Education & Workforce Development and Government

ECONOMIC ANALYSIS: State's 'circuit breaker' law worsens flawed tax system

July 10, 2006

Fifty years ago, economist Charles Tiebout expressed a vision of how freeing local governments to pursue their own unique strategies for setting taxes and providing services could produce an efficient outcome much like the private marketplace.

He called it "voting with your feet." The idea was simple-by moving, people could sort themselves out and live in communities that came closest to providing the tax and expenditure combinations they valued most.

Reality is quite a bit more complicated. When people move in substantial numbers within an urban area, there can be significant costs, for one thing. New schools may have to be built in growing areas, while infrastructure must still be maintained with a shrinking tax base in the areas left behind. But that's just the beginning.

The ability of localities to truly innovate is quite limited. In Indiana, like most states, legal status flows from the state-counties, cities and towns are allowed to do only what the Legislature says they can. Schools may be locally run, but their functions are dominated by the Indiana Board of Education, just as the locally elected city council can enact the taxes and pass laws only on matters the Legislature says they can.

But with the recent passage of so-called "circuit breaker" legislation in Indiana, capping local property tax rates at no more than 2 percent of assessed value, a new curve ball has been delivered to localities. A tax rate cap is like an unfunded mandate in reverse-no new responsibilities are mandated, but the ability to pay for existing ones is reduced.

Some think these efforts are noble; others are less than flattering. But to my way of thinking, it's a bit like putting a Band-aid on a broken arm.

First off, let's get things straight. The law limiting 2008 residential property tax payments-which will affect tax bills distributed this year-isn't really a circuit breaker, at least as it is defined in most of the 34 states that have adopted them.

Those states have some form of incomebased test, often limited to those over age 65, which kicks in to limit the exposure of those who are older and of limited means to the full brunt of property taxes. It's a sensible, if somewhat complicated, provision to the tax code that Indiana would be well advised to consider.

Indiana's law is simply a rate cap. It's a message from state government, which remains free to set its own tax rates as it wishes, to local governments and other taxing entities, which have their own budget priorities and obligations. And it says this: Don't raise your taxes beyond $2,000 for a $100,000 home.

Proponents call this living within your means. A less polite way of putting it would be "starving the beast." The beast, of course, is our own government, whose appetite for our tax dollars is well-documented. Since local governments can't legally run deficits, starving them of funds may be a crude, yet effective, way to stimulate reform and create greater efficiencies.

But why are local governments getting this message from the Legislature, instead of from their own voters? Don't we always say local government is closer to the people, better able to respond to individual demands for specialized services? Isn't this why we fight for things like locally run schools, police and fire protection?

The answer to these questions is quite simple. Indiana's system of setting local tax rates is broken, at least from the taxpayer's point of view.

Unlike in states like neighboring Ohio and Michigan, increases in property tax rates, or even renewals of existing rates, are not subject to voter approval in Indiana. The entire process of setting the size of the tax proceeds, then arithmetically determining the tax rate that will generate those proceeds, creates an impression of automatic tax rate increases that is largely accurate.

Making local tax rates more responsive to the wishes of the locals who pay them, rather than the whims of a Legislature sitting in Indianapolis, is what really needs fixing.



Barkey is an economist and director of economic and policy study at the College of Business, Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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