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ECONOMIC ANALYSIS: No simple solutions for our property taxes

July 21, 2008

There has been a common theme in many of the recent op-ed pieces in newspapers throughout the state: Our tax system is hard to understand and full of unnecessary complexities.

I disagree, although there was a time when I also worried excessively about the intricacy of the tax system. But now that I am older, wiser and have come to understand that simple answers are usually helpful only for simple problems, my concern has abated. Here's why:

The real angst about taxes is over the difficulty in understanding how the system works and how different taxes do different things. This is mostly misplaced worry.

While there is some truth to the notion of tax complexity, it lies only in the completion of forms, not in the administration of taxes. The complexity of the tax system reflects the of economic life.

A more simple tax system would be as unfair-by that I mean in distorting taxpayer behavior-as any combination of taxes currently in place around the United States.

Let's take Indiana as an example. Hoosiers pay income, property, sales and use taxes, along with assorted fees. Most all our transactions involve taxation of some sort.

A basic principle of taxation holds that higher taxes influence taxpayers' behavior. In economic jargon, this means taxes can act as a disincentive to related activities, from working extra hours to buying a more expensive house.

However, the level of behavior distortion changes both with the type of item taxed and the rate of the tax. Generally, the lower the tax rate, the less consumers care about taxes. Also, the more important the item is to us, the less tax policy alters our purchasing patterns.

So, a 7-percent sales tax rate won't have as much impact on our behavior as a 14-percent tax rate. And we care less about taxes on insulin than we do about taxes on soda pop.

Taxes also affect folks differently in different times of their lives. Retirees, who spend more proportionately on food and travel but make less money, for example, may favor income taxes over sales taxes. Younger workers, on the other hand, may prefer property taxes. (This might also speak to the demographics of the property tax debate.)

Different types of taxes also affect government administration. Property taxes in particular focus tax revenue to the locations where costs are incurred (the household). Nothing holds government accountable like local property taxes.

To economists, the mantra is "broad tax, low rate." To do this requires many tax instruments that reflect the complexity of our free markets. Calls for a simple "flat tax" or simple tax policies are too good to be true.



Hicks is director of the Bureau of Business Research at Ball State University. His column appears weekly. He can be reached at bbr@bsu.edu.
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