Indiana had a $700 million deficit at the start of 2005 and a $2 billion surplus by end of 2012. During this seven-year stretch, America experienced the worst economic crisis since the Great Depression. All across America, states were facing fiscal crises during this period, but not Indiana. Why?

The Pre-2005 Landscape: Fiscal Laziness

Like many other states, Indiana knows what it’s like to be bankrupt. That was effectively its status in 2004 when Mitch Daniels was elected Governor. Like other states, Indiana was accustomed to punting certain expenditures into the future through various accounting gimmicks so that the state’s budget would appear sound in any given fiscal year. But there was no hiding the reality that Indiana was fiscally unbalanced. Balancing the state’s budget was an immediate priority to make the state more competitive and to protect taxpayers.

To get Indiana out of its fiscal straits, the Daniels administration utilized authorities that are, in on way or another, generally available to other states. They had certainly been available to Indiana’s previous governors, who had chosen not to use them.

Whether a state’s budget is balanced or out of whack is almost always a story of whether there is the political will and discipline necessary to use available statutory authorities to maintain fiscal prudence. Critical to Daniels’ success in Indiana was an understanding of how to combine new forms of oversight and accountability with existing cost-controlling authorities. Each of these elements is described below.

State governments are supposedly forced to operate balanced budgets. They do not have the luxury of printing money as the federal government does. They cannot run structural deficits the same was the federal government can. But many appropriators in states across the land have mastered the art of hiding or moving funds illusorily through a variety of techniques. Indiana was no exception. In addition legislators and special interests alike enjoyed operating in Indiana’s fiscally lazy environment, which was sustained by the absence of any central accounting and budgeting. Agencies did their own budgets and the Governor’s office traditionally had no systematic way to analyze costs and control expenditures.

From day one, Daniels put reforms into place to address these systemic dysfunctions, and he has earned a national reputation as America’s most fiscally disciplined governor as a result. As Indiana implemented structurally balanced budgets, shed its negative cash balance, and developed healthy cash reserves, it became one of just nine states with a AAA credit rating.

This much is known by just about every political observer. Fewer commentators can tell you how Daniels achieved all these good things, however.

Tools for Creating a Structurally Balanced Budget

The best time to be fiscally tough is during good times. And yet, any governor and state legislator will tell you that discipline during good times is probably harder than making tough fiscal decisions during bad times. Reining in spending when there seems to be so much money to go around is even frequently described as morally suspect.

So how do you do it? In the Indiana Story, Daniels used five main tools to bring Indiana’s budget into balance, and ultimately into a surplus:

• He created the Office of Management and Budget
• He used impoundment authority aggressively and relentlessly
• Reducing unnecessary workforce costs
• Competitive outsourcing
• Consolidating IT

Each of these will be discussed in more detail below, but it would be disingenuous to dive into those details without addressing the all-important matter of leadership and moral resolve.

The Intangible that Makes all the Tangibles Work

The inertial drag on governing is real, persistent and strong. There is a reason why even the easiest of policy reforms get stuck in the mud or transformed during the policy process into something other than what they were supposed to be. As noted earlier, Indiana’s previous governors had the same tools that Mitch Daniels had when he entered office. He used statutory authorities to rein in spending that were on the books before he arrived.

The difference was that overused word, leadership. It wasn’t just any leadership, though. By the time Mitch Daniels left office after his second term, he had reduced the public workforce to levels not seen since the 1970s and cut spending in virtually every area of the government, and yet his approval ratings were in the 60s. Aren’t the masses supposed to protest when a forceful cost-cutter diminishes the services they rely on? Isn’t the friend of seriously limited government  the same things as a heartless enemy of the poor?

These familiar memes fall flat in the Indiana story because of Daniels’ unique leadership style. From his unprecedented tour around Indiana during the 2004 campaign, he heard regularly about frustrations Hoosiers had with public services. He picked his battles accordingly, not according to a pre-baked ideological theory. He also anticipated what all of America came to see years later during the 2011 protests in Wisconsin: the more taxpayers learn about how their dollars are being used by the government sector, the less sympathy they have with the usual memes.

