The Indiana legislature gave final approval this week to a measure asking Indiana voters whether the property tax caps enacted less than two years ago should be enshrined in the state’s constitution.  Embedding these caps in the constitution is a radical step. They were only fully phased-in less than a month ago, so the full effect of these provisions has yet to be seen.  Moreover, despite the large amount of uncertainty surrounding the caps, available evidence already suggests that less well-off renters will be among those most hurt by the caps, while homeowners with highly-valued homes will receive enormous benefits.

The property tax cap amendment (which is already permanent law, regardless of whether voters decide to amend the state’s constitution) works by limiting property taxes to 1%, 2%, or 3% of assessed value, depending on the type of property in question.  Homeowners receive the benefit of the generous 1% cap, while rental units and farms will benefit from the less helpful 2% cap.  Other properties’ tax bills (e.g. businesses) will be capped at 3%.

A number of aspects of Indiana’s new tax cap regime are troublesome from a tax fairness perspective.  Since renters are generally less well-off than their home-owning neighbors, their higher cap is reason for concern. The 1% cap for homeowners is not helpful to owners of less expensive homes since they already benefit from a pair of large homestead deductions offered by the state. Instead, only those Hoosiers with very expensive homes (who may in fact be paying more than 1% of their property’s value in tax), are expected to benefit most from the caps. 

Finally, since some of the cost of these recent changes to the property tax was offset by a regressive sales tax increase, renters and lower-income homeowners can expect to pay more in taxes overall.

Inserting this problematic policy into the state’s constitution will only compound its shortcomings.  Specifically, as the head of the Indiana Association of Cities and Towns (IACT) put it: “This action will forever tie the hands of future General Assemblies to react to any unforeseen economic reality and put a level of specificity into our Constitution that is completely unprecedented.”

Nonetheless, politics made passage of the caps by the legislature almost inevitable.  As one Republican mayor in the state explained, "It's the same old political trick bag. It's typical that the 150 [state] legislators sit there and put a cap on property taxes and get to sit there and look good, when we're the ones taking all the heat, having to cut services."

At present, available polling indicates that the caps are popular among Indiana voters.  November is a long way away, however, leaving plenty of time for Indiana voters to become informed about the shortcomings of these caps.

Until this week, New Jersey was one of just nine states refusing to publish a tax expenditure report – i.e. a listing and measurement of the special tax breaks offered in the state.  Such reports greatly enhance the transparency of state budgets by allowing policymakers and the public to see how the tax system is being used to accomplish various policy objectives. 

Now, with Governor Jon Corzine’s signing of A. 2139 this past Tuesday, New Jersey will finally begin to make use of this extremely valuable tool.  Beginning with Governor-elect Chris Christie’s FY2011 budget, to be released in March, the New Jersey Governor’s budget proposal now must include a tax expenditure report.  The report must be updated each year, and is required to include quite a few very useful pieces of information.

The report must, among other things:

(1) List each state tax expenditure and its objective;
(2) Estimate the revenue lost as a result of the expenditure (for the previous, current, and upcoming fiscal years);
(3) Analyze the groups of persons, corporations, and other entities benefiting from the expenditure;
(4) Evaluate the effect of the expenditure on tax fairness;
(5) Discuss the associated administrative costs;
(6) Determine whether each tax expenditure has been effective in achieving its purpose.

The last criterion listed above is of particular importance.  Evaluations of tax expenditure effectiveness are extremely valuable since these programs so often escape scrutiny in the ordinary budgeting and policy processes.  Such evaluation can be quite daunting, however, and the Governor’s upcoming tax expenditure report should be carefully scrutinized in order to ensure that these evaluations are sufficiently rigorous.  One example of the types of criteria that could be used in a rigorous tax expenditure evaluation can be found in the study mandated by the “tax extenders” package that recently passed the U.S. House of Representatives.  For more on the importance of tax expenditure evaluations, and the components of a useful evaluation, see CTJ’s November 2009 report, Judging Tax Expenditures.

Ultimately, New Jersey’s addition to the list of states releasing tax expenditure reports means that only eight states now fail to produce such a report.  Those states are: Alabama, Alaska, Georgia, Indiana, Nevada, New Mexico, South Dakota, and Wyoming.  Each of these states should follow New Jersey’s lead.

This week, the Institute on Taxation and Economic Policy (ITEP), in partnership with state groups in forty-one states, released the 3rd edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.”  The report found that, by an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy.  The response has been overwhelming.

