Pence 10 percent tax cut

THE STATE THAT WORKS:
PRACTICE FISCAL DISCIPLINE AND PUT TAXPAYERS FIRST

Policy Goal: Continue to practice the fiscal discipline necessary to make Indiana the state that
works by balancing budgets, maintaining adequate reserves, and using the next dollar for tax
relief.

Vision Plan Goals Served:
Goal #1: Increasing private sector employment
Goal #2: Attracting new investment in Indiana, with emphasis on manufacturing, agriculture,
life sciences and logistics

Policy Steps:
 Pass structurally balanced budgets without gimmicks or tax increases.
 Maintain reserves equal to at least 12.5 percent of appropriations.
 Allocate the structural budget surplus to enact a 10 percent, across the board income tax
reduction for every Hoosier and to further enhance our savings.
 Task the Office of Management and Budget to perform a new government performance
review called PACE (Program Accountability Comprehensive Evaluation) that will focus
on government operations and develop a plan to utilize performance-based budgeting to
fund core government functions.
 Practice the fiscal and debt management necessary for Indiana to maintain a top credit
rating.
 Enhance taxpayer transparency with a robust commitment to public disclosure at the state
and local level.

Rationale:
Every Hoosier should be grateful for the fiscal stewardship of Governor Daniels. His leadership
has left the state with more than $2 billion in reserves and a $500 million structural surplus in the
state budget. He has instilled a culture of performance management in state agencies, reduced
government debt, built our reserves and promoted transparency in government funds. All this is
reflected in the fact that Indiana has a top credit rating from all three major credit rating agencies.

We can never forget the fiscal situation that Governor Daniels inherited in 2005. The state had a
structural deficit of $820 million.1 Our universities and local governments, including schools,

1
See Indiana’s Fiscal Condition: A Different Set of Policy Choices, p.3, Indiana Fiscal Policy Institute (July 12,
2012), located at http://www.indianafiscal.org/pdf/IFPI-Report-on-Indianas-Fiscal-Condition.pdf.

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were owed over $700 million by
the state due to payment delays.2
Our reserves were functionally
non-existent, equaling only 0.2
percent of operating revenue in
FY2005.3 State government
agencies and programs were not
consistently measuring their
results.4 Finally and
unsurprisingly given the fiscal
mess that Indiana was in, the
state had seen its credit rating
lowered twice between 2002 and
2004.5

To make Indiana the state that
works, we must reject the Source: Calculations based on data from the Indiana Budget Agency
practices of borrowing, taxing
and spending that left Indiana broke before Governor Daniels took office, and embrace fiscal
discipline, living within our means, and performance-based budgeting and management, and
return the fruits of these efforts to the taxpayers who earned the money in the first place.

Indiana must continue to pass balanced budgets without gimmicks or tax increases. Each budget
must be structurally balanced, meaning that our annual expenses should not exceed the annual
revenue collected by the state. We cannot return to the practices of the past, where lawmakers
used tactics like raiding teacher pension funds or delaying payments to schools in order to
support spending that was unsustainable based on current receipts. Finally, tax increases to
balance the budget should absolutely be off the table. Government should live within its means,
just like Hoosier families.

2
Id.
3
Id at 4.
4
In 2006, when OMB issued their first report on performance management, they found that only 38 percent of state
programs had any performance measures in place. See Interim Report: Budgetary and Functional Review of
Executive Branch Agencies, p.4, Indiana Office of Management and Budget (January 2006), located at
http://www.in.gov/omb/files/OMB_Interim_Report.pdf.
5
http://www.in.gov/tos/files/BondRate.insideindianabusiness.com.pdf.

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The next governor will work with the General Assembly to produce a budget for FY 2014 and
2015. Assuming that revenue grows by 2.5 percent6 and appropriations grow by 1.5 percent,7 and
that funding for full day kindergarten is included in the next budget, the structural surplus will be
$516 million in FY 2014 and $667 million in FY 2015 (see Table 1 and Chart 1). Structural
surpluses are a sign of fiscal health and put Indiana in a position of strength nearly unheard of in
other states.
Table 1: FY 2014/2015 Surplus Projection (amounts in millions)
FY 2013 (projected) FY 2014 (projected) FY 2015 (projected)
General Fund Revenue $14,432 $14,793 $15,163
Projected Growth Rate n/a 2.5% 2.5%
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Other Revenue $205 $223 $223
Total Revenue $14,637 $15,016 $15,386
General Fund $14,318 $14,532 $14,750
Appropriations
Projected Growth Rate n/a 1.5% 1.5%
9
Other Spending ($107) ($31) ($31)
Total Spending $14,211 $14,501 $14,719
Structural Budget $426 $516 $667
Surplus
Source: Calculations based on data from Indiana Budget Agency. Totals do not add due to rounding.

