeeded yet, the governor is trying to further reduce taxes by adding an automatic tax refund for Hoosiers when state reserves exceed 10% of budgeted appropriations.

Such a reform creates a new constituency for government performance. If voters know they get a refund when government is run well and spending is constrained, lawmakers will be less likely to let the spending interests dictate the contours of the budget debate.

Through the Indiana equivalent of impoundment authority, we achieved $2 billion in spending cuts in the 2009-2011 budget cycles, as the recession reset state revenue to levels not seen since the mid-2000s.

We cut most state agencies by 25%, enabling the state to prioritize education and public safety spending by cutting those by lesser amounts. Taxpayer satisfaction with government services is up, and the state is running well.

That’s because our reforms were enacted before the recession began. And doing more, or as much, with less was already in Indiana’s DNA.

The AAA rating was the capstone of our multi-year track record in Indiana. But there are other important results. The number of state employees has been cut to the 1970s level. We have had no tax increases during a time when the majority of states raised taxes to meet their spending obligations. (Our neighbor, Illinois, recently raised income taxes by 66%.)

Finally, even in the wake of a tough, protracted recession, Indiana’s cash reserves are strong. We will have an estimated 5% of our budgeted appropriations in reserves at the end of 2011, with a plan in place to grow those over the next two-year budget cycle.

States have most, if not all, of the tools they need to get their fiscal houses in order and become attractive destinations for investment. Indiana is a story of taking what we know works for families and businesses and applying it to the business of government: Spend within your means, use borrowed money frugally, set aside money in a savings account and, most importantly, keep taxes low.

It takes discipline, leadership and consistency from the state’s CEO. I’m privileged to share these successes on behalf of our CEO, Mitch Daniels, who has instilled these principles since his inauguration in 2005.

Christopher Ruhl is the director of the Indiana Office of Management and Budget.

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