In Michigan, The Detroit Free Press hit the nail on the head: “There’s nothing even remotely fair about the state’s heaviest tax burden falling on its least wealthy earners.  It’s also horrible public policy, given the hard hit that middle and lower incomes are taking in the state’s brutal economic shift.  And it helps explain why the state is having trouble keeping up with funding needs for its most vital services.  The study provides important context for the debate about how to fix Michigan’s finances and shows how far the state really has to go before any cries of ‘unfairness’ to wealthy earners can be taken seriously.”

In addition, the Governor’s office in Michigan responded by reiterating Gov. Granholm’s support for a graduated income tax.  Currently, Michigan is among a minority of states levying a flat rate income tax.

Media in Virginia also explained the study’s importance.  The Augusta Free Press noted: “If you believe the partisan rhetoric, it’s the wealthy who bear the tax burden, and who are deserving of tax breaks to get the economy moving.  A new report by the Institute on Taxation and Economic Policy and the Virginia Organizing Project puts the rhetoric in a new light.”

In reference to Tennessee’s rank among the “Terrible Ten” most regressive state tax systems in the nation, The Commercial Appeal ran the headline: “A Terrible Decision.”  The “terrible decision” to which the Appeal is referring is the choice by Tennessee policymakers to forgo enacting a broad-based income tax by instead “[paying] the state’s bills by imposing the country’s largest combination of state and local sales taxes and maintaining the sales tax on food.”

In Texas, The Dallas Morning News ran with the story as well, explaining that “Texas’ low-income residents bear heavier tax burdens than their counterparts in all but four other states.”  The Morning News article goes on to explain the study’s finding that “the media and elected officials often refer to states such as Texas as “low-tax” states without considering who benefits the most within those states.”  Quoting the ITEP study, the Morning News then points out that “No-income-tax states like Washington, Texas and Florida do, in fact, have average to low taxes overall.  Can they also be considered low-tax states for poor families?  Far from it.”

Talk of the study has quickly spread everywhere from Florida to Nevada, and from Maryland to Montana.  Over the coming months, policymakers will need to keep the findings of Who Pays? in mind if they are to fill their states’ budget gaps with responsible and fair revenue solutions.

There’s a lot that can go wrong when a state turns to legalized gambling as a source of revenue.  This is a fact that Kentucky, Pennsylvania, and others should keep in mind during their continuing efforts to push for expanded gambling as a solution to their budget woes

For starters, a poor economy, opposition by local residents, legal challenges, and a number of other factors can delay the opening of newly legal gambling establishments.  And without functioning gambling venues, there’s no money for the state.  Recent stories out of Maryland and Pennsylvania demonstrate the very real nature of this threat.  Additionally, recent polling done in Illinois suggests that opposition to gambling at the local level – fueled in part, no doubt, by the Not-In-My-Back-Yard (NIMBY) syndrome – could cause similar delays there.  And legal challenges in Ohio indicate that the Buckeye state could be in for delays in gambling implementation as well.

But even after a state manages to get its gambling operations up and running, the revenue stream produced by gambling may not be as lucrative as advertised.  A recent New York Times story details the degree to which gambling revenues (from casinos, racetracks, lotteries, etc) are disappointing states this year.  The most obvious culprit in this case is the slumping economy, though some experts believe that increasing competition for gamblers both between states, and within states – known as “market saturation” – may be at least partially to blame.  Worries about market saturation have been on full display in Ohio, where racetrack owners are on edge about the effect that casino legalization (to be voted on by Ohioans this November) could have in cutting into their profits.

In other cases, it may simply be the case that gambling just isn’t as popular as first expected.  The perceived need among many states to legalize slot machine gambling as a means of drawing gamblers back to struggling racetracks is evidence of this problem.  Unfortunately, the failure of this method in Indiana has drawn into question the wisdom of this revenue-raising strategy as well.

Other methods, such as loosening the restrictions on betting limits or alcohol sales (which were originally imposed to secure support for gambling from reluctant lawmakers) are being tried as well.

Ultimately, the fact is that gambling is far from a fiscal panacea for the states, and given the tendency for implementation delays, is exceedingly unlikely to result in much revenue to fix the current round of state budget shortfalls.  Take a look at this ITEP policy brief for more on the gambling issue.

