Local officials say a new state law that caps property tax bills for homeowners and businesses will send the city into a financial tailspin if legislators don't modify it in an upcoming session.
The law was intended to shield homeowners from unmanageable tax increases as Indiana moves to a market-based assessment system. But city leaders say the new cap limits their ability to generate revenue and will cause them to forfeit millions of dollars in taxes from businesses, some of which already pay more than the cap would allow.
Bond rating agencies have noted the city's predicament, which is increasing the cost of issuing municipal bonds. In just a few years, the law might force local officials to choose between firing cops, firefighters or teachers.
"It's a recipe for disaster," said City Controller Bob Clifford. "If this remains unchanged, you will see draconian cuts in every aspect of the city."
Legislators, however, said local fears are overblown.
For property owners, the new cap is simple. Unofficially known as a "circuit breaker," it prevents taxes from rising above 2 percent of a property's total assessed valuation. For a home assessed at $100,000, for example, that means a $2,000 annual tax ceiling. The state is phasing the cap in over time. It takes effect for residential property in 2008, but won't apply to business property until 2010.
Legislators love the political results, said Karl Berron, vice president of government relations for the Indiana Association of Realtors. Rising property taxes regularly top the list of constituent complaints. The cap shows voters their groans are heard.
"This is something that's pretty tangible, easy to explain," Berron said. "In some ways, you wonder if the more people hear about it, the more they're going to like it."
Homeowners may be thrilled with the cap, but local officials are downright distraught about it. Property taxes pay for the vast majority of local public services, from parks and schools to cops and trash collectors. The cap was originally to be accompanied by authorization for local governments to impose another tax, such as a sales or income tax, to make up for any lost revenue. But when push came to shove, the General Assembly didn't authorize new local taxes. So any money the city, county or schools lose to the cap can't be recouped elsewhere.
The bond market is now processing the change. Although the city's bond rating remains AA, the major rating agencies have expressed concerns.
Standard & Poor's, for example, has shifted its outlook on new bonds from stable to negative. As a result of the cap, municipal bonds in Indiana are no longer considered "general obligation," backed indefinitely by property taxes.
"Standard & Poor's believes that the new legislation has effectively changed the security on property-tax-backed debt … to limited tax from unlimited tax," wrote S&P's primary Indiana credit analyst, Eden Perry, in a May 24 research report. "It is our understanding that local units of government are likely to seek legislative changes to mitigate the effects of the cap before it takes effect … . However, until subsequent legislation is adopted, Standard & Poor's will apply its limited tax criteria."
Rating agencies' outlook change has already driven up the cost of bond insurance, Clifford said.
For example, the Indianapolis Bond Bank is preparing to sell $45 million in bonds to pay for a new emergency communications system for local police and firefighters. The old system is antiquated, Clifford said, and spare parts for it aren't even made anymore. The project's bond insurance increased "several hundred thousand" dollars as a result of the property-tax cap.
If the cap remains in place, Clifford said, it will ultimately affect many of Indianapolis' long-term obligations. For example, the city used bonds backed by a special downtown tax-increment-financing district to underwrite its share of major projects such as Circle Centre mall, the new Simon Property Inc. headquarters and the Marriott hotel. Together, companies in the TIF district are contributing $5 million annually to repay the bonds.
But once the cap applies to businesses in 2010, it will effectively become a tax cut because many companies are already paying more than the cap would allow. Companies, in general, are more likely to face property taxes above 2 percent of assessed valuation because residential tax breaks like the Homestead Credit don't apply to them.
If the cap limits tax revenue produced by the downtown TIF district, the city will have to make up the difference with money meant for parks, potholes or public safety. The city has similar concerns about its new TIF district meant to spur redevelopment on the near-east side.
Clifford estimates the cap will ultimately cost local government and schools $115 million in property-tax revenue annually.
"They're going to have to start robbing Peter to pay Paul for debt service," said Indiana Fiscal Policy Institute CEO Steven Johnson. "That's why the bond market is beginning to react."
Indianapolis isn't the only place concerned about the cap. Matthew Greller, executive director of the Indiana Association of Cities and Towns, said it has "caused shock waves across the state."
"By the year 2010, if nothing is done with the circuit breaker, you'll see municipal governments and schools down the line slashing literally millions and millions of dollars out of their budgets as they stand today," Greller said. "We'll see firefighter layoffs, police layoffs, parks closed. You're looking at some cities that will have to cut upwards of 30 or 40 percent of their budgets."
Not so fast, respond the cap's authors.
On average across the state, property owners pay only 1.25 percent of their property's assessed valuation–well beneath the cap–so most won't be affected, said Sen. Luke Kenley, R-Noblesville, chairman of the Senate's Tax and Fiscal Policy Committee. The cap was written to help protect the small minority of homeowners whose property taxes rose suddenly by tens of thousands through reassessment, Kenley said.
What's more, trend information about the new market assessment system isn't known yet. As properties appreciate across the state, legislators expect the vast majority of tax bills to stay under the cap. So local governments may not lose any tax revenue at all.
Bottom line: Until the market-based assessment system's implementation is finished, it's impossible to say whether local predictions of disaster are deadly accurate or wildly exaggerated.
"Frankly, I think they're overstating their case," Kenley said. "I'm willing to listen, but I'm not too convinced by what I've heard so far."
Rep. Jeff Espich, R-Uniondale, chairman of the House Ways and Means Committee, said the cap will probably have to be tweaked next year, at least to the extent that the state can provide the guarantees the bond market needs to lower its insurance pricing.
"There are, in retrospect, some problems with the legislation," Espich said. "I'm trying to find a compromise that gives the bonding companies assurance they're going to be repaid. If we don't do that, we're simply costing ourselves money in terms of higher payments. That's a stupid thing to do."