Property Tax Reform in Indiana Gets a Reality Check

August 29, 2007

Everybody hates property taxes. Who likes writing a check for thousands of dollars each year to the local government? But they do pay for local government services such as schools, police, fire, and roads (as well as some spending that is probably questionable in many places). And thereby lowering property taxes requires that spending on these services be cut or other taxes be increased. The latter (raising other taxes) was discussed as a reform option in Indiana. The results show that cutting property taxes is far from a free lunch. From Tax Analysts:

A state legislative panel considering short- and long-term fixes to Indiana’s property tax crisis heard August 27 that it would take a 9 percent income tax rate or a 13.2 percent sales tax rate to eliminate property taxes.

Either scenario would cover the 2007 net property tax levy of $6.1 billion that goes to fund local governments and schools.

The state Legislative Services Agency also gave the Commission on State Tax and Financing Policy a mix of options. Lawmakers could cover half the revenue by increasing the 6 percent sales tax to 9.5 percent and the remaining 50 percent of the levy by increasing the income tax—currently 3.4 percent—to 6 percent. Or, if the state wanted to add services to its sales tax base, the sales tax rate would go up to only 11.1 percent.

No data were given for a graduated income tax rate. Indiana is one of only six states with a flat income tax rate.

The commission is expected to give recommendations to the General Assembly later this year for possible reform.

A 13.2 percent general sales tax would be the highest in the nation, by far. The highest currently is Tennessee, which has a combined state/local tax of 9.4 percent. At 13.2, you are getting into evasion territory, especially among communities near the border with other states. A flat 9 percent income tax rate may sound appealing, but that is still very high. Concerns about progressivity would likely kill that proposal as many poor and even middle-income Hoosiers would be paying more to Indianapolis in income taxes than they pay to Washington. However, either one of these options would allow for the property tax to be eliminated.

Many on the anti-property tax side are politically conservative. But they must realize that cutting property taxes while not cutting spending is nothing more than a bait-and-switch. Furthermore, one downside for many conservatives is that such a proposal would likely shift more control over government functions to the state government, meaning less local control. Furthermore, there would be much less tax competition between jurisdictions. A person can easily move from one county to the next because of lower taxes. A person cannot as easily move from one state to the next for that reason. Finally, in terms of control over policy, it is much easier for small voices to be heard at a local city hall than at the state capital, and the threat of leaving or voting somebody out of office is much more credible at the local level than at the state government level.

Overall, the main point of this commission’s report is that if the goal is to lower taxes, one must lower spending. Otherwise, cutting one tax merely means that another tax is going to have to go up in order to raise the same amount of revenue.

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