In addition to a healthy structural surplus, it’s important that the state continue to maintain
adequate reserves. Good kitchen table budgeting provides a strong savings account for
unexpected emergencies. Reserves also serve as a last line of defense for taxpayers in an
economic downturn. Currently, the state has very healthy reserve levels, exceeding $2.1 billion
in FY 2012 and projected to exceed $2 billion at the end of FY 2013.10 These levels exceed 14
percent of appropriations in each of those fiscal years (see Chart 2). Moving forward, the state
should maintain reserves at a minimum of 12.5 percent of appropriations, to adequately protect
taxpayers in a downturn or emergency situation.

6
The current state revenue forecast predicts 2.5 percent general fund revenue growth in FY 2013.
http://www.in.gov/sba/files/rev_forecast_20111214_revenue_forecast.pdf
7
Appropriations growth in the current biennium (FY 12/13) is 0.7 percent. Given Indiana’s fiscal health, it’s
reasonable to assume that appropriations growth will roughly double in the FY 14/15 biennium.
8
Includes, most significantly, revenue collected from the Quality Assessment Fee (QAF) and the Hospital
Assessment Fee (HAF).
9
Includes full day kindergarten augmentation and reversions.
10
http://www.in.gov/sba/files/FY_2012_Surplus_Statement.pdf.

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With adequate reserves in place and a strong budget surplus, the state will need to determine how
to allocate the surplus. Surplus
funds are the result of years of
careful, prudent management
of state resources, and they
must be managed with the
same level of care. Therefore,
they should be allocated to
further enhancement of broad-
based tax relief for Hoosiers
and further enhancement of our
reserve accounts.

The state should first allocate
the surplus to phase in a 10
percent, across-the-board
reduction in the state’s
Source: Indiana Budget Agency individual income tax rate (see
Table 2). The rate would be
reduced by 5 percent in FY 2014 and another 5 percent in FY 2015.11 This would reduce
Indiana’s state income tax rate from 3.4 to 3.06 percent.

Table 2: Proposed Allocation of Projected Budget Surplus
FY 2014 FY 2015
Projected Budget Surplus $516 million $667 million
Phased in 10 percent reduction $261 million $534 million
in individual income tax rate
Transfer to Reserves $255 million $133 million
Source: Calculations based on data from the Indiana Budget Agency

While Indiana has relatively low tax rates and a competitive tax system overall,12 Indiana has an
“all of the above” tax system as shown by our middle of the pack ranking on state and local tax
11
The current revenue forecast projects that Indiana will collect a little over $5 billion in individual income tax
revenue in FY 2013. See http://www.in.gov/sba/files/rev_forecast_20111214_revenue_forecast.pdf.
12
Indiana ranks 11th best on the Tax Foundation’s State Business Tax Climate Index.
http://taxfoundation.org/article/2012-state-business-tax-climate-index.

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burden paid by Hoosiers.13 Furthermore, neighboring states like Illinois are raising taxes due to
their inability to control spending, while states like Michigan and Ohio are looking at tax
reductions. An across the board tax cut for all Hoosiers would send a strong signal that we are
managing our funds wisely and also reducing the tax burden on our taxpayers and businesses.

For a family of four in Indiana, the tax cut will be more than $228.14 For a small business with
net income of $300,000, the tax cut will be more than $1,000. In total, this will deliver a tax cut
to approximately 92 percent of all business establishments in the state which pay through the
individual income tax, providing a direct jolt to the Indiana economy by allowing them to hire
more and invest more.15

A 10 percent, across the board income tax cut would also give Indiana the lowest tax burden in
the Midwest. According to the Tax Foundation, Indiana’s state and local tax burden is currently
second lowest in the Midwest (see Table 3). Reducing income taxes by $533 million per year
would give us the lowest overall tax burden in the Midwest. Achieving the lowest tax burden in
the Midwest would be a major improvement in our state’s overall business climate and even
better position Indiana to grow private sector jobs and attract new investment.

Table 3: Income Tax Cut Gives Indiana Lowest Taxes in the Midwest
State State/Local Tax Rank (1st is lowest) State/Local Tax Rank (1st is lowest)
Burden Burden (with
income tax cut)
Illinois 9.97% 6 9.97% 6
Indiana 9.49% 2 9.25% 1
Iowa 9.53% 3 9.53% 3
Kentucky 9.28% 1 9.28% 2
Michigan 9.67% 4 9.67% 4
Minnesota 10.29% 7 10.29% 7
Ohio 9.71% 5 9.71% 5
Wisconsin 10.98% 8 10.98% 8
Source: Calculations based on data from the Tax Foundation
13
Indiana ranks 25th (1st is highest) on tax burden as a percentage of personal income.
http://taxfoundation.org/article/indianas-state-and-local-tax-burden-1977-2009.
14
Median income for a family of four in Indiana in 2010 was $67,296. See State Median Family Income by Family
Size (1-Year), available for download at http://www.census.gov/hhes/www/income/data/statemedian/.
15
According to an analysis by Robert Carroll and Gerald Prante, 92 percent of Indiana business establishments are
non C-corporations, which means their business income is taxed via the individual income tax system. http://www.s-
corp.org/wp-content/uploads/2011/04/Flow-Through-Report-Final-2011-04-08.pdf.

