SEVEN BIG TAXES:

CHARACTERISTICS OF MAJOR STATE AND

LOCAL TAXES IN INDIANA


Larry DeBoer

Dept. of Agricultural Economics

Purdue University

Staff Paper #94-27 December 1994


Updated November 1995




CONTENTS

Page

Introduction 1

Criteria for Evaluating Taxes 1

TABLE 1 3

State Individual Income Tax 5

State General Sales Tax 6

State Corporate Income Taxes 8

State Motor Fuel Taxes 9

Local Property Tax 11

Local Individual Income Taxes 13

Local Motor Vehicle Excise Tax 14

Taxes and Economic Development 16

Appendix 18

Sources 20

Introduction

Policy debates often include choices about taxes. Should the sales tax be raised to reduce the property tax? Should a county use an income tax or a property tax to pay for a project? Should a new state program be financed with income, or sales, or corporate income taxes? Should the motor vehicle excise or motor fuels tax be cut? Information on the characteristics of taxes should be useful in making these choices.

This offers information on the characteristics of the seven biggest taxes used by state and local government in Indiana: the state individual income tax, the state general sales tax, the state corporate income taxes, the state motor fuels taxes, the local property tax, the local income taxes, and the local motor vehicle excise tax.

The three criteria used to evaluate taxes are incidence, growth and stability, and the use of each tax in Indiana relative to other states. The following section explains these criteria. Subsequent sections describe the seven big taxes, and evaluate them under the three criteria. The final section contains information on the economic development effects of taxes. An appendix describes the sources and methods used in compiling the information in Table 1.

Criteria for Evaluating Taxes

Incidence. The question of incidence is the question "who pays?" Is a tax paid by individuals or businesses? Rich people or poor people?

Table 1 shows two measures of incidence. BUSINESS SHARE shows the estimated percentage of each tax that is paid by businesses. The remainder is paid by individuals. RICH/POOR shows the difference between the percentage of income paid to a tax by a family earning $100,000 per year, and the percentage paid by a family earning $15,000 per year. When the number is positive, the rich family pays a higher percentage of income to the tax than the poor family pays. Such taxes are often called "progressive." When the number is negative, the poor family pays a higher percentage of income to the tax. Such taxes are often called "regressive." An alternative to this "ability-to-pay" standard of incidence is the "benefit" standard. Under the benefit standard a tax is considered fair if it is paid by people in proportion to their use of government services. No measurement of the degree of fairness under the benefit standard is available, however.

The business share shows what percent of tax bills are paid by businesses. But the ultimate incidence does not necessarily rest with business. For example, sales taxes paid by businesses on their purchases of equipment and materials are probably passed on to customers in higher prices. Some state corporate taxes are partially passed on to customers in higher prices, and partially to employees in lower wages. Part of the property taxes paid by landlords of rented apartments are passed on to tenants in higher rents. The rich/poor percent differences reflect this tax shifting by business. They assume that property taxes and corporate income taxes are partially passed on to consumers and employees, and only partially paid by business owners.

Growth and Stability. Taxes differ in how fast their revenue grows, and in how steadily their revenue grows.

Table 1 shows three measures of growth and stability. GROWTH shows the average yearly percentage change in revenue from each tax over the 1974-93 period. For sales, state and local income and motor fuel taxes, the revenue was adjusted for tax rate changes, so that GROWTH shows revenue increases apart from these changes: VARIABILITY shows the standard deviation of the yearly percentage changes in revenue from each tax over the 1974-93 period. The standard deviation measures the typical difference between each year's growth and the 20 year average growth. A larger figure implies less stability or predictability in revenue growth. ELASTICITY is the tax's income elasticity. This measures the percentage response of each tax's revenue to a one percent change in Indiana income. An elasticity of one, for example, implies that a one percent increase in income causes a one percent increase in revenue. Elasticities greater than one imply that tax revenue grows faster than income; elasticities less than one imply that tax revenue grows slower than income. Often taxes with high elasticities also show high growth. Sometimes, however, other factors reduce growth. Motor fuel tax revenue growth has been relatively slow despite a high elasticity, because vehicle fuel efficiency has been improving.

Capacity and Effort. The Advisory Commission on Intergovernmental Relations (ACIR 1993b) publishes tax capacity and effort indexes in order to give standard comparisons of the level of taxation across states. CAPACITY is an index that measures the size of Indiana's tax base per person relative to that of the average state. A capacity index less than 100 implies that Indiana has a smaller than average tax base per person, while an index greater than 100 implies that Indiana has a larger than average tax base per person. EFFORT measures the amount of revenue per person collected from each tax relative to the average state. An effort index less than 100 means that Indiana uses a tax less than the average state, probably because Indiana's tax rate is lower than average or its tax base is narrower than average. An effort index greater than 100 means that Indiana uses a tax more than the average state. The measures were compiled for the year 1991, and have been adjusted to reflect Indiana's definitions of sales and corporate income taxes, and to differentiate between state and local income taxes.

TABLE 1. SEVEN BIG TAXES COMPARED.

Table 1. Definitions and Sources:

Business Share Percentage of tax paid directly by business, rather than individuals. Does not account for taxes shifted to others through product price increases or wage decreases. DeBoer (1992).

Rich/Poor Percentage of income paid to a tax by a family with an income of $100,000, minus percentage of income paid by a family with an income of $15,000. Positive numbers indicate "progressive" taxes; negative numbers "regressive" taxes. Citizens for Tax Justice (1991), Congressional Budget Office (1990), DeBoer (1993), Papke (1987).

