ECONOMIC ANALYSIS: Changing state’s tax system would be tough to pull off

Keywords Economy / Government

When it comes to matters of tax policy, inertia reigns supreme. The federal government still collects the proceeds of an excise tax on telephones that was borne as a temporary measure to help finance the Spanish-American War. The tolls on the Indiana Toll Road have not changed in almost 20 years. And the granddaddy of them all, the property tax, has existed in one form or another since the Middle Ages.

So when the mayors of Indiana cities and towns propose to rework the way in which they receive tax support of their citizens, they face formidable odds. Like most states, Indiana municipalities receive their taxing authority from the Legislature, and major changes to the tax system don’t successfully run that gauntlet often.

But there’s a price to be paid for this ossification. The economy that forms the base for the wealth that we tax does not obey any legislative majority. And with economic transformation occurring all around us, it is easy for our methods of collecting taxes to get out of step. That, in turn, usually means our tax system inflicts more pain than it needs to.

It’s nearly impossible to overhaul the tax system in a way that makes everyone pay less, and you can expect those who might pay more to make plenty of noise. So tax reform generally takes some kind of crisis or other highly visible event to break through the logjam of special interests that block most major changes.

Is local public finance in such a state? Many of its leaders seem to think so. Even with the recession now well behind us, you still hear of municipalities strapped for cash, forced to choose between the painful options of raising property tax rates or laying off public safety workers.

Such talk, of course, would likely occur no matter how we collected taxes. The process of budgeting is all about choosing between priorities, and funding every public function the way its agency head would like is never a workable option.

But the recent strain on cities and towns in Indiana has exposed some warts in the property tax system that are worthy of attention. One is the treatment of the not-for-profit sector. The relationship between the demand for public services-ostensibly what tax burdens are supposed to be about-and the amount of property one owns has always been approximate. If I have a $200,000 home, do I use twice as many services as I would if I owned a $100,000 home? Probably not.

But that crude relationship breaks down completely when dealing with taxexempt property owned by schools, churches, governments and other notfor-profits. The simple solution-removing the tax exemption-is politically infeasible. So the idea of shifting the local tax burden away from property taxes to local income taxes is proposed as a work-around.

That idea also addresses another longrunning trend in most regions in the state-the growth in suburbs and exurbs outside central cities. It is said that the population of Manhattan on a noon weekday is more than 10 million. But only a fraction of those see a property tax bill from the mayor. Income taxes, it is thought, better align tax burdens geographically with wealth generation.

But this may be a case where mayors should be careful what they wish for. Not only are income tax receipts much more erratic than property tax collections, they are also much more easily avoided. The physical placement of structures and property are relatively permanent, but the same cannot be said of payrolls in a metropolitan area where tax rate differentials exist.

And there is something undemocratic about collecting tax revenue from those who do not have a say in how it is spent, namely, non-residents. Since they do have a vote in the Legislature, the mayors should expect a hard fight.

Barkey is an economist and director of economic and policy study at the College of Business, Ball State University. His column appears weekly. He can be reached by e-mail at

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