I Am Confused by Tax Proposals

I confess to often being confused by tax proposals, which might seem unusual given that I’ve authored dozens of tax studies. So, instead of trying to help readers understand an economic issue in this column, I’m going to explain to you why I’m a bewildered by some of the proposals that are before the Indiana legislature this year. First, the basics.

Indiana, like almost every other government in the world, taxes three things: wealth, consumption and income. There are lots of names for these taxes, but this is the universe of taxes.

Wealth taxes are the oldest form, appearing in the archeological record between 4000 and 6000 B.C., in ancient Mesopotamia. Consumption taxes and income taxes are first recorded in Rome, from Julius and Augustus Caesar, in the first century B.C. So, there’s nothing new here.

Modern taxes on wealth are primarily property taxes. Consumption taxes are sales and use taxes. Taxes on income are, well, income and payroll taxes. Every state (yes, every state) collects some version of all these, even if they have different names. There’s a great deal of variability in who pays each of these taxes, how they are administered and what types of businesses or people are taxed.

Economic research provides almost no evidence that the mix of taxes plays an important role in household or business location, or economic growth. Here in Indiana, our wealth taxes (property taxes) are the seventh-lowest in the nation on a per capita basis. Our taxes on consumption (sales taxes) are 26th-lowest and our taxes on income (income taxes) are 34th-lowest on a per-person basis.

I am confused why there’s such strong push to reduce or eliminate the one really low tax in Indiana. I’m especially confused since the property tax was required in the Northwest Ordinance of 1787, which proscribed rules for establishing our state.

The most likely explanation for this is that some Hoosier elected leaders are listening to a relatively small number of wealthy folks who would prefer someone else pay the taxes that fund their local schools, police, fire and other services. I suppose that is a pathway to electoral success. It is dubious public policy.

Still, economists are suspicious of asking people what they want. Instead, we prefer to observe what people do. Though almost everyone says they want lower taxes, folks are actually moving to places with higher taxes. Since 2010, all the population growth in Indiana has come in just a few high tax counties. The best way to see this is simply to inspect the effective overall tax rate (taxes as a share of household income) and the median property tax payment.

Growing counties have a total state and local tax rate that is 34 percent higher than the counties that have lost population. In those growing counties, the median property tax payment per resident is $456 higher—a whopping 54 percent higher—than in counties that have lost population. The 10 fastest-growing counties have an effective state and local tax rate that is 238 percent higher than the 10 fastest-shrinking counties, and pay an enormous 131 percent higher property taxes per resident ($937 more per year).

So, listening to people who are complaining about taxes gives you a very different answer than asking “what are the taxes like in the places that are growing versus places that are in decline?”

Now, people aren’t moving to those places because of high taxes. Rather, they are moving there to access the public services those taxes provide.

Again, you can learn this not only by watching where they move, but also by the value that people place on property in these high-tax locations. There is a large body of research on this question. This work offers clear estimates of how much households are willing to pay to live in different locations.

For example, if you take two identical homes and put one in the best school corporation in the state (as measured by test scores) and the other in an average school corporation, the difference in home prices is about 30 percent. Likewise, if you put one in a quiet residential area and the other near an airport runway, you’d find the value of the home drops by about half a percent for each additional decibel of aircraft noise.

The quality-of-life differences between the low-tax and high-tax counties are substantial. By my calculations, Hoosiers are willing to pay about twice the price for an identical house in Hamilton County than the same one in Martin County. That difference is almost exclusively due to the quality of locally provided services—good schools, safe neighborhoods, and the availability of private amenities like grocery stores.

It is easy to see how a place that attracts more residents experiences rising property values, and thus its property taxes grow. If cities and counties spend those tax dollars wisely, then they attract more residents. And, yes, this could get out of hand. If taxes rise more than the value of the local amenities they are paying for, then people leave. Americans vote with their feet.

This is a critical point. So, when there’s population decline in a city or county, it isn’t just because taxes are too high or amenities are too low. It is primarily because residents (or potential residents) don’t think the county is providing value for the tax dollars they are spending.

However, it is necessary to stipulate that there are precisely zero communities in Indiana that are stagnating because the schools are too good, the streets too safe and well maintained, or that lure too many good grocery stores for residents. Neither is there a single municipality or county that is losing residents because taxes are too high.

I’m heartened that the legislature seems to understand these issues and has rejected the more than $1 billion in local property tax cuts proposed by the Braun administration. It’s wise to think about taxes in a budget session. But it is courageous, as well as wise, to think deliberately and rigorously about the potential effect of cuts or increases.

Our legislature seems to have done just that.

In the end, it is important to consider not only the people complaining about high taxes, but also those who want to live in a place that provides high-quality local public services, which they are willing to pay for.

Those are the people Indiana desperately wants, but is now struggling to attract and retain.