Opinion and Forefront

KETZENBERGER: State taxes will suffer until wages recover

February 12, 2011

John KetzenbergerThe best tonic for Indiana’s finances is an extended and robust economic recovery, but even a recovery may not be enough to balance the books.

Despite efforts to boost the pay of Hoosiers, the state’s per-capita income is among the lowest in the nation at $33,912, according to the Bureau of Economic Analysis. That’s 40th among the states, a full $5,700 less than the national average.

Worse, Indiana is losing ground over time. In 1990, the state’s per-capita income ranked 30th; in 2000, it was 32nd.

These statistics defy the best efforts of every governor since Robert Orr to remake the Hoosier economy and boost take-home pay.

At the same time, Indiana’s tax structure has evolved. In 1980, sales and personal income taxes generated about 60 percent of state revenue. Last year, those taxes generated a whopping 80 percent of revenue.

Given the state’s reliance on economically sensitive sales and personal income taxes, it’s no surprise revenue has become more volatile. The recession has reset revenue to the 2007 level and the reliance on sales and income taxes is a major reason.

Optimists will observe that, when the economic recovery kicks into a higher gear, Indiana will benefit quickly. True enough. The recent revenue forecast prepared for the State Budget Committee anticipates 3.5-percent growth in fiscal 2012. That will produce $450 million in new tax revenue for the state. A projected 4.5-percent increase the next year should mean another $540 million.

That’s about enough to balance a flat-line budget and make up much of the $600 million to $800 million structural deficit staring down lawmakers.

Is it good public policy to be so reliant on sales and personal income taxes (not to mention gambling taxes, the fifth-ranking source of tax revenue behind “other” and corporate income taxes)?

The state receives no revenue from property taxes, which is the most stable tax. But recent changes to local property taxes have had a major effect on state spending. Indiana now pays for all the operating expenses for schools, which used to rely on local property taxes for about 20 percent of their revenue. The state also absorbed the cost of county welfare as part of the property tax reform.

Even with the elimination of state credits that counties used to get to subsidize local property taxes, the changes cost the state $1 billion.

Indiana’s sales tax increased a penny to 7 cents on the dollar to help defray these costs, but the state’s recession-wracked revenue figures show how vulnerable it is when it relies so heavily on sales and personal income taxes.

Lawmakers understood the policy implications when they decided to use sales and personal income tax revenue instead of property taxes to pay for these things. It may be that they just chose a poor time—the recession—to make the change, but they still have to deal with the consequences.

The state’s lagging per-capita income doesn’t help matters. Wages in the state’s manufacturing sector are falling as two-tier wage structures and other pressures reduce workers’ income. Only two sectors showed any year-over-year wage growth, according to the BEA: health care and government.

This means less personal income tax revenue for the state. Most of the ingredients to rebuild personal income tax revenue without a rate increase are in place.

Indiana’s a low-tax state with a relatively skilled work force. Those who need training, or retraining, have a robust Ivy Tech Community College to help them. The major universities are chock full of patented ideas and there are nodes of innovation across the state ready to be tapped. Grease it with investors’ money—the ingredient currently lacking in sufficient quantity—and jobs that pay well will emerge.

It takes time to create jobs that pay well while the economy creeps out of a recession. Those facts and Indiana’s reliance on personal income and sales tax mean it is likely lawmakers will face similar circumstances when they gather in 2013 to write the next two-year budget.•

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Ketzenberger is president of the Indiana Fiscal Policy Institute, a not-for-profit dedicated to non-partisan research into the state’s tax policies and budget practices. Send comments on this column to ibjedit@ibj.com.

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