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Capital Comments by Larry DeBoer - New Tax

Legislators passed a big tax bill, Senate Bill 1. It phases down the corporate income taxes and gives counties the option to exempt small businesses from property taxes on their equipment and the option to exempt new equipment. The bill also creates a commission on business personal property and business taxation, which will include legislators, appointees of the governor, and business and local government representatives, among others.

The bill didn't eliminate the property tax on business equipment. That idea didn't make it into a bill during the session. Perhaps the results of the Legislative Services Agency's report on the concept discouraged legislative proposals. Businesses pay about a billion dollars in property taxes on equipment. If the taxes were eliminated, about a third of that billion would shift to other taxpayers and two-thirds would be lost revenue for local governments. That's big money.

The commission will probably look at elimination again, if only because "business personal property" is in its name.

Could we simply eliminate the tax, and leave it at that? Well, there's that one-third of a billion-dollar increase in everyone else's property taxes, about a 7 percent hike in the average tax bill. The tax bill increase would top 20 percent in half a dozen counties. Then there's the two-thirds of a billion-dollar loss in revenue to counties, cities, schools and other local units. Locals are already struggling with the loss of more than $700 million to the tax caps.

The commission might consider that possibility. But suppose we wanted to replace personal property taxes with other revenue. Where could we get a billion dollars?

There are only three Indiana taxes that can raise money like that: the property tax, the individual income tax and the sales tax. The property tax raises about $6 billion a year (including the equipment tax); the individual income tax raises $5 billion for the state and another $1.9 billion for local governments; and the sales tax raises $7 billion. Plausible rate increases in any of these taxes could generate a billion dollars.

The property tax is out, though. The tax caps that we put into the Indiana Constitution prevent big increases. The state's individual income tax seems unlikely, too. We've scheduled a reduction in the state income tax rate, from 3.4 percent now to 3.23 percent by 2017. That rate is going down, not up.

Local income taxes would have to increase by half to raise a billion dollars. That's a lot. More plausibly, those local taxes could offset the property tax shift to other taxpayers. That's about a third of a billion dollars, closer to a 20 percent increase in local income taxes. When we phased out the property tax on inventories between 2002 and 2007, half the counties adopted local income taxes to prevent a shift of property taxes to homeowners.

That leaves the sales tax, the traditional way that Indiana reduces property taxes. In 1973, the sales tax increased to fund credits that cut property taxes by 20 percent. In 2002 an increase defended homeowners from the effects of the property tax reassessment. And in 2008, the most recent hike helped fund the elimination of property taxes for school general funds. When Indiana wants to fund big property tax relief, we use the sales tax.

Our 7 percent sales tax raises about $7 billion a year. That's a billion dollars per point, more or less. Raise the rate to 8 percent, and there's your billion dollars.

Way too easy. For one thing, an 8 percent state sales tax rate would give Indiana the country's highest state rate. That's not a distinction we want. Of course, most other states tack on local sales taxes, so there are plenty of combined rates over 8 percent. For another, that's funding a business tax cut with a tax paid mostly by households. Households might object.

Looks like the new business tax commission will have to study more than just business taxes. How much should we pay for local government? What should be the mix of business and household taxes? Sure enough, the list of issues the commission will study includes all those – and more.