Should Indiana eliminate its individual income tax?
Sen. Travis Holdman’s proposal to review Indiana’s taxes through a two-year Blue Ribbon panel is a wise and thoughtful approach. I say that as someone who participated in a comprehensive state tax reform as a young economist and testified on at least four other state tax reform efforts. But the value of this approach is not that it will result in a pre-ordained outcome. Rather, the timing is crucial.
Indiana is about two years from retiring pension debt that will free up significant revenue. This would permit a smoother transition and allow a bolder and more comprehensive review of tax and spending. More important, Indiana’s economy continues to perform poorly.
For more than a decade, our growth in incomes and GDP has been at roughly two-thirds the national average. That means Hoosiers are falling further behind the rest of the nation, and that is poised to worsen in the years to come. Tax and spending policy plays a role in economic growth. Thus, the study commission cannot help but take a deep look at the evidence surrounding taxation, spending and growth. It will be eye-opening.
Economists view taxation simply as the price of public goods and services. It is silly to talk about prices without also discussing quality. Households and businesses are increasingly informed about the quality of schools, roads, crime, blight and other quality measures of state and local government.
Ironically, over the past several decades, nearly all the economic and population growth has been clustered in higher-tax places. That is not because folks like paying taxes. Rather, the quality of public services matters much more than it did in decades past. That fact might surprise many, but it will surely inform the commission’s work.
With an eye toward a healthy economy, economists propose several important questions about a tax system. Is it adequate for current needs and stable over a business cycle? Is it elastic, so that it grows along with the economy? Is the tax system simple to administer? Is it easy to comply with as a taxpayer? Is the tax fair, in the sense that it treats similar economic activities the same? Does the system encourage tax avoidance? Does it distort the behavior of taxpayers in unhelpful ways?
These goals are in tension. It is not possible to achieve all these goals with a single tax. This is why economists favor low tax rates, levied against a broad tax base—covering income, wealth and consumption. This likely means taxing the rapidly growing share of services, in addition to the declining share of goods. This means broader, not narrower, taxation.
This timely, two-year examination of tax and spending policy will give Hoosiers better insight about the role of taxes and spending on growth. In some areas, we’ll find Indiana does very well; in others, very poorly. In the end, there is no such thing as an optimal tax system. But, with a little work, Indiana can craft a much better one.•
Hicks is a professor of economics and the director of the Center for Business and Economic Research at Ball State University. Send comments to firstname.lastname@example.org.
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