The Center on Budget and Policy Priorities recently released a very useful report summarizing tax expenditure reporting practices in the states, as well as methods for improving a typical state's tax expenditure report. For those unfamiliar with the term, a "tax expenditure" is essentially a special tax break designed to encourage a particular activity or reward a particular group of taxpayers. Although tax expenditures can in some cases be an effective means of accomplishing worthwhile goals, they are also frequently enacted only to satisfy a particular political constituency, or to allow policymakers to "take action" on an issue while simultaneously being able to reap the political benefits associated with cutting taxes.

Tax expenditure reports are the primary means by which states (and the federal government) keep track of these provisions. Unfortunately, most if not all of these reports are plagued by a variety of inadequacies, such as failing to consider entire groups of tax expenditures, or not providing frequent and accurate revenue estimates for these often costly provisions. Shockingly, the CBPP found that nine states publish no tax expenditure report at all. Those nine states Alabama, Alaska, Georgia, Indiana, Nevada, New Jersey, New Mexico, South Dakota, and Wyoming, undoubtedly have the most work to do on this issue. All states, however, have substantial room for improvement in their tax expenditure reporting practices.

For a brief overview of tax expenditure reports and the tax expenditure concept more generally, check out this ITEP Policy Brief.

For state lawmakers facing a balanced-budget requirement, the problem of revenue volatility can be a serious one. Since one of the more important goals states pursue is to provide a consistent level of services each year, it only makes sense that a correspondingly consistent level of revenue be available. In California, the Governor, together with state legislators, has appointed a commission specifically tasked with providing recommendations on how to reduce volatility. Minnesota recently formed one such commission as well, which actually released its findings just this week. Some of the commission's findings include (as summarized by the Minnesota Budget Project):

- "Shifting to more stable revenue sources would lead to a more regressive system with slower growth rates. Instead of attempting to rebalance the tax system, they recommend establishing a much larger budget reserve ($2.1 billion for now) to help carry the state through economic downturns."
- "Using one-time surpluses strictly for one-time purposes (like rebuilding the reserves)"
- "Avoiding permanent tax cuts or spending increases unless reserves are filled and shifts have been bought back."
- Ensuring "that policymakers and the public have access to more information to improve the decision-making process. That includes releasing a demographic forecast every biennium and adding inflation back to the expenditure side of the state's budget forecasts."

As these recommendations should make clear, revenue volatility is only a problem if it is not planned for in the budget. Restructuring an entire tax system just to smooth out revenue collections is an extreme example of trying to 'throw the baby out with the bath water'. In fact, as we've pointed out in our policy brief on progressive income taxation, restructuring a tax system with this aim in mind is likely to create even more revenue problems in the long-run.

But while there's much to be excited about in the wisdom behind the Minnesota Commission's recommendations, those ideas have yet to take root everywhere. In Indiana, for example, just this week the Governor called for automatically refunding any tax collections above some pre-determined level, during good economic times. Such a change would directly restrict the flexibility policymakers need to plan for rough budgetary times when things are going well.

Over the past few months, there's been a movement in Missouri to expand the circuit breaker program that benefits low-income property taxpayers. In addition, Indiana Governor Mitch Daniels recently signed legislation increasing his state's renter deduction. Clearly Minnesota Governor Tim Pawlenty didn't get the memo about the trend to help ease property tax burdens in targeted ways. Instead, Governor Pawlenty is proposing to reduce his state's renters' credit by 21 percent. The Minnesota Budget Project rightly points out that approving the Governor's proposal "would not only have a significant impact on ... low-income households, but also increase the regressivity of the property tax." As ITEP notes in its policy brief describing circuit breaker credits, whether such credits are designed to aid renters as well as homeowners is a critical consideration, since it's widely understood that some portion of the rent people pay consists of property taxes.

To read more about benefits of the Minnesota renters' credit, check out the Minnesota Budget Project's report here.

Governor Mitch Daniels of Indiana finally got the property tax reforms he wanted. The central components of the plan, signed by the Governor on Wednesday, cap property taxes at 1% of the value of a home, 2% of the value of rental property, and 3% of the value of business property.

The revenue loss to government will in large part be offset by a variety of tax increases, meaning the plan is actually more of a tax "swap" than a tax "cut". The sales tax is raised from 6% to 7% by the bill, and most localities can be expected to raise their flat-rate income taxes to help compensate for the property tax reductions.

Reducing one tax (the property tax) and replacing the revenue with a more regressive tax (an increased sales tax) can often mean that low-income people really face a tax hike rather than a cut. Or, if the tax increases are not enough to replace the lost revenue, this tax "reform" could result in a loss of funding for state and local public services. "Swapping" lower property taxes for higher sales taxes is not a fair deal for working families.

