Rising property prices now lead to high tax bills
As real estate prices have skyrocketed since the pandemic, homeowners across the country are now receiving new, higher property tax bills as a result.
Scripps News
It’s election season, and we’re inundated with tax proposals. I think that’s a good development because the legislature is in the middle of a two-year tax study. We have the time and resources to work out the strengths and weaknesses of each proposal.
This is also a good time to step back and ask a simple question: “What would a good, conservative state tax system look like, and how does Indiana’s compare?”
A brief history of taxes
Taxation is an ancient institution. The very first written documents found in archaeological excavations are tax and accounting books. The first colonial-era taxes were levied on property and sales. Income, which was harder to measure, was not generally taxed until the 19th century.
In the early days of our founding, there was fierce debate over the method and purpose of federal taxation. For state and local governments, taxes were a recognized necessity. Property taxes and what they must fund were detailed in the Northwest Ordinance of 1787, the document that laid out the requirements for Indiana statehood.
This should come as no surprise. John Locke and Adam Smith, two major intellectual forces that influenced our Constitution, both wrote about taxes in ways that are familiar today. From Abraham Lincoln’s Lyceum speech to Ronald Reagan, conservative thought offers a view of taxes that is dramatically different from much of today’s rhetoric.
There are three major things we can tax: wealth, income, and consumption (spending). A major goal of conservative tax policy would be to minimize the distortion of family and business decisions through taxes.
The goals of a conservative tax system
To achieve this, a conservative tax system would first tax all wealth, income and consumption, but at a very low rate. This is the first principle of a good, conservative tax system.
A second goal would be a tax system that is easy for governments to administer and whose obligations are easy for taxpayers to comply with. Simplicity is important.
A third goal would be a tax system that can withstand the inevitable ups and downs of an economy. This is important not only to raise tax revenues in a recession, but also to offset rising government spending during inflation.
Fourth, taxes should increase roughly in line with the rate of economic growth and not slower or faster than economic growth.
All these rules ensure stability and security in the tax system.
There are two other, more subjective, measures of a conservative tax system. The first is that a system should be progressive. Adam Smith, the father of free-market economics, argued clearly that the wealthier should pay higher tax rates. His argument focused on expanding trade and infrastructure.
Finally, conservative tax policy argues that taxes should meet the needs of the government. It is easy to see why this is subjective and changeable. Sometimes the government needs a lot of money – to defeat terrorists or Nazis, for example. At other times it may need much less revenue, such as during a major expansion.
One way to judge the adequacy of tax revenue is to measure how well your state or local government is doing on key public service metrics. It’s important to ask questions like: How good are your roads? What is the crime rate? How good are the schools at basic tasks like literacy? How successful is the education system at sending children to higher education?
The answers to these questions help answer another question: Are we generating enough tax revenue?
Why Indiana’s tax system doesn’t meet the standard
So how does Indiana’s tax system compare to these traditional measures of a conservative tax system? It’s a mixed bag.
Unlike some other states, we levy taxes on consumption, income, and wealth. Our income tax is a flat rate and very low. The tax is still slightly progressive because it allows for deductions and includes an Earned Income Tax Credit (an idea of Milton Friedman, the godfather of conservative economics).
Our sales tax rate in Indiana is high for a state tax, but it doesn’t include local option taxes, putting it comfortably in the middle of the pack. A real weakness of our sales tax is that we only tax the sale of goods, not services. If we taxed everything, we could raise the same annual tax revenue with less than 4% sales tax.
And finally, the smallest of our three major taxes is the property tax. We tax businesses and households based on the value of their land, homes or buildings, and their amenities. We cap these taxes at 1%, 2%, and 3% of the total value (gross value) for primary residences, secondary residences, and businesses, respectively.
Local governments grant huge tax breaks to favored businesses. Residents receive tax breaks if they have a mortgage, are getting old, or are disabled veterans. Farms are taxed according to a more complex formula.
Assessing these taxes against the background of conservative framework conditions produces a completely different picture than the “conservative” anti-tax zealots would have us believe.
Hiccup: People prefer to live where property taxes are high
If we taxed everything low, we could keep our current income tax system, which together with state and local taxes is almost 4%. We would have to tax all transactions – not just goods, but services – and reduce the tax rate to almost 4%. That would give us balanced income and sales tax rates, but we would have a property tax rate of less than 1%.
The traditional conservative goal of a broad tax base and a low tax rate would actually lead us to raise property taxes, not lower them. But our tax system has other problems.
The current system is regressive, meaning poorer households pay higher state and local taxes than richer households. The largest portion of regressive taxes are sales tax and property tax. About 7 out of 10 households own their homes, so they don’t pay more than 1% unless there is a referendum to raise more money for schools.
These people are the wealthiest residents of Indiana, while renters are the poorest. But remember, rental properties are taxed at 2%, most of which is passed on to renters.
For this and other reasons, our property tax system is highly regressive, imposing higher taxes on Indiana’s poorest residents. The bigger problem is actually the adequacy measure. Indiana ranks in the bottom 10 states in public health, school outcomes, and educational attainment. We score poorly on road maintenance and have only average crime rates. Our tax system is clearly inadequate to provide adequate public services.
Indiana does not fit the traditional description of a conservative tax system.
Michael J. Hicks is director of the Center for Business and Economic Research and the George and Frances Ball Distinguished Professor of Economics at the Miller College of Business at Ball State University.
