Chris Watts: Two ways the state could boost Indy’s budget outlook

Without diving into specific spending priorities, does Mayor Joe Hogsett’s 2022 budget proposal offer clues to the local fiscal outlook beyond COVID? The $1.35 billion plan is based on tax revenue that is expected to fall $18 million next year, which stands in contrast to the double-digit revenue surge that drove increased spending in the state budget.

The good news? Federal aid from the American Rescue Plan more than fills this gap. The money can be used to cover some revenue losses, along with targeted commitments to public safety, housing security, economic recovery and water infrastructure upgrades.

Indianapolis is receiving nearly a quarter-billion dollars from the American Rescue Plan, part of a $2 billion statewide allotment. The money must be spent by 2026, creating a window of opportunity to focus on longer-term budget pressures that were building in Indiana’s cities and urban counties before the pandemic.

Here are two ideas covering the two largest sources of (non-school) local revenue: property taxes and local income taxes.

Indiana’s property tax caps had a $170 million impact on Marion County this year. These constitutional protections for individual tax bills aren’t going anywhere, but the state also limits total property tax collections by county. The “maximum levy” is allowed to grow only as fast as the six-year average of personal income growth, a formula created by the General Assembly in 2002.

Using this measure, maximum levies can increase 4.3% in 2022—higher than recent years but still below the growth trend for net assessed values in Indianapolis. That means the city’s property tax base won’t keep pace with its housing boom or fully capitalize on economic development successes and strategies like transit-oriented zoning that spur new real estate investment.

Does it make sense for property taxes in Indianapolis to be tied to the incomes earned as far back as 2017 by workers in opposite corners of the state? Rep. Jeff Thompson offered legislation this year to update the maximum levy growth quotient, reconnecting it to assessed values to help revenue keep up with costs in growing parts of the state (like Marion County). The idea got lost in the shuffle of the budget session, but it is worth revisiting.

It’s also time to revisit local income tax administration. State and local income taxes are filed together, a convenience for Hoosier taxpayers that complicates how revenue gets to local units of government. The state makes distributions by tabulating the previous year’s income tax returns, based on taxable earnings another year removed.

This is managed through county income tax accounts, akin to checking accounts with tax collections as deposits and distributions as withdrawals. The state requires a 15% reserve in these accounts to protect against negative balances if collections dip below distributions during a recession.

Because distributions are always based on delayed data, it’s difficult to control the 15%. In 2020, total balances were approaching $1 billion, more than double the statutory limits. Marion County’s “trust fund balance” was near $150 million.

The Indiana Fiscal Policy Institute will release an analysis from Purdue University professor Larry DeBoer “stress testing” the 15% requirement against recession scenarios. The COVID recession was sharp but short, making only a modest impact on taxable income.

Even against deeper downturns, DeBoer’s study will show that a lower reserve (11%-12%) would have protected the solvency of county income tax accounts while releasing more revenue to local governments—up to $200 million statewide (based on 2022 estimates), including more than enough to make up Indianapolis’ anticipated revenue loss.

The Indianapolis City-County Council will pass next year’s budget in October. Three months later, the General Assembly will reconvene. If revenue is still outperforming forecasts, lawmakers will face pressure to cut taxes and reconsider spending from the historic surplus. But they should spend part of the short session contemplating ways to help local revenue capacity keep up with Indiana’s economic recovery, before the next crisis tests state and local finances.•

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Watts is president of the Indiana Fiscal Policy Institute.

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