Balancing tax reforms, public investment in Indiana


By David Ober

Guest columnist

It’s something of a paradox that over the summer, while debating the need for increased public investment in child care access, transportation infrastructure, public employee retirement benefits, and Medicaid reimbursement, legislators also considered proposals that could dramatically reduce the revenues needed to finance those priorities.

Appointees to the State and Local Tax Review Task Force have been exploring the potential elimination of the state’s individual income tax (income tax), a goal that is central to the campaign of at least one candidate for governor.

The fiscal impact of such a policy change is far from trivial. In FY23, the income tax generated approximately $7.6 billion, constituting roughly 36% of state revenues. In just the first three months of the current fiscal year, income tax collections exceeded estimates by nearly $150 million. The proposal to eliminate the income tax echoes former Gov. Mike Pence’s promise to reduce the income tax rate by 10%, from 3.4% to 3.06%. At the time, Pence’s tax cut was estimated to reduce state revenues by $500 million, a nominal figure compared to what is now under consideration.

Next year, Hoosiers will finally realize the 10% income tax cut Pence proposed in 2012. Granting that a modest rate cut took more than a decade to achieve, the prospects of eliminating the income tax appear dubious. The means of achieving the tax cut are more significant than the motivations behind the policy, and the cadence of rate cuts might reasonably measure in decades.

To achieve such an aspiration, let’s first consider the income tax base along with the deductions, exemptions, and credits which narrow the base and reduce state revenue. Broadening the tax base could enable policymakers to further decrease the tax rate. Just repealing a handful of deductions, exemptions, and credits with the largest base-narrowing impacts would enable the state to capture more than $2 billion over the biennium. However, these reforms include eliminating the personal and dependent child exemption, the renter’s and homeowner’s deduction, as well as the earned income tax credit and 529 contribution credit. Eliminating these tax benefits, some of the most popular among Hoosiers, represents significant political risk and would make the tax code more regressive.

Another proposal could be expanding the sales tax base to include more goods as well as services. Though considered by legislators in the past decade, this idea has never advanced to a vote by a House or Senate committee. Taxing these transactions would generate greater sales tax revenue to offset revenue losses resulting from a lower income tax rate.

However, imagine receiving a little more in your paycheck but paying 7% more on various goods or services, effectively reducing your buying power. Also consider what proportion of an average salary earned by a Hoosier, just over $58,000 per year, would be dedicated to state taxes. Without new or expanded exemptions this base-broadening would, by definition, exacerbate the regressivity of the state tax code.

A third option could include dramatic reductions in state spending. Given the high proportion of the state budget dedicated to K-12 education and health services, it’s hard to envision the scope and quality of these services remaining intact with reduced funding. Perhaps reducing the state workforce of roughly 32,000 employees could reduce costs. The reality is that for nearly two decades the seeming raison d’être of state leaders has been responsible budgets, prudent reserves, and a competitive tax environment for individuals and business. As of 2021, Indiana ranked 37th (well below the national average) in total state expenditures per capita. Can more spending be cut? Certainly. Can legislators cut enough to meaningfully reduce the income tax rate while maintaining the services Hoosiers have come to expect? Decidedly not.

Returning to our paradox, the legislature is considering the need for increased public spending in critical areas to boost our quality of life, improve our health and access to care, increase workforce participation, and provide greater connectivity between our communities. A focus on tax policies that are understandable, equitable, and just, with a bias toward competitiveness is important. However, growing our citizenry and enhancing their well-being will require similar focus and dedication.

David Ober is vice president of taxation and public finance at the Indiana Chamber of Commerce. He previously served as a commissioner for the Indiana Utility Regulatory Commission and as a member of the Indiana House of Representatives. This column first on the Indiana Capital Chronicle website at Send comments to [email protected].

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