It seems likely the Indiana General Assembly will discuss major tax changes this year. This discussion is warranted for many reasons. First, this is a non-budget session, and these matters take time. So, beginning homework on our taxes is prudent, even if change takes several years. Second, we have some growing structural problems with our taxes that must be fixed. Third, we are enjoying a second year of budget windfall, with revenues coming in a half billion dollars ahead of expectations. And, finally, there are budget needs we have not adequately met over several budget cycles.
Indiana taxes the income, property and consumption of both businesses and families. At the state level, we tax income and consumption. At the local level, we tax income and property. There are other, smaller taxes and fees, but these elements comprise most of our tax system.
Our income tax rate is low and flat at 3.23 percent, but the income tax is complex, imposing large compliance costs on Hoosier families and businesses. Merely simplifying this tax would be a tax cut. We also tax corporations at a higher rate than individuals. This causes distortions in the way firms organize themselves, contributing to the shrinking of that tax revenue.
It must be noted that corporations are often viewed as a juicy target for taxation, but corporations are owned by people who are also taxed on that income. It isn’t only rich folks who own these corporations; among the largest owners are retirement funds. So, raising taxes on a corporation is literally the same as raising taxes on retirement plans for teachers, your local plumber or nurse.
Our state sales tax is high at 7.0 percent, but lacks a local option tax. So, the actual sales tax paid by Hoosiers is middle of the pack across the nation. The real problem with the sales tax in Indiana is simply that it is levied on a relatively small share of the things we buy. Hoosiers pay sales tax only on goods, with exclusion for most food items. When sales taxes were first started almost 60 years ago, more than half of a family’s budget went to the consumption of goods. Today, it is about one-third, and much of that is spent on untaxed food items.
With Hoosiers spending a shrinking share of their family income on goods, sales tax revenue faces long-term decline. That would mean cut-backs to government services or an increase in tax rates. But, if we were to spread the sales tax across all goods and services we purchase, we could reduce the tax rate to less than 4.0 percent and raise roughly the same tax revenues.
Finally, there is open discussion of eliminating the floor for local property taxes on business property. This requires a bit of explaining, so let me use an example. A business buys a new piece of equipment, say a dump truck or robotics. That property is supposed to be taxed up to 3.0 percent, but the business can depreciate the value of that property over time. This ‘depreciation schedule’ is a formal tax incentive designed to promote business investment in new technology.
Often, the whole purchase price of that new piece of equipment is depreciated over a few years. But, in Indiana there is a 30 percent floor on that depreciation. Both the depreciation schedule and the floor are accounting artifacts, not economic principles. Changing either simply alters the way businesses are taxed. A more useful way to think about this is to see what Indiana has done with business taxes over the past 20 years.
In 2000, Indiana’s business subsidies were 0.6 percent of our Gross Domestic Product. Our net tax rate on businesses of all types was 5.6 percent of GDP. By 2019, our net taxes declined to 5.5 percent of GDP. Nationally, the net tax rate on business rose from 6.5 percent to 5.8 percent over the same two decades. Since 2000, Indiana’s taxes on businesses declined from 86.7 percent of the national average to 80.8 percent of the national average. At the same time, our economy grew by 30 percent, while the nation as a whole grew by 45 percent.
Let me state it more plainly. Over the past two decades, Indiana cut business taxes and saw agonizingly slow economic growth, averaging under 1.5 percent per year. At the same time, the nation as a whole raised business taxes and saw much faster economic growth, averaging over 2.2 percent per year. You may ask, how this can be; no business or family likes paying taxes?
The simple answer is that businesses and families are smarter than anyone seems to give them credit for. When purchasing a car, appliance or robot or hiring an employee they make a judgement based on value, not just price. For most businesses and families, the biggest economic decision they ever make is where to open shop and where to live. We’d be wise to assume they make these decisions based on value, not price. This translates into tax policy.
Indiana has been cutting the price of living and doing business for two decades, but those price cuts have not translated into more people and businesses. This means we have a problem with value, not price. We have far too many communities that lack the amenities that mobile American families seek. We have a declining share of young people heading to college, and an even smaller share of them graduating and staying in Indiana.
We need a tax system along state and local governments that focus on providing value, not competing on price. That must be top of mind in the General Assembly as they consider tax changes. In a world of businesses and people seeking value, being the low price location is not a winning strategy. As the General Assembly considers changes to taxes, they must keep in mind ways to improve the value proposition for Indiana. That is a call for better schools, more college graduates and more livable communities. A tax system can help deliver these, but it won’t happen by cutting the price.
Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University. Hicks earned doctoral and master’s degrees in economics from the University of Tennessee and a bachelor’s degree in economics from Virginia Military Institute. He has authored two books and more than 60 scholarly works focusing on state and local public policy, including tax and expenditure policy and the impact of Wal-Mart on local economies.