Larry DeBoer
Professor of
Agricultural Economics
Purdue University

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Local Income Taxes and State Budget Balances

Indiana has a state income tax. Ninety-one Indiana counties have local income taxes (all but Lake). To make things easier for taxpayers and local governments, the state administers the state and local income taxes together. Taxpayers make one income tax payment, and the state keeps track of how much comes from the state income tax and how much comes from the local taxes.

Unfortunately, the state counted those payments wrong in 2009 and 2010. A programming error caused too little to be allocated to local and too much to be allocated to state. No money was lost. It was just divvied up incorrectly. The state announced this error on April 5.

Local option income tax (LOIT) distributions for the coming year are announced each July so that local governments can set their budgets. The distributions for 2011 were based on collections in 2010, which were payments on 2009 income. The distributions for 2012 were based on collections in 2011, which were payments on 2010 income. The 2009 error meant that LOIT distributions to local governments in 2011 were too small. The 2010 error meant that the distributions in the first four months of 2012 were also too small, and the distributions for the rest of calendar 2012 set too low.

On April 5 the state sent checks to the counties for the under-distribution in 2011 and the first four months of 2012. The checks totaled $206.3 million. Scheduled distributions for the rest of 2012 were increased. In total, local governments will receive about $336 million in added LOIT distributions.

More money for locals means less for the state. The April 5 distribution of $206.3 million included $70.6 million in the first half of calendar 2011, which was state fiscal year 2011. That fiscal year is over, so this amount was covered with a transfer from state balances to local governments. It includes another $70.6 million for the second half of calendar 2011 and $64.7 million for the first four months of calendar 2012. These latter amounts were paid from 2012 income tax revenues. Add $401,000 in interest, and the total is $206.3 million.

Future state balances will be affected by more than this amount. LOIT distributions for all of calendar year 2012 were set too low. The added distributions for May and June amount to $32.4 million. That means state balances will take a $238.7-million hit by the end of fiscal 2012. Added distributions in the second half of calendar 2012 are in state fiscal year 2013. One half of the calendar 2012 error is $97.1 million.

The effect in the second half of fiscal 2013 is tricky. The December 2011 state-revenue forecast was made before the error was discovered, so state income tax revenue was probably overestimated. The December 2012 forecast revision will take the error in account and will likely reduce projected state income tax growth for the rest of fiscal 2013. Let's be conservative and call it another $97.1 million drop, although the number could be a little bigger than that. The total balance reduction for fiscal 2013 would then be $194.2 million.

In total, the added distributions of LOIT revenue to local governments could reduce state balances by about $433 million by the end of the biennium in June 2013.

Excess state balances are to be distributed partly to the teacher pension fund and partly as income tax rebates to taxpayers. Bigger LOIT distributions mean smaller state balances, but the State Budget Agency still expects to distribute $209 million in rebates from end-of-fiscal-2012 balances. The tax rebates would be distributed in 2013. The end-of-fiscal-2013 balances would likely be too small for a second rebate in 2014.

It's probably no coincidence that the LOIT error happened in the aftermath of the Great Recession. Had the error been made in 2005, the sudden drop in LOIT revenues would have smelled funny. Officials would have sniffed around and found the mistake. But it made sense for LOIT revenue to drop in 2010. Those taxes were paid on 2009 incomes, and 2009 was the worst year of the recession.

So nothing smelled funny. When the whole economy stinks, the smell test doesn't work.



Writer: Larry DeBoer
Editor: Cindie Gosnell