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It is also recommended that the state set aside $255M in budget surplus in FY 2014 and $133M
in FY 2015 to further augment the state’s reserve accounts. This is recommended not only as
cushion against a future downturn, but also to give the state additional flexibility to meet future
challenges or investment needs.

After allocating the surplus to a 10 percent income tax cut and further enhancement of our
reserve accounts, Indiana would remain in a strong fiscal position. Reserves would equal 14.3
percent of appropriations at the
end of FY 2014 and 15.0
percent of appropriations at the
end of FY 2015 (see Chart 3),
putting the state in an even
stronger position to address
future challenges.

This plan is responsible and
flexible, puts taxpayers first,
and will grow our economy
instead of growing government.
If economic circumstances
change before or after the
budget passes, we will have
additional flexibility in our
reserve accounts to manage the
changing circumstances. The Source: Calculations based on data from Indiana Budget Agency
phased-in nature of the tax relief
will give us two years to monitor how it is impacting the bottom line. This plan puts taxpayers
first while also giving the state flexibility to meeting future challenges.

State government also should continue to manage taxpayer funds to deliver results for taxpayers
in a cost-effective, efficient manner. In 2005, Governor Daniels ordered OMB to review the
budgets and functions of each executive branch department, agency, and instrumentality for the
purpose of finding cost-saving efficiencies and establishing performance measures.16 This effort
was called the PROBE (Program Results: an Outcome Based Evaluation).

16
See Executive Order 05-02, located at http://www.in.gov/gov/files/EO_05-02_Creation_of_OMB.pdf.

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A fresh comprehensive review should be undertaken, called PACE (Program Accountability
Comprehensive Evaluation). Under PACE, OMB should review all agency performance
measures, including an evaluation of program performance since the measures were adopted.
OMB should concentrate its review on those policy areas that are most crucial for job growth,
such as education, regulatory,17 tax, and transportation. In addition to efficiency review, each
program should be explicitly measured for its support of private sector job growth.

After this review is complete, OMB should prepare a plan to move from performance-informed
to performance-based budgeting, including the adoption of a performance-funding matrix that
will guide budget development and the budget management process.18 Taxpayers deserve to see
their hard-earned dollars flow toward programs that work and away from programs that don’t.
Programs that consistently fail to meet their measures should be re-evaluated. To support
performance-based budgeting, OMB should devote management resources to agencies and
programs that are not meeting their performance targets, to assist agencies with best performance
and financial management practices.

Indiana currently has a top credit rating from all three major credit rating agencies.19 A top credit
rating is more than just a tool for acquiring low-interest debt. It is a market signal of the state’s
fiscal health. Indiana’s underlying strengths in its balanced budget, sound fiscal management,
low debt per capita, and an ever-diversifying economic base provide the foundation for a top
credit rating. Conversely, losing a top credit rating would put Indiana at a competitive
disadvantage with other states and increase the State’s cost of doing business. Therefore,
maintaining a top credit rating should be a continued priority.

With billions of dollars running through the hands of state lawmakers, the public has the right to
know how their dollars are spent. Under the leadership of Governor Daniels, the state established
the Indiana Transparency Portal and the Gateway system for state and local governments and
developed the first tax expenditure reports for taxpayers. As technology changes and
information becomes increasingly easy to access, so too should government disclosure of its
financial condition be easier to access.

17
OMB’s new performance review will be integrated with the OMB regulatory review that Candidate Pence
announced earlier.
18
OMB’s 2006 report called for moving toward a performance-informed budgeting process.
19
INDIANA FINANCE AUTHORITY, INVESTOR RELATIONS, available at http://www.in.gov/ifa/2717.htm.

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Building on the success of Governor Daniels, there are several enhancements that can be pursued
to offer further transparency to taxpayers. First, the tax expenditure reports should be codified
and presented on an annual or biennial basis. Second, state government should begin processing
all contracts electronically to improve transparency for taxpayers and efficiency for government.
Third, we should ensure that all documents posted on the Indiana Transparency Portal are easily
searchable by the public. Fourth, OMB’s review of existing performance metrics should include
a review of how they are presented to the public on the Indiana Transparency Portal. Finally, a
gubernatorial commission should be established, consisting of local units of government, local
businesses, and concerned citizens, to review the Gateway project and begin to develop an
understanding of important financial metrics at the local level.

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