Indiana Mulls Local Income and Property Tax Reforms

This legislative session, local taxes are a major topic of debate in Indiana. Although the state’s property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. system is already nationally competitive, dramatic increases in assessed values have created discontent in recent years. Governor Mike Braun (R) proposed a significant reform aimed at reducing the growth of property taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. bills. After several rounds of discussion in the General Assembly, both the Senate and the House introduced their own proposals to amend the structure of local taxes in Indiana. While the debate continues, this blog post reviews the existing local tax system in Indiana, analyzes the major elements of each proposal, and discusses potential risks associated with replacing property taxes with local income taxes.

The Existing Local Tax System in Indiana

Localities in Indiana have two primary sources of tax revenue: property taxes and local income taxes. While property taxes have traditionally been the most important source of revenue, local income taxes have gained momentum in recent years. As of 2022, property taxes accounted for about 83 percent of local tax revenue, while local income taxes were at 12 percent.

Indiana’s property tax system ranks fifth best nationwide on our State Tax Competitiveness Index. The state sets property tax caps as a percentage of a property’s gross assessed value: 1 percent for homesteads, 2 percent for other residential and agricultural property, and 3 percent for commercial property. Indiana also offers generous homestead exemptions for owner-occupied dwellings (both standard and supplemental). Additionally, the state imposes a levy limit (maximum levy growth quotient, MLGQ), which is set annually (e.g., 4 percent for 2025) for all local government units. This limit depends on the growth of personal income in prior years, along with other socioeconomic factors. The MLGQ determines the maximum dollar amount each locality can collect in property taxes in a given year.

In recent years, median housing values, even adjusted for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. , have skyrocketed nationwide. From 2014-2023, Indiana experienced a 27.6 percent appreciation of inflation-adjusted housing values, slightly lower than the nationwide average (28.9 percent) but higher than all other neighboring states except Michigan.

At the same time, due to existing property tax limitations, inflation-adjusted median property taxes paid by homestead owners increased by 8.1 percent—lower than the nationwide average and Kentucky, but higher than in Ohio, Illinois, and Michigan.

Overall, Indiana has had the lowest effective property tax burden among its neighbors since 2015. In 2023, Indiana homeowners paid an average of 0.74 percent of the value of an owner-occupied dwelling—lower than the nationwide average of 0.97 percent and the effective tax rates in Illinois (2.07 percent), Ohio (1.36 percent), Michigan (1.28 percent), and Kentucky (0.77 percent), indicating that the average cost of local services in Indiana is still relatively low compared to most other states.

However, local income tax rates have risen significantly since 2014, largely offsetting recent reductions in the state individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate. While Indiana’s state rate declined from 3.4 percent to 3 percent between 2014 and 2025, the average local income tax rate increased from 1.4 percent to 1.72 percent.

The availability of the property tax relief component within the combined local income tax rate already incentivizes some counties to shift revenue from property taxes to local income taxes, further increasing the variation in local income tax rates across the state due to the lack of uniformity in local income tax policy. Greater reliance on local income taxes carries certain risks: it raises the overall income tax burden in the state, with limited state-level control over these increases; introduces a more volatile revenue source that tends to decline during economic downturns, especially compared to property taxes; and may negatively impact employment, particularly in the long run.

Three Proposals

Gov. Braun’s Original Proposal

While running for office, then-candidate Braun proposed significant changes to the existing property tax system, including increasing the homestead deduction and capping property tax bill increases. Under the plan, the modified homestead deduction would allow all homeowners with an assessed value over $125,000 to deduct 60 percent of the assessed value, with an even higher deduction for those with an assessed value below $125,000.

Currently, the owner of a home assessed at $400,000 can take a standard homestead deduction of $48,000 and a supplemental deduction of $132,000, totaling $180,000 or 45 percent of the assessed value. Under the proposed system, they would be able to deduct $240,000. Additionally, property tax bill increases would be capped at 2 percent per year for seniors, low-income individuals, and families with children under 18, and 3 percent for other homeowners. This would effectively introduce a relatively strict assessment limit within the existing property tax system. As we have outlined elsewhere, assessment limits, while superficially appealing, ultimately yield wildly unequal tax burdens and make homeownership less affordable in the long run.

