Larry DeBoer
Professor of
Agricultural Economics
Purdue University

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Frozen Property Tax Relief

The governor's budget freezes property tax replacement credits.

What a boring, technical way to start a column. But the freeze is a big deal, and it could have important effects on how we pay for local government services and how much of those services we get.

Property tax replacement credits (PTRC) were invented during the first year of the Gov. Otis Bowen's administration in 1973. Gov. Bowen was elected on a pledge to provide "visible, lasting and substantial" property tax relief. To deliver on this promise, he pushed through an increase in the sales tax, from 2 percent to 4 percent, and paid the added state revenue to local governments to reduce property taxes.

This idea worked so well that it was used again. In 1980, homestead credits were invented, which paid state revenue to local governments to reduce homeowner property taxes. More recently, in 2002, sales, cigarette and gaming taxes were raised, and the revenue used to replace a big chunk of school general fund property taxes.

With all these credits, property tax relief became the second-largest item in the state's budget, after K-12 education. The state will pay $2.2 billion in property tax relief this fiscal year, about 19 percent of the operating budget.

We'd rather pay for local services with more sales and income taxes and less property taxes. PTRC and homestead credits are how we make that happen. The state is good at collecting sales and income taxes, so we have the state do it. Then, the state hands the money over to the local governments (with a lot of strings attached).

Part of the trouble is recession. Property taxes are more stable in recessions than are sales or income taxes. The state pays out PTRC based on a formula, so tax relief payments grow as steadily as property tax revenue. When a recession hits, however, sales and income taxes stop growing. Property tax relief doesn't. Stable payments from unstable revenues create a budget problem.

The Governor's budget addresses this problem by freezing PTRC payments at the 2005 level. To fully fund the tax relief required by the PTRC formula, about $270 million more would be needed in 2006 and 2007. State property tax relief is going to fall short.

On a taxpayer's property tax bill, the gross tax payment is calculated from the property's assessed value and the local tax rate; then a PTRC percentage is subtracted. The budget bill, as it now stands, reduces the PTRC percentage. There will be more left over for property taxpayers to pay. The average taxpayer might see his or her taxes go up an extra 3 percent, above the usual increase.

But it's early yet. There are other possibilities.

Local governments could be told to reduce their property tax revenues by the amount of lost PTRC. They'd get the same amount from their local taxpayers, but they'd have less in total because of the lower state tax relief payments. They'd have to cut local services.

Or, lost PTRC could be made up through some other local tax. Perhaps the caps on the local income taxes could be raised. At the moment, the highest local income tax rate is 1.73 percent in Pulaski County. The cap depends on which local income tax a county has adopted, and what the revenue is used for. Another couple of tenths would probably do it for the average county.

Or, perhaps a new local tax could be invented, like a local sales tax.

Or, the state could come up with the money and continue tax relief as before. This would require cutting funds for other state services or raising a state tax.

It's pretty simple, in the end. There's not enough money to do what we've been doing. So, we must cut spending or raise a tax. We could cut local spending or state spending. We could raise the property tax, a local income tax or a state tax.

It's all tied up in the budget bill, which is often the last bill passed during the session.

That gives us until the end of April to decide.




Writer: Larry DeBoer
Editor: Cindie Gosnell