Critics fear tax reform will favor suburbs

December 10, 2007

As legislators prepare to overhaul the state's property-tax system, Marion County's future hangs in the balance.

Indianapolis residents--particularly in the city's older, urban core--already pay far higher taxes than their suburban counterparts. And they arguably get less bang for their buck. Census figures show many people believe Marion County's neighbors offer a better product at a discount. Crumbling schools and dangerous streets are a tough sell. Changes on the table could make it an even tougher one.

"We need to make sure that the heart of the region continues to pump blood throughout the region," said Roland Dorson, president of the Greater Indianapolis Chamber of Commerce. "The heart has to stay strong and healthy. It's very important that Marion County not be disadvantaged in all this."

Property taxes are the primary source of revenue for local government, which builds schools, paves streets and hires the police to patrol them. According to an analysis by the Legislative Services Agency, Gov. Mitch Daniels' restructuring plan would force Marion County to slash $100 million in services in its first full year--or to raise local income taxes high enough to generate the equivalent. The eight "doughnut" counties would have to cut just $39 million combined.

Disparity across central Indiana could increase over time. Daniels' plan ties future spending increases to each county's personal income growth over a six-year average. That would favor wealthy suburbs like fast-growing Hamilton County, whose 6.9-percent income growth rate is the highest in the region, well above Marion County's 4.2 percent.

"You're going to have a real crisis in Marion County if the governor's plan goes into effect," said Beth Henkel, former commissioner of the Indiana Department of Local Government Finance, which oversees property taxes. "Will it cause people to continue to move to the doughnut counties? I think so."

Daniels' senior policy adviser, Neil Pickett, argues that the status quo would be even worse.

"Marion County has a problem today versus the surrounding counties because its high property tax rates are driving business and individuals out," he said. "The governor's plan, by providing tax relief and certainty, may well bring wealth and investment back into the county and make it more attractive as a place for people to live and want to do business."

The doughnut's center

Every day, people and businesses decide where to put down roots. And for years, they've been choosing Indianapolis' suburbs.

In 1990, just 42 percent of central Indiana's 1.4 million residents lived in the doughnut counties. Today, almost 52 percent of the region's 1.7 million people live in a neighboring county.

Much of the region's wealth has migrated outward, too. The trend is most pronounced in Hamilton County. Since 1990, Marion County's population has increased nearly 9 percent, to 865,504, with a per-capita income of $36,286. Hamilton County's has grown a staggering 130 percent, to 250,959. Per-capita income there is $44,354.

What's driving such blistering suburban expansion?

Taxes are one factor. Marion County residents pay median property taxes of 3.38 percent per $100 of assessed valuation--more than a percentage point higher than Hamilton County's 2.26-percent median rate. And some unlucky Marion County residents pay rates as high as 4.12 percent. Hamilton County's highest rate is 2.96 percent.

That means real differences between property tax bills. After claiming the $45,000 homestead exemption, the owner of a $200,000 house taxed at the median Marion County rate pays $5,239 a year. For the same house taxed at Hamilton County's median rate, the bill would be just $3,503--$1,736 less.

But lower taxes aren't the suburbs' only selling point. Hamilton County Alliance President Jeff Burt said attracting residents boils down to quality of life. And solid schools are the foundation.

"That seems to be one of the front-and-center things people are looking for when they come to Hamilton County--the expectation they can come into a good-quality school district," he said. "You've got support in the community to deliver the resources to produce a good-quality education."

Why can suburban counties offer more for less? Some argue they've made better, more efficient decisions. But many of their costs are lower, too. For example, there's no need for suburban fire departments to purchase all the equipment needed in a big city with skyscrapers. And suburban governments don't bear the enormous expense of delivering services to large populations living below the poverty line.

Most important, the steady addition of new houses gives suburban governments additional properties to tax every year.

Critics of Daniels' reform plan say it worsens Marion County's challenges. The plan would cap property taxes statewide at 1 percent of a home's assessed value.