While the plan would provide relief to current homeowners (estimated to be around $1.3 billion in 2026, according to the fiscal note), it could create significant revenue shortfalls for local governments, particularly cities and school districts (they would lose $263 million and $536 million, respectively), limiting their ability to provide services or incentivizing them to seek alternative revenue sources.

Senate Amendments

The amended version of Senate Bill 1, introduced by Sen. Travis Holdman (R), presented a different vision for the local tax reform. Instead of increasing the homestead deduction and capping property tax bills, the revised bill included a more moderate set of proposals.

Specifically, the amended version implemented a significantly stricter levy limit, capping the MLGQ at 0-2 percent for 2026-2028 and modifying its formula thereafter. Additionally, it introduced a local option property tax deferral program, allowing qualified homeowners to defer up to $10,000 in property taxes per year. The bill also established a first-time homebuyer tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income rather than the taxpayer’s tax bill directly. , enabling new homeowners to receive a credit of up to $2,500 for up to five consecutive years in which they have a property tax liability for their homestead.

Other provisions of the amended bill included higher targeted deductions and circuit breaker credits for certain retirees and disabled veterans, new rules for tax referenda and excess levy appeals, and various other minor adjustments.

According to the fiscal note, the proposed relief for homestead owners would be considerably more limited in scope, ranging from $91 million in 2026 to $254 million in 2028. At the same time, cities and school districts would experience revenue losses of $50 million and $61 million in 2026, and $150 million and $183 million in 2028, respectively.

House Amendments

House Bill 1402 represents a third approach. The bill would increase the de minimis exemption for tangible personal property from $80,000 to $200,000 and introduce a full exemption for new business personal property. These changes would continue providing tax relief and reducing compliance costs for small and medium-sized businesses.

Additionally, the bill outlines a gradual transition to a flat supplemental homestead exemption equal to two-thirds (67 percent) of the assessed value, accompanied by the phaseout of the standard homestead deduction. This proposal aligns with Gov. Braun’s plan but simplifies it further. The bill also introduced an additional deduction for all property subject to the 2 percent circuit breaker credit, which would gradually phase in by 2031.

The most problematic aspect of the bill, however, is its dramatic restructuring of the local income tax system. Under the proposal, the new maximum local income tax rate would be 2.9 percent for counties and 1.2 percent for cities and towns with populations of 3,500 or more (currently, only counties are allowed to impose this tax). If this restructuring is combined with property tax reductions from one of the earlier proposals, counties and cities will have strong incentives to raise their local income tax rates to the maximum allowable level.

This could significantly increase Indiana’s overall income tax burden. While the state’s individual income tax rate has been gradually declining in recent years (now at 3 percent), a substantial rise in local income tax rates could push the top combined state and local income tax rate to 7 percent by 2027—assuming all counties and cities adopt the maximum rate. This would be considerably higher than the current combined rate of just under 5 percent. As a result, the benefits of recent income tax reforms in Indiana could be entirely offset by this potential local tax shift. For context, this would surpass rates in neighboring Illinois, Michigan, and Kentucky. The average effective local income tax rates in Michigan and Kentucky were 0.18 percent and 1.31 percent as of 2022, respectively, while Illinois does not authorize local income taxes.

A Path Forward

While each proposal has its own merits and drawbacks, Indiana policymakers should prioritize incremental changes over abrupt tax reductions, as the state’s property tax system is already among the most competitive in the nation. Levy limits are a more efficient and neutral tool for keeping property tax bills (and revenues) in check than assessment limits, and the existing levy limit provides room for further refinement. If policymakers believe this limit still allows for an inequitable distribution of the property tax burden across different property classes, they could modify it to ensure tighter control over levy growth from each class (e.g., property tax levies from each class should not exceed the greater of 5 percent or the MLGQ).

Finally, shifting property tax revenue to local income taxes is not a growth-oriented strategy. Income taxes are generally more distortive than property taxes and can influence the decisions of current and prospective Indiana residents. For instance, relatively affluent individuals may consider relocating to states without an income tax, and any Indiana resident may decide to move from one county to another if the latter offers a significantly lower income tax burden. These behavioral shifts could have long-term implications for Indiana’s economy. To maintain its competitive tax system, the state should prioritize keeping local income tax rates relatively low and within a narrow range (currently, rates vary from 0.5 percent in Porter County to 3 percent in Randolph County) instead of incentivizing counties and cities to significantly increase the income tax burden.

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