Estimated Effects of Indiana's New Tax Reform on the Median Indiana Homeowner and Renter

Revised April 2, 2008

 

Contents
Introduction
Policy Changes
Household Incomes, Home Values and Spending
Changes in Tax Payments
Sixty Representatiave Households

 

Introduction
What’s the effect of Indiana's new tax reform on the taxes paid by Indiana households? The new laws include property tax cuts and a sales tax increase, so who will pay more and who will pay less is a question.

Policy Changes
Here are the basic changes in state and local taxes that are included in Indiana's new tax reform, which are in House Enrolled Act 1001.

Under HEA1001, by 2010 the state would take over about $2.8 billion worth of local property tax levies. The two property tax credit programs would be eliminated, which would free up about $2 billion to pay for the takeovers. The state would increase the sales tax from 6% to 7%, and some wagering taxes would be redirected, to raise the extra billion. The new sales tax and wagering revenue is a net increase in property tax relief. The added 35% homestead deduction, and the increase in the homestead standard deduction cap to 60%, channels this relief to homeowners.

Homeowner property taxes would be limited to 1% of their gross assessed value, which is the market value before deductions. This is known as the circuit breaker credit. Any taxes over 1% would be erased with a tax credit. Local governments would lose this revenue from their budgets.

Renters are allowed to deduct up to $2,500 of their rental payments from their Indiana taxable income. Raising this to $3,000 would reduce their taxable income. The Federal earned income credit is an income tax program that delivers bigger refunds to low-income working people. Indiana’s earned income credit is set at 6% of the Federal amount. The proposal raises this credit to 9%.

The changes listed above are what will happen once all the reforms are fully phased in. The circuit breaker caps take full effect in 2010. In 2009 the caps will be 1.5% for homeowners, 2.5% for rental housing and farm land, and 3.5% for all other property. In 2008, 2009 and 2010 the sales tax increase will fund additional homestead credits, even as existing homestead credits are eliminated.

Links to More Information

To Find: Go To:
Information about HEA1001 on the General Assembly's website. Indiana General Assembly, Bill Info (Type "1001" in the "Go To Bill" box)
The Legislative Services Agency Fiscal Note for HEA1001. This website: HEA1001 Fiscal Note.

 

Household Incomes, Home Values and Spending
Let’s construct a couple of households and see how much they pay in taxes before and after these policy changes. To construct households, we need data.

The U.S. Bureau of Census now conducts an American Community Survey each year, using a sample big enough to give us information about states and some of the larger counties. The most recent data are for 2006. Among the numbers that the survey makes available are household incomes and home values. That’s just what we need.

The survey says that the median Indiana home is worth $120,700. Half are worth more, half less. The median homeowner has an income of $55,634. The median renter household has an income of $24,922. Table 1 shows the number of households in each of 98 combinations of income and home values, and 7 income categories for renters.

Table 1

The income and home value data provide a starting point for calculating income and property taxes. We need data for sales taxes too. The U.S. Bureau of Labor Statistics’ Consumer Expenditure Survey shows how much people spend on 73 categories of goods and services. Table 2 shows some of the data from this survey, for households with three people. These are national average data—no data for individual states is available.

Table 2

 

Table 2 shows some of the data available from the Consumer Expenditure Survey. The table shows the broader categories of spending. For most of these more detail is available. The average 3-person household, for example, spends $109 on apparel and services for boys, aged 2 to 15. That spending is included in the apparel and services category. The table shows the averages for all 3-person households and the spending amounts for the income ranges that include the median renter household and the median homeowner household.

A couple of details stand out in Table 2. First, the averages for all households in most categories exceed the averages for the income ranges that include the median renter and homeowner. This is because the very high income households pull the averages for all households higher.

Second, for the lower income households, expenditures exceed income. This implies that the households must be drawing on savings, or going into debt. Does this make sense?

One explanation is that some households with lower incomes have experienced a temporary reduction in their incomes—unemployment or business losses, for example—and have savings accumulated from their previous higher incomes. Another explanation is that, according to the Federal Reserve’s Consumer Finance Survey, 44% of families with a median income of $26,000 save some of their income. Of those same families, 70% owe some kind of debt, including 40% who owe on installment loans and 43% who carry credit card balances. Apparently, upper income households save a lot; lower income households save little, draw upon past savings, or take on debt.

The expenditure data is matched with the household income data by estimating “consumption functions” with statistical methods. The results allow the expenditures on each kind of product to be adjusted for income levels in between the averages compiled by the Consumer Expenditure Survey.

