Indiana: A Case Study in the Dangers of Fiscal Entanglement

Lawmakers in the Indiana House of Representatives just approved a measure that would reduce property tax bills this year by an average of 7 percent. Just two days ago, lawmakers in the House gave similar approval to a provision that would completely abolish property taxes in 2009.

This story highlights the degree to which state lawmakers can interfere with local governance by fiddling with local taxation. The following paragraph perfectly encapsulates the property tax problem in Indiana:

“During the next three years, several factors will contribute to what’s being called a ‘perfect storm’ that will drive up tax bills. The basic problem: State and local government spending is increasing, and property taxpayers are footing part of the bill.”

When spending at the state and local level goes up—particularly on education, a function of local governments—local taxes have to rise to maintain levels of spending. This often makes voters angry. Strangely, however, their anger is not addressed to their local officials, but to their state lawmakers. State lawmakers then seek to cut local property tax levels (as Indiana did four years ago by raising the state sales tax rate to fund a property tax rebate) but the spending pressures remain.

If a state like Indiana is going to have local governments with specific responsibilities—like education—then they must have the power to raise revenues to provide those services. If voters are not satisfied with either their level of local taxes or services, they should hold their local officials accountable. But when state lawmakers interfere with this process, they diminish the transparency and accountability of the local fiscal system. If Indiana lawmakers have to do something, cutting state income or sales taxes would increase the income of local taxpayers, thus leaving them better able to pay their property tax bills.