Local government spending pushing tax burdens up

Regardless of who foots the bill, problems with the system exist for all to see. Assessment miscues like township assessors not getting the bills done right or fairly, let alone on time – as was the case in Marion County in 2007 – obviously must be dealt with, but so too must local government spending be scrutinized and controlled.

Many local communities are rapidly increasing their spending – leaving it to taxpayers to pick up the bill. This spending comes from a wide range of government units that have expanded their budgets – be it cities, towns, townships, schools, libraries, sewer districts, etc.

On the whole, local government budgets in Indiana are growing annually by an average of over 6%. In contrast, the annual cost of living increase for Social Security recipients stands at 3.3%.

From a dollar standpoint, the spending jump is particularly staggering. Chart 1 shows exactly how much local government has increased over the last 20 years. Libraries have had the largest surge by percentage – at just over 7% per year, which took them from $58.5 million to $246 million. Schools have had the greatest influx in terms of new money, going from $1.08 billion in 1984 to nearly $4 billion in 2005.

The Indiana Chamber believes more visibility and accountability in the property tax system should be high on everyone’s to-do list. Then, people can see exactly what their property tax money is paying for and who is responsible for the increases, they can make informed decisions about whether they want to support those increases or hold the responsible entities accountable.

Thankfully, the governor’s Commission on Local Government Reform has produced a very workable plan for reducing wasteful government, one that soon should get the ball rolling toward greater transparency and efficiency.

Homestead deduction – the quiet culprit
While assessment inaccuracies and local ballooning budgets have garnered much attention in the press, the increase to the state’s homestead deduction is also a key contributor.

In 2002, the state Legislature raised the amount Hoosier homeowners would receive as the homestead deduction on their tax bills from $6,000 to $35,000. Subsequently, the amount was increased again, to $45,000 in 2004. This deduction is taken off the value of residential property for assessing purposes. For example, a home valued at $110,000 – the statewide average – would only be assessed and taxed on $65,000. (Homes less than $45,000, receive a deduction of 50% of their worth). In the big picture, this translates to a whopping $50 billion in assessed value that is wiped off the books at the onset, only to be reallocated to other taxpayers.

When the homestead deduction was $6,000, the amount of taxes transferred was rather insignificant. At $45,000, however, it has noticeably shifted the tax burden to not only businesses but other homeowners. Just how much of a shift depends on the diversity of property value in a taxing district.

Chart 2 provides an idea of the effect that the last increase – from $35,000 to $45,000 – had on homeowners, with the greatest change in tax bills hitting both extremes; those with the lowest and highest valued homes.

At the time, the Indiana Chamber and other groups told legislators their concerns with the homestead deduction – that this was akin to robbing Peter to pay Paul, and that many homeowners would be negatively impacted. In some taxing districts, this redistribution of the levy has really hit a particular group hard. And it’s been largely overlooked publicly, but is something that certainly needs to be reexamined as the entire system is now under the microscope.

In effect, what this has done is create a graduated property tax system; that’s unconstitutional and results in property tax burden shifts.

The real impact of the inventory tax elimination
The elimination of the state’s tax on inventory has also been a focal point of why tax bills went skyward. When the inventory tax repeal passed the 2002 General Assembly, measures were provided to protect homeowners, but it was up to each county to act. Counties were encouraged to eliminate the inventory tax early – before 2007 – and to implement a homestead credit in order to offset any shift in taxes to homeowners from an inventory tax elimination that has helped secure thousands of new jobs throughout the state.

Ratification of the inventory tax repeal was on the 2004 general election ballot and passed with more than 70% of the vote statewide. All counties were well aware it was coming; only 43 of Indiana’s 92 counties took steps to protect their homeowners. Fast forward to 2007, residents in these 43 counties have seen, on average, less dramatic property tax increases this than homeowners in the other counties.

Why eliminating residential property tax won’t work
The old adage says it all: Looks can be deceiving. A proposal to eliminate homeowners’ property tax and replace it with increases in sales and income tax will no doubt attract many homeowners to its side. But when you examine things up close, such a plan could throw the state’s economy into reverse and threaten Hoosiers’ quality of life.

Fallout for businesses, citizens and residential/rural communities could be extreme.

• Indiana would be the only state in the nation with a “business-only” property tax. In addition to paying 100% of property taxes, businesses would also be subject to increases in sales and incomes taxes. This would have a devastating impact to Indiana’s economy and cripple efforts to attract investment and job growth to the state.
• A real “winners” and “losers” scenario is created among citizens. Individuals with large property wealth but low income will come out on top. Meanwhile, those with large incomes but are non-homeowners will lose big time. Such a proposal transfers tax responsibility to its most productive and most mobile individuals, who could then easily decide to take their in-demand skills to another state.
• Businesses will be reluctant to invest in areas of the state that do not currently have substantial levels of additional business investment. They will want to “share” the property tax burden as opposed to being responsible for the bulk of the burden. This will make diversifying the economic structure of residential communities, as well as developing current undeveloped areas of the state, much more difficult.

Relying more on income and sales taxes is inherently flawed.

• Traditionally, states have attempted to have balanced tax systems with equal portions attributable to income, sales and property taxes. The thinking: unbalanced systems cause economic distortions. Thus, by going to a system heavily reliant on sales and incomes taxes, Indiana would be placing greater emphasis on those taxes easiest to avoid.
• The property tax is a stable tax, whereas income and sales taxes are much more volatile revenue sources. With a greater dependence on more volatile revenue sources, how is a steady and predictable revenue stream assured?

Local governments develop budgets that are currently funded through property tax revenue…what’s the domino effect for them?

• While property tax rates are set annually by function of the local budgeting process, income and sales tax rates are capped, and it takes legislative action to change them. Who will determine when the need for additional spending at the local level warrants a sales or income tax increase?
• Currently, the interests of homeowners (i.e., voters) have a moderating effect on the growth of property tax. If homeowners are removed from local spending concerns, how will local spending be controlled? Will all popular but arguably unnecessary spending projects be approved?
• The Indiana General Assembly may ultimately need to negotiate a distribution formula (of collected tax funds) for local government similar to the school formula. It’s likely the partisan party politics would be rampant; local elected officials would become lobbyists, and a part-time state Legislature could be a thing of the past.