The resulting effect on local governments would vary dramatically from county to county. To maintain current services, Hamilton County in 2009 would have to cut just $4 million from its local spending, or raise local income taxes 0.04 percent. In contrast, Marion County would have to cut $100 million, or raise its income taxes 0.53 percent. Hamilton County's 1-percent local income tax rate starts well below Marion County's 1.65 percent.

"Instead of Marion County being a high property tax county, it'll be a high income tax county," said state Rep. David Orentlicher, D-Indianapolis, who has proposed his own property tax plan. "And you'll still have an incentive for people to live outside."

Orentlicher said residents of doughnut counties get a free ride for many Indianapolis cultural amenities that make the area attractive, such as pro sports. He argued that statewide income tax hikes should be used to offset property tax cuts so everyone pays their fair share.

But Ball State University economist Michael Hicks said the state's taxpayers would be in no mood to carry a larger load of urban areas' costs until they saw evidence their money would be put to good use.

Hicks, who has analyzed Daniels' plan, said residents of many U.S. cities are willing to pay a tax premium to live closer to the urban center. They perceive value for the higher cost of living.

He said that's not the case here.

"The disconnect in Indiana, and I can't stress this enough, is there is no linkage between the quality of public services and the price we pay by taxes," said Hicks, who leads the university's Bureau of Business Research. "Until local government accountability is fixed, what you're going to see is continued movement away from Indiana's cities."

Indianapolis leaders want to avoid an us-vs.-them battle over taxes. They say protecting the financial health of Marion County is in the interest of the entire region.

"This is a well-worn phrase, but it's as applicable today as when Mayor Hudnut uttered it [more than two decades ago]. 'You can't be a suburb of nothing,'" Dorson said. "We have to be acutely conscious of that going forward."

Proposed plans

Legislators are preparing to spend the next three months debating property tax reforms. They'll consider "circuit breaker" rate caps, offsetting tax hikes and constitutional amendments to cement changes permanently.

Four major tax plans are on the table--the two from Daniels and Orentlicher, along with proposals from Indiana Farm Bureau and state Sen. Luke Kenley, R-Noblesville.

To replace lost revenue from property tax cuts and rate caps for homeowners, each plan recommends a blend of new sales, income or corporate taxes. The plans also shift financial responsibility of some expensive services, such as school operations and child welfare, from local governments to the state.

For legislators, the plans serve as the starting gun for marathon debate.

"It doesn't make any difference where you begin. It's where you end, because that's what people have to live with," said Steve Johnson, former CEO of the Indiana Fiscal Policy Institute. "By March, where the process started won't be remembered."

Legislators already have had a head start. Led by Kenley, the General Assembly's Commission on State Tax and Financing Policy met repeatedly for public meetings from July to November, studying every aspect of the property tax system.

Kenley said his commission is well aware that it can't set up a system where urban governments are so choked of resources that they must lay off hundreds of police officers and firefighters--or raise income taxes so high that everyone who can moves away. He expects the Legislature will craft its property tax reform with more nuance than one-size-fits-all.

"There's a difference between the severity of the problem in Marion and other counties that have completely different demographics," he said. "We recognize that those differences may eventually call for different solutions."

Marion County's future is intimately tied to the question of how much government it actually needs, and what quality of services it can provide. The bipartisan Kernan-Shepard Commission--led by Supreme Court Chief Justice Randall Shepard and former Gov. Joe Kernan--is expected to issue its recommendations this week about how to restructure city, county and township governments to provide the best service for the least cost.

"We're in a very special moment, when a great many people in our state are paying close attention to their government," Shepard said. "That's always good, but it's especially good if you're interested in reform."

But however helpful the commission's proposals might be, they're not likely to be addressed until 2009, said Senate President Pro Tem David Long, R-Fort Wayne. The pressing need for property tax reform that immediately affects homeowners' bills will dominate the General Assembly's short session, he said. There's just not enough time for anything else.

"Marion County itself is ground zero on the property tax issue. It is by no means the only place in the state where people are openly concerned about taxes and have expressed it, but it is certainly the most visible," Long said.

"Property taxes are woven far deeper into the fabric of local government than anyone realized," he said. "To unravel it requires a great effort, and it has to be done right."

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