Links to More Information

To Find: Go To:
An Excel Spreadsheet with the Home Value and Household Income data in Table 1. This website: Home Value/Household Income data table
The U.S. Bureau of Census, American Community Survey. Census website: American Community Survey
The Bureau of Labor Statistics, Consumer Expenditure Survey. BLS website: Consumer Expenditure Survey
The Federal Reserve's Consumer Finances Survey. Fed website: Consumer Finances Survey

 

Changes in Tax Payments
The income, home value and sales data of each household can be used to calculate the tax liability of Federal, state and local taxes. Included are the property tax, sales tax, Federal, state and local income taxes, Federal and state excise taxes on tobacco, alcohol and gasoline, the Indiana motor vehicle excise tax, and the Federal Social Security tax. The households are assumed to have three people, two adults and one child, because this is closest to the 2.6 person average household in Indiana.

Table 3 shows the results for the median homeowner and median renter. Tax payments “before” refer to payments under our existing tax system. Tax payments “after” refer to payments with the changes in the new tax reform, HEA1001.

Table 3

The median homeowner sees a 32% cut in property tax payments. This amount reflects the decline in the tax rate due to the state takeover of several property tax funds, the increase in the homestead deduction, and the elimination of property tax credits. The Indiana Legislative Services Agency finds that these policy changes cause a 32% reduction in homeowner property taxes overall, so this reduction is assigned to the median homeowner. At state average rates, this amounts to a $420 drop in the property tax bill.

The homeowner pays an added $192 in sales taxes, a 16% increase due to the one point rise in the sales tax from 6% to 7%. Federal, state and county income taxes increase, because the median homeowner household itemizes its income taxes. The lower property tax bill means a smaller property tax deduction, a higher taxable income, and so a higher income tax payment, for the Federal, state and county income taxes. Excise taxes rise slightly. With a higher after-tax income the household spends more on tobacco, alcohol and gasoline, which are subject to excise taxes.

Overall, the homeowner household saves $209 in Indiana taxes, and $149 in total taxes. For the median homeowner, the property tax reduction exceeds the increases in sales and income taxes.

The median renter household, of course, receives no direct property tax cut. (In the long run, rents might be lower because of property tax cuts received by rental housing owners. Research suggests that this probably would not be enough to offset the added sales taxes, though.)

The renter household pays $140 more in sales taxes, because of the sales tax rate increase. The renter household's state income taxes decrease by $71. Of this amount, $22 is the result of the $500 increase in the cap on the renter's deduction, and $49 is the result of the increase in the Indiana earned income credit from 6% to 9% of the Federal credit.

Overall, the renter pays $69 more in Indiana taxes and total taxes. For the median renter, sales tax increases exceed state income tax cuts.

So far we’ve ignored the circuit breaker, which would cap a homeowner’s property taxes to 1% of the home’s value. The median homeowner’s cap would be $1,207—1% of 120,700-- but after the tax rate cuts, added deduction and credit elimination, this homeowner owes $906 in property tax. The middle-income homeowner at the state average tax rate would not be eligible for the tax cap. Higher valued homes would be eligible for the cap at statewide tax rates, and the median homeowner would be eligible for the cap at above average tax rates.

Links to More Information

To Find: Go To:
The Legislative Services Agency tax shift analysis for HEA1001. This website: LSA Tax Shift memo, HEA1001

 

Sixty Representative Households
These are just two households. The methods described here can be used for households with any combination of income, home value and spending. Table 4 shows the results of tax change calculations for sixty different households, with income and home values based on the American Community Survey ranges in Table 1.

The shaded cells in Table 4 show the households with small changes in tax bills, of less than $50. These households are essentially “held harmless.” Households to the “northeast” in the table see tax increases. These are households that are relatively “income rich and property poor.” All renters see tax increases. Those households to the “southwest” in Table 4 see tax cuts. These households are relatively “income poor and property rich.” Retired homeowners on fixed incomes—a group that policymakers are particularly concerned with—are in this group.

Table 4

 

The shaded cells divide the table approximately in half, so one might get the impression that nearly half of households see tax increases. This is not correct. Recall that almost one-third of Indiana households own homes in the $100,000 to $200,000 range (see Table 1). These households are represented in Table 4 by the $150,000 home value. All of these households see tax decreases of more than $50.

In fact, the household numbers in Table 1 can be used to give a rough estimate of the shares of households that see tax increases and tax decreases. The cells in Table 4 that show increases, decreases, or (almost) no change are matched with the numbers of households in each cell in Table 1. Including homeowners and renters, about 57% see tax cuts, 23% see tax hikes, and 20% see only small changes. Among homeowners, 78% see tax cuts, only 8% see tax hikes, and 14% see only small changes. Among renters, 60% see tax hikes, 40% see only small changes, and none see tax cuts.

 

Links to More Information

To Find: Go To:
An article in the Indiana Business Review with further results from this household tax model. IBR website: The Impact of Property Tax Legislation on Indiana Households, Spring 2008