Growth Average annual percent change in tax revenue, adjusted for tax rate changes. Calculated by regressing the logarithm of tax revenue on a time trend. The coefficient of the time trend is the growth measure (Dye and McGuire 1991).

Variability Standard deviation of difference between annual percent changes and the average percent change. Larger numbers indicate greater variability or unpredictability. Figures shown are the standard errors of regression from the growth regressions (Dye and McGuire 1991).

Elasticity Percent increase in revenue produced by a one percent rise in Indiana income. Calculated by regressing the logarithm of tax revenue on the logarithm of income. The income coefficient is the elasticity. Author's calculations.

Capacity Index of size of tax base per person relative to national average. Numbers less than 100 indicate that Indiana has a smaller tax base per person relative to the nation; numbers greater than 100 indicate that Indiana has a larger tax base per person relative to the nation. ACIR (1993b).

Effort Index of extent a tax base is used to raise revenue--essentially a comparison of tax rates. Numbers less than 100 indicate that Indiana has lower tax rates compared to the nation; numbers greater than 100 indicate that Indiana has higher tax rates. ACIR (1993b).

Further information on how these figures were derived is available in the appendix.

State Individual Income Tax

Description. The state of Indiana collected $2,768 million from its individual income tax in fiscal year 1995. The base of the individual income tax is federal adjusted gross income with some Indiana modifications, earned by individuals, partners, subchapter S corporation stockholders, trusts and estates. The major deduction which Indiana allows is $1,000 for each taxpayer, spouse and dependent claimed on the federal return. The tax rate is 3.4%. Indiana applies the same 3.4% flat rate to all income earners, unlike the Federal income tax, which uses rates which rise with higher incomes.

Incidence. Table 1 shows that the BUSINESS SHARE of the individual income tax is 12%, which represents payments by small corporations, partnerships and individuals on their business income. This is the second lowest business share among the major taxes. The income tax is mildly progressive, as shown by RICH/POOR. The 0.3 figure means that families with incomes of $100,000 pay 0.3% more of their incomes to the tax than do families with incomes of $15,000. This is true despite the fact that all taxpayers pay at the 3.4% income tax rate. The $1,000 personal deductions are a larger share of low income family incomes, so a smaller share of their incomes are subject to the flat rate tax. The state individual income tax is the most progressive of the major taxes.

Growth/Stability. Individual income tax revenue GROWTH averaged 7.1% over 1974-93, the second fastest growing Indiana tax source. Tax growth showed moderate stability, as shown by the VARIABILITY measure of 7.0. Income tax growth was not as stable as property tax growth, is about as stable as sales, motor fuel and motor vehicle excise tax growth, and is more stable than corporate and local income tax growth. The state income tax had the second highest income ELASTICITY among the major taxes at 1.2. For every one percent growth in Indiana income, income tax revenue grows 1.2%.

Income tends to vary with both the business cycle and inflation. As the economy expands, incomes rise, and so does income tax revenue. When inflation occurs, incomes rise too, so income tax revenue responds to inflation. Income growth tends to reduce the share that deductions are of family incomes, so income tax revenue rises faster than income, accounting for the elasticity greater than one. Unemployment, bankruptcy and slower wage hikes characterize recessions, and all of these factors tend to slow income growth. Income tax revenue grows more slowly in recessions.

Capacity/Effort. Indiana per capita income is lower than the national average, which accounts for the CAPACITY index of 86, less than 100. Indiana's tax EFFORT is 98, implying that Indiana's use of the income tax base to raise revenue is slightly less than the national average. Indiana's overall use of income taxes--including the local income tax--is greater than the national average, however. Including local income taxes, the effort index would be 119. Few other states use local income taxes.

Other Issues

Most states use progressive tax rates which increase with taxable incomes. Indiana uses a flat rate. Some analysts claim that a state must have a progressive income tax rate structure to prevent the whole state and local tax system from placing a large relative burden on the poor (Citizens for Tax Justice 1991).

Some analysts are concerned that the income tax will grow more slowly in the future. An increasing share of employment compensation is being paid in untaxable insurance and pension benefits. Also, an increasing share of the population is over age 65. A large part of their income is untaxable (primarily social security benefits), and the state provides extra personal deductions for people over age 65 (Snell 1993).

The state income tax is usually regarded as the "most fair" tax in an annual survey by the Advisory Commission on Intergovernmental Relations (ACIR 1991). There are several possible reasons. The tax is paid through withholding, so it may be easier to ignore. State income taxes appear to be much simpler than the Federal income tax, so that taxpayers may think there are fewer loopholes. Income is regarded as a good measure of ability to pay by many taxpayers, making the income tax seem fair by ability to pay standards. The income tax is paid by a large share of all citizens, which makes the tax seem fair by the benefit standard. Most people who use government services pay some income tax.

State income taxes usually have income elasticities greater than one, and greater than state sales taxes. Gold (1994) compiled income and sales tax elasticities for 28 states. All states' income tax elasticities were one or greater, and in all but two states the income tax elasticity exceeded the sales tax elasticity.

State General Sales Tax

Description. The state of Indiana collected $2,786 million from its general sales tax in fiscal year 1995. The tax base is the sales price of taxable transactions, which include sales of tangible personal property, sales of public utility services, and rentals. Major exemptions include wholesale sales, sales of goods used directly in manufacturing production, farming, public utilities, and public transportation, and sales of most services. The tax rate is 5%.

Incidence. The BUSINESS SHARE of the sