Indiana Mulling Elimination of Property Taxes

July 30, 2007

It would be one of the most significant changes in state public finance ever: the elimination of property taxes in the Hoosier State. Here was the scene in Muncie last Thursday:

Fed up with skyrocketing property tax bills, hundreds of people marched to Delaware County’s government building Thursday to call for the tax’s elimination.

The protest came a day after Gov. Mitch Daniels ordered a property reassessment in Delaware County and a few other counties — a move that could ultimately lower many homeowners’ tax bills.

The governor also said people in those counties would be able to pay the amount they paid last year, with the difference — either up or down — to be made up later. But Thursday’s protesters said the move wasn’t enough.

“There will never, ever be property tax relief until it is repealed,” one of the protesters, Bill Harter, said. “You need to contact your representative and your senator.”

One state, New Hampshire, has neither a sales nor an income tax (except for capital income). Oregon has no sales tax. And nine states total essentially have no income tax (New Hampshire and Tennessee tax only capital income). But every state has a significant property tax that raises at least 6.5 percent of the combined state and local government general revenue. (Alabama is the lowest, but the national average is 16.6 percent.) In Indiana, it makes up 19.5 percent of combined state and local revenue, while it makes up 33.9 percent at the local level.

Would eliminating the property tax be good or bad for Indiana? It depends. If the goal is to restrain an excessively big local government, then eliminating the property tax in the short run may work to starve the beast. However, while it may restrain spending, spending will not be restrained by the full amount of the current property tax liability, and over the long haul, it may not restrain spending at all. Other taxes are going to have to be increased, such as the local income tax, and the state government will likely take over some funding, meaning taxes statewide would have to go up, and local control over taxes and government services could diminish.

Indiana does have a local income tax, which could serve to fill the property tax void. Local governments in Indiana receive approximately 3 percent of their revenue from local individual income taxes, and only a handful of states have local income taxes. Raising local income taxes to pay for property tax elimination will obviously change many taxpayers’ financial welfare. Some will gain and some will lose. The effects on various groups and the progressivity/regressivity change will depend upon the underlying incidence of the property tax and the income tax. The academic literature, however, is divided on whether property taxes are regressive.

Some people are suggesting a less drastic option: sending a one-time rebate check to all property owners. Ultimately, no matter what method of tax reduction, if any, is chosen, the 800-pound guerilla in the room is government spending.

If people want lower taxes, they’re going to have to demand lower spending. Or Governor Daniels and the legislature can give some people a free lunch as they did recently this year – just arbitrarily tax a minority (smokers) to pay for spending that benefits everybody. Such policies, which are essentially tyrannies of the majority, are currently popular across the country.

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