As discussed in a previous Digest, earlier versions of the bill contained modest protections for low-income taxpayers, including an expansion of the earned income tax credit (EITC) and some relief for renters. The final version of the bill did expand and make permanent the EITC, as planned, though the relief to renters was scaled back to a meager 20% of the original proposal.

Under this bill, the state now assumes responsibility for funding a variety of programs previously handled by local governments. Even combining this with the prospect of local income tax increases, however, some local governments are already preparing for budget shortfalls.

A better policy would provide tax relief in a more targeted way (i.e. based on one's income) and would be much less costly. The legislature did pass a constitutional amendment that would move in this direction, but under the state's ratification rules this measure must be approved again by the next legislature before it's put to the voters. But even this plan, while it has the right idea, has some flaws that are outlined in an earlier Digest article.

Committees in both houses of the Indiana legislature this week proposed major changes to the property tax reform legislation first reported in the Digest in early February. A Senate Committee left untouched the heart of the bill, which would pay for across-the-board property tax cuts with a sales tax rate increase, but made several serious changes at the margin that strip even the modest gains in tax fairness for low and middle income residents that the original bill had offered. Most importantly, the proposed increases in the state's EITC and renter deduction were pared back, eliminating the only two clearly progressive components of the entire proposal.

In contrast to the Senate plan, a new proposal passed by the House Ways and Means Committee departs fundamentally from the Governor's original plan. The plan endorsed by the House Committee limits homeowner property tax bills to a maximum of 1% of a household's income. Though income-based "circuit-breakers" such as this one are by far the most effective method for ensuring that nobody's property tax bill rises beyond their ability-to-pay it, the version endorsed in this instance has an unknown (but likely large) cost, and unlike every other circuit-breaker credit in existence, would be available even to the wealthiest homeowners. The best circuit-breakers exempt very low income individuals from property taxes entirely, and then limit everybody else's property taxes based on a graduated rate system that may range anywhere from 1% to 9% of income.

Given the constant concerns voiced by Indiana residents since at least July regarding their inability to afford their property tax bills, it is astounding that it took this long for a proposal that directly measures ability-to-pay in calculating property taxes to be given any notable attention. Though in this case the plan is unrealistic and unlikely to pass, adopting an income-based circuit-breaker is especially important in Indiana since its tax system would be made much less fair by the proposed sales tax hike.

Yet another bill attempting to swap a property tax reduction for a sales tax increase is working its way through a state legislature, this time in Indiana. Low-income Hoosiers can expect to lose out not only because of the regressive sales tax hike (from 6% to 7%). They will also find the distribution of $700 million in property tax credits completely divorced from need-based considerations. Further, the expansion of property tax caps (deceptively labeled "circuit breakers") will inevitably create inequities akin to those running rampant in Florida. The bill also caps the taxes that can be levied by Indiana localities in a manner that does not adequately take account of the rising cost of providing public services.

In an effort to offset the myriad regressive implications of the bill, the Indiana legislature also expanded the Earned Income Tax Credit (EITC) and provided some income tax relief to renters. But these comparatively minor steps will not be enough to offset the harm done to low-income Hoosiers. A recent report released by the Indiana Association for Community Economic Development includes a number of recommendations for reforming Indiana's tax system, most of which are not addressed by the current bill.

This week, taxpayers in Indiana will read promising headlines like, "Daniels announces property-tax plan" and assume that their angst about the property tax will disappear. But one doesn't have to read very far to know that Governor Daniels' proposal is an empty promise for low-and middle-income taxpayers. He is proposing $1 billion in property tax relief by 2009, but the relief comes at a steep price in the form of raising the state sales tax by 1 percent and capping homeowner property taxes at 1 percent of assessed value. Property tax caps are a long proven foe for taxpayers with less ability to pay. For more on property tax caps check out ITEP's policy brief.

As we've told you in past Digests, some Indiana taxpayers are threatening a revolt over property taxes. Rather than considering constructive reforms to the property tax, some anti-tax zealots are using the current situation as a reason to call for its outright elimination. Last week members of the Commission on State Tax and Financing Policy heard about the impact that property tax repeal would have on the state. The Legislative Services Agency (LSA) rightly titled their presentation "Challenges of Change."

