FEBRUARY
2007

 

By
Larry DeBoer
 
Professor of
Agricultural Economics
Purdue University

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02-22-07

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Could We Axe the Property Tax?


The Indiana General Assembly is considering an historic innovation in local government taxation. It's a constitutional amendment to abolish the property tax.

A pair of House and Senate joint resolutions add a sentence to the state constitution: "N either the General Assembly nor a political or municipal corporation in the state may provide by law for the imposition of ad valorem property taxes." Municipal corporations are cities and towns. Ad valorem means "according to value." You can see House joint resolution 14 and Senate joint resolution 16 on the General Assembly's Web site at http://www.in.gov/legislative. Click on "Bills and Resolutions."

This would be historic because no state has come close to eliminating property taxes, which account for nearly a third of total state and local taxes in the United States. Indiana ranks near the middle among the states at 29 percent. That's $6 billion a year for Indiana local governments. Without the property tax, where would this money come from? The General Assembly would have to decide after the constitution was changed. The resolutions don't say.

Only the general sales tax and the individual income tax could raise enough revenue to take up the slack. Our 6 percent sales tax raised $5.3 billion for the state in 2006. Our 3.4 percent flat rate income tax raised $4.4 billion, and the county income taxes added another $1.1 billion. No other tax raised even a billion dollars.

So, what would rates on the two big taxes have to be if we split the $6 billion in property taxes between them? We'd need to research this, to figure out, for example, how many purchases a higher sales tax would chase to neighboring states or the Internet.

In ballpark figures, though, a sales tax rate of about 9.5 percent and a state income tax rate of about 5.7 percent would raise the added $6 billion. Indiana would have the highest state sales tax rate in the country, though there are half-a-dozen states where the combined state and local rates can top 9.5 percent. There are plenty of states that have income tax rates higher than 5.7 percent, but they're all in the higher brackets in graduated-rate systems.

The source for replacement revenue is just one of many questions that we'd have to answer if we were to abolish the property tax. Here are a few more.

How will we pay debt service on bonds? Lenders like the property tax because it's an almost unlimited source of money for debt repayment. The resolutions require the General Assembly to provide revenue "from any source" to pay obligations. Will that be good enough for the bond market? Or will they make us pay higher interest rates because they think our bonds are riskier?

Will we collect the added income or sales taxes on the state level or the local level? If on the local level, we may lose the savings that we hope to get by abolishing property tax administration. If on the state level, how will we distribute the revenue? Based on local collections? That would create some big winners and losers, because there are places with a lot of property to tax, but little sales or income, and vise versa. Based on a formula? How will we cut up the revenue pie among more than 2,000 local units?

And what about school aid? The state delivers billions to local schools, using a formula that partly offsets differences in property wealth. The formula "equalizes" revenue, but not perfectly. Some schools still spend more than others. With no property tax, will the formula become perfectly equalizing? Will it raise low-spending schools to the levels of high-spending schools? That would cost billions. Or will it maintain current spending, so that the state formula becomes the source of spending differences? That's a court case in the making.

Then, there's the question that would occupy the minds of taxpayers and legislators more than any other. Who would pay more and who would pay less under the new tax scheme?

It's not that these questions can't be answered. They can, but it would take some hard work. Maybe we'll know that we're serious about abolishing property taxes when we start trying to answer them.

 

 

 

Writer: Larry DeBoer
Editor: Olivia Maddox