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S&P report: Stagnant incomes threaten Indiana revenues

September 15, 2014

Rising income inequality in the U.S. appears to be slowing tax revenue growth in Indiana and other states, according to a new report by the credit rating agency Standard & Poor's.

The report found that the rising wealth of the top 1 percent richest Americans has been accompanied by a three-decade-long slowdown in states' revenue streams.

That funding squeeze and stagnant wages for most Americans is expected to increase spending pressures on education, infrastructure and social services programs as states struggle to increase their tax revenues, the report contends.

Indiana could be among the states hardest-hit by that trend.

The state has one of the nation's highest sales taxes. According to the conservative Tax Foundation, California's is the highest at 7.5 percent, and Indiana and four other states—Mississippi, New Jersey, Rhode Island and Tennessee—are tied with the second-highest, at 7 percent.

That sales tax is Indiana's largest source of revenue. But it is tied to consumer spending, and Americans have become increasingly reluctant to spend as median incomes have remained virtually stagnant over the past 30 years.

"It's by the far the largest source of revenue for the state, and it's so economically sensitive that if the economy's not doing well, it shows up pretty quickly in the state's revenue," said John Ketzenberger, president of the Indiana Fiscal Policy Institute.

That creates a challenge for legislative leaders trying to craft the state's budgets, he said.

The S&P report said Indiana's overall tax revenue grew by an average of 9.29 percent a year between 1950 and 1979 — the year that the gap between the most affluent Americans and the rest of the nation began growing.

Indiana's average annual tax revenue growth has fallen every decade since, dropping to 4.35 percent between 2000 and 2009, the report found. Annual revenue growth has fallen even lower since 2009, to 3.24 percent.

A 2008 law raised Indiana's sales tax from 6 percent to 7 percent to offset limits lawmakers placed on property taxes. Local governments and school districts have faced millions of dollars in revenue losses since then because of those property tax caps.

State Budget Director Brian Bailey said he could not comment on the report's findings because he had not read it. However, he said that during 2014 fiscal year, which ended June 30, about $6.9 billion of Indiana's $14.4 billion in total revenue came from its sales taxes.

Indiana's top 5 percent wealthiest residents earned an average of about $246,000 during 2012, according to income estimate data from the U.S. Census Bureau. That compares with about $47,000 for the middle one-fifth of the state's earners, $11,342 for the bottom fifth of the state's earners and $146,468 for the top fifth of Hoosier earners.

But S&P notes that the affluent tend to save a greater share of their income and spend it on untaxed services, meaning states are unlikely to see much of an increase in sales tax collections based on the gains among this well-to-do group.

Across all states, sales taxes account for 30.1 percent of all state revenue, according to the National Conference of State Legislatures. Personal income taxes make up 36.6 percent. The rest comes from other sources, such as taxes on fuel, alcohol and cigarettes.

As consumers have spent more online and on untaxed services, many states have tried to tax items like Netflix subscriptions and iTunes downloads. Washington state now taxes services at dating centers, tanning salons and Turkish baths.

Kim Rueben, a senior fellow at the Urban Institute, said the rise of untaxed purchases might have squeezed state revenue even if income inequality hadn't widened.

"Sales taxes are being eroded by the fact that we're moving to a services economy, and people are buying far more on the Internet," she said.

Research by Lucy Dadayan, a senior policy analyst at the Nelson A. Rockefeller Institute of Government, notes that income tax collections have become more volatile from year to year, making it harder for states to plan budgets, provide services and launch programs. She endorses an overhaul of state tax codes to produce a more balanced revenue flow.

But S&P says its findings suggest that the wealth gap derives from many factors and that state tax-code revisions don't fully address the consequences.

"Changes to state fiscal policy alone won't likely fix what's wrong," S&P concludes.
 

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