The LSA estimates that in order to replace the $6.1 billion Indiana property taxes currently bring in, lawmakers would have to either increase the state income tax rate from 3.4 to 9 percent, or hike the sales tax rate from 6 percent to a whopping 13.2 percent. The LSA's presentation shows that repealing all Indiana property taxes would be prohibitively expensive. While Indianans' angst over their rising property tax bills is understandable--property taxes are regressive, and are often not based on a homeowner's ability to pay them-- enacting targeted property tax reforms such as a low-income "circuit breaker" credit would allow local governments to retain this important revenue source, and would make Indiana property taxes less unfair without requiring a double-digit sales tax to pay for it.

Property tax reform continues to make headlines in several states. Some Indiana property taxpayers are revolting against what they perceive to be an unfair system. Recently more than 3,000 Hoosiers signed post cards addressed to their state policymakers urging them to fix the state's property tax mess permanently. In fact, a legislative commission began hearings last month and Governor Mitch Daniels' appointed blue ribbon commission started work this week. The problems are that taxes are not based on a homeowner's ability to pay and that assessments are executed poorly.

One thought-provoking solution described in the Indianapolis Star is to closely study the property in the state that is not being taxed. Indiana, like most states, exempts nonprofit organizations and religious institutions from paying the property tax. In Marion County alone millions of property tax dollars could be collected if religious institutions paid property taxes. Estimates show there is $2.7 billion in property that goes untaxed in Marion County. Should churches and nonprofit organizations pay property taxes? It's probably the case that no politician in Indiana would seriously propose to tax churches, but the fact that some are contemplating such a move could startle legislators enough to enact real reform.

Are Rebates the Answer?

Indianans will receive locally-funded property tax rebates this winter, but those rebates aren't being greeted with much enthusiasm. Many question the motives of the legislators who approved these rebates. The Post-Tribune writes that instead of offering credits that would be applied to a homeowner's property tax bill directly, "The General Assembly instead decided property owners should receive checks in the mail, so they can see what their elected officials did for them this year."

This week Montana homeowners can begin to apply for a $400 state-funded property tax rebate. The rebates were a highly contested issue in the legislative session as Republicans pushed for permanent property tax cuts instead of the one-time rebates supported by Governor Brian Schweitzer. The Montana rebates shed light on a problematic aspect of property tax rebates and circuit breakers. Because states don't often know how much property tax a homeowner paid, it becomes the homeowner's responsibility to know about and apply for the credit.

Itemized Deductions on State Tax Are No Better

Another misconceived approach to property tax reform is the itemized exemption for property taxes, which is allowed for most states' income taxes. One problem with this is that in the low- and middle-income families hit hardest by property taxes typically don't itemize. Also, income tax deductions are an "upside-down" tax break, since deductions are worth more to the wealthy taxpayers who typically pay higher income tax rates. If property taxes are problematic for some families, offering a deduction that is largest for the wealthiest and not available at all to many middle-income families is certainly not the solution.

In the current skirmish between Missouri and Kansas discussed above, some Missouri legislators have asked why people should be granted such an itemized deduction for property taxes paid in another state (which certainly angers those who pay Missouri income taxes because they work in Missouri, even though they live in and pay property taxes in Kansas). But the better question is why should Missouri allow an itemized deduction for property even if its located in Missouri. The deduction probably does little to help those who could actually use some help.

Emotions were running high this week in Indiana during the state legislature's public property tax hearing. Hundreds of people showed up to protest in what some say is the beginning of a tax revolt. Protestors were angry over what they see as the unacceptable rise in property tax bills this year. Many speakers called the current property tax system "broken" and advocated drastic cutbacks in school spending, or even a complete repeal of the property tax system. Just this week, Governor Mitch Daniels ordered that property tax levies in four counties remain at their 2006 levels until reassessments are conducted and the list of counties where reassessments will be ordered is expected to grow. Governor Daniels has hinted at a calling a special session to deal primarily with property taxes. Expect this raging debate to continue.

In earlier Digests we've told you about how policymakers across the country have been dealing with increasing gas prices. Indiana Governor Mitch Daniels (R) been asked recently to suspend the state's sales tax on the sale of gasoline. The Governor declined to do so, saying "...although I can appreciate the short-term popularity that would go with it, I don't think it is a responsible step when you consider all the factors." Now it looks like the Governor may be relieved of the burden of making any choice at all. The state's Attorney General ruled late last week that the Governor doesn't have authority under a specific statute to suspend the gas tax. However, the ruling hasn't ended the controversy as the Speaker of House is urging that the gas tax be suspended anyway.