Education & Workforce Development and Government

EYE ON THE PIE: Focus on expenses, not revenue, in state budget

February 21, 2005

In fewer than 700 words, I'm going to tell the story of how we finance government in Indiana. It's my belated valentine to the Indiana General Assembly. The data are for 2001-2002, but things don't change much from year to year.

Indiana governments had revenue of $34.2 billion in fiscal 2002. But forget about separating state and local government finances. It's a fraudulent idea to talk about local taxes vs. state taxes. The two are totally intertwined. Localities can do only what the Legislature allows, and that beneficent body sends $6.3 billion to local governments to underwrite property-tax relief and local services. This $6.3 billion exceeds the total amount collected by local governments in the form of property taxes.

Some people mistakenly are impressed by the fact that property taxes make up 88 percent of the tax receipts of local governments. But that doesn't mean much, when you realize that property taxes account for only 17 percent of the combined revenue of state and local governments in Indiana. It's the combined figure that is important because, ultimately, it is the Legislature and not the localities that controls taxation in the state.

Few folks understand that our largest source of home-grown revenue, the property tax, is less than the amount (18 percent ) the state gets from the federal government. The third-largest revenue source for Indiana governments is individual income tax, which equals 12 percent of revenue. This is followed by the general sales tax, which provides another 11 percent. Together, these four sources account for 59 percent of Indiana's governmental revenue.

At this point, any good Hoosier legislator asks, "Well, how do they do it in other states?"

Nationally, the results are the same. These same four revenue sources account for 59 percent of the total. There are some differences. We are higher on property taxes and individual income taxes as a percentage of the total, while being lower on our general sales tax and funding from Washington.

But the differences are small.

"What is the other 41 percent of revenue?" These are other taxes and various miscellaneous charges-for example, tuition at state universities-used by governments to finance their activities.

To be sure, there are differences among the states. For example, Indiana's taxes on alcohol and tobacco together account for 1.3 percent of state tax revenue, whereas in the nation they equal 4 percent of state taxes. Is this because our tax rates are low? Is it because we are more virtuous and avoid these sinful products? Or is it because our taxes on other things are higher and the percentage coming from these two sin taxes is pushed down?

If we look at revenue, not as a percentage of some total, but on a per-person basis, Indiana collects $6.16 for alcoholic beverages while the nation gathers in $16.35. Again, differences in tax rates or consumption patterns? It's the same with tobacco: Indiana has $20.27 taxes per person vs. a national figure of $32.31.

And now for the sweet part of this valentine to the General Assembly: FORGET IT! Forget the comparisons with other states. Forget the percentages and the per-capita figures. Focus on what is necessary: raising the revenue the state needs to do what needs to be done.

The important side of the budget is the expenditure side. What must we do to be a competitive state? What must we do to meet our health, education and safety responsibilities to our citizens? Once you figure that out, you'll know how much money you need and you have the taxing power to get it.

But if you start from the revenue side, your thinking will be constrained by your courage. Too often, we have seen governments hold back from doing what needs to be done because they are afraid to take bold steps that might be unpopular in the short run. The welfare of Hoosiers will be determined by how wisely money is spent, not by what revenue sources are used to finance our future.
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Marcus taught economics more than 30 years at Indiana University and is the former director of IU's Business Research Center. His column appears weekly. To comment on this column, go to IBJ Forum at www.ibj.comor send e-mail to mmarcus@ibj.com.

... Indiana's taxes on alcohol and tobacco together account for 1.3 percent of state tax revenue, whereas in the nation they equal 4 percent of state taxes.
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