Daniels made transparency a core pillar of his reform efforts from the beginning, explaining in frank detail why programs needed changing, why budgets needed trimming, and how citizens could check in on how his reforms were going. By publishing regular performance reports, he opened up his books to the public so they could be the judge of whether, say, there was a direct relationship between reduced spending and quality of service in a particular program. When opposition arose to one of his proposals, such as leasing the Indiana Toll Road, he hit the road himself, went to town halls, met with people in diners. He took people’s questions in person, he asked them how they would fix the problem another way if they didn’t like his idea.

It may sound like too simplistic a summary to say Daniels treated people like adults, but when one asks people in Indiana about their experience with Daniels as Governor, that’s what they frequently say. He took on real problems that others, when they were honest, had to admit were actually problems that could no longer be tolerated if Indiana wanted to be a great state. He laid out what he thought was the most sensible solution that put citizens first, and challenged opponents to explain why their ideas were better for the people of Indiana. He won a large swath of the public to his side this way on issue after issue.

The Five Tangibles

Only after the intangible of quality of leadership is understood, or at least contemplated, can one begin to see why the tangible tools work. Or why they worked in Daniels’ case, at least.

Creating the Office of Management and Budget

Governor Daniels’ creation of the Indiana State Office of Management and Budget (OMB) in January 2005 was perhaps the single most important step in restoring Indiana’s fiscal health. Prior to its creation, the state had no system for measuring government performance. Government – as is the case in many other states – just kind of “happened” with relatively undisciplined oversight of budgetary and fiscal matters.

Governor Daniels charged the new agency with increasing accountability and improving government performance while bringing balance to the state budget. To accomplish these tasks, he created a Government Efficiency division by setting clear performance standards and employing techniques to hold agencies accountable. The division has significantly increased the availability of performance information available to decision-makers and has also made that information readily available to the public through the Performance Measure Dashboard, which displays key performance measures for each agency. When the system was established in 2005, 62 percent of results were rated unsatisfactory and 16 percent superior. By August 2008, unsatisfactory measures had dropped to 28 percent and superior measures had risen to 45 percent.

Additionally, Governor Daniels created the Indiana Finance Authority, also housed within the OMB, to combine multiple debt issuing authorities into a single agency in order to ensure that Indiana didn’t use borrowing to avoid difficult budget decisions. This division has significantly contributed to the development of structurally balanced by budgets by equipping decision-makers with key information concerning the financial impact of certain decisions.

Impoundment Authority

The State Budget Agency and the OMB dispense appropriations to agencies periodically throughout the year. Through impoundment authority, the governor has the authority to dispense less than the amount appropriated to agencies. Every governor in America should seek to have this authority if he or she doesn’t already possess it. It’s critical to sound fiscal management. This tool is useful when revenues are less than projected, but it is especially useful when a governor is serious about trimming government where it has gotten too big. Daniels used impoundment authority to shrink agency budgets from one year to the next, correcting years of swelling budgets that benefited government objectives more than the public good.

Impoundment authority reduced expenditures by nearly $3 billion during the period between when Governor Daniels first took office and 2012. Indiana’s balanced budget efforts would have been entirely different had Daniels chosen to do what his predecessors did – largely ignore impoundment authority.

Reducing Workforce Costs

Governor Daniels has overseen a 16 percent reduction in the number of state employees, a return to employment levels not seen since the late 1970s. During the same time that state employee rolls were dropping, customer satisfaction with government services increased. So much for the theory that larger government is a necessary precondition for the happiness of the people.

How did the Daniels administration achieve its workforce reductions?  By prioritizing a pay-per-performance bonus system, slowing hiring through prioritization rather than a hiring freeze, and revoking or declining to renew collective bargaining for government workers.

On his first day in office, Governor Daniels terminated an existing executive order that gave public employee unions collective bargaining rights, the benefits of which were twofold: it reduced the political pressures that often stagnate state governments and allowed him to create incentives to reward employee performance. He implemented a pay-for-performance system, with bonuses ranging between four and ten percent, to reward employees for achieving hard-dollar savings, meeting or exceeding explicit agency goals, and/or improving customer service in place of the common public sector practice of across-the-board raises. And perhaps most importantly, he created a strategic hiring committee to prioritize new positions for hiring. Agencies are required to provide evidence that each new hire is critical to advancing their mission. When you as a government agency know that you will have to justify each new hire to the Governor’s office, it’s amazing how judicious you become. You begin to think about new hires more like small business owner would. As a result of this process, Indiana’s government was able to control overall hiring levels without implementing a hiring freeze.

Competitive Contracts

Competitive sourcing is not a new concept. But using it effectively is still a rarity. Governor Daniels directed agencies to review existing contracts and create new contracts in a way that both reduces costs and provides better quality for the citizens of Indiana. Over the past twenty years, many public officials have used competitive bids with the aim of lowering costs, often looking for just a few big wins to demonstrate their commitment to “innovation.” In Indiana, competition has become the modus operandi of the state government and is used in even the most mundane, “non-sexy” aspects of government. The Daniels administration consolidated the systems of major welfare programs in 2007 to the tune of $10 million savings annually and realized $29 million in savings by re-negotiating the state’s Medicaid systems, but it also saved $1.6 million by privatizing its mail and document delivery system the same year. The list of small-item savings goes on and on. Taken together, the long list of savings through competition has played a big role in the larger story of Daniels’ success as a cost-cutter.

Consolidate Information Technology Services

Indiana consolidated information technology (IT) departments in different agencies into a single IT agency. This agency has been highly effective and has focused on improving IT capabilities of the state government and has also sought to reduce staffing burdens for certain services by providing self-service options for certain services. The most notable example of this is the Bureau of Motor Vehicles, which has received national media attention. By allowing customers to access a number of services online, such as renewing their drivers licenses and license plates among other things, the average wait time was reduced from more than 40 minutes to 28 minutes in 2006, to about 12 minutes in 2007, to 8:54 minutes (to be exact) in 2008 – and single-digit wait times have held steady since then. As a result, customer satisfaction rose to 97 percent in 2008, an increase of 20 percent since 2005.  Together with the new performance culture that OMB created across government, IT consolidation can go a long way to improving both service quality and satisfaction.

The Benefits of Balanced Budgeting

The aggressive approach Daniels took to balance the budget made possible the historic property tax relief that he signed into law in 2008. Without three straight years of building reserves on top of the balanced budget, it would have been next to impossible to address Indiana’s tax situation the way Daniels did.
Figure 3: Balanced Budget & Reserves Make Historic Tax Relief Possible

Here’s what balanced budgeting has wrought in Indiana:

• Inflation-adjusted per capita state spending declined 13.6 percent from 2005 through 2012.
• Indiana’s debt was paid off in Governor Daniels’ first term. Indiana has now enjoyed seven straight years of positive cash balances, reaching a high point of $2.155 billion in cash reserves and rainy day funds with no debts to other units of government.
• Indiana has gone from the verge of bankruptcy to having fifteen percent of its budget in cash reserves by the end of 2012.
• Indiana’s government workforce is 20 percent smaller today than when Daniels took office. Unlike other states, these reductions were not because of the economic downturn, but intended as part of Daniels’ overall reform efforts.
• Indiana’s credit rating was upgraded to AAA, the highest rating, and is only one of nine states to enjoy such a rating as of the end of 2012.
• Though the use of the impoundment authority, the state has saved nearly $3 billion. More than $2 billion of these reversions occurred in the 2009-2011 budget cycles as America (and Indiana) struggled through the after-effects of a brutal recession.
• Expenditures have grown only 1.3 percent annually during Governor Daniels’ time in office. This is the result of parlaying spending reductions into reduced appropriations in subsequent Governor’s recommended budgets, permanently reducing base expenditure levels.

These kinds of benefits are not free. They take a willingness to confront so-called indispensable interests with a harder truth: what is indispensable to some is clearly dispensable for the sake of the general public.

To do this, a leader needs the capacity and patience to win people over to the course of prudence, which isn’t always easy – but is always necessary. One of the guiding objectives for Daniels since election day, 2004, was to always seek to maintain the approval of the public for the big things that were necessary for Indiana to aim higher. By consistently explaining, devoid of ideological edginess, how budget sobriety benefited taxpayers and was in fact what was owed them, voters supported Daniels’ balanced budget efforts. This in turn put pressure on some lawmakers who may not have otherwise cooperated.

Daniels consistently connected the rather technocratic task of budget reviews with agencies to the voters’ interest in living in a state that was an appealing place to do business and raise a family. In the end, if balancing the budget is the people’s business, they need to feel it is so. One of the Daniels’ most enduring legacies will be his success in engaging the interests of his fellow citizens in holding the State to entirely new, elevated standard when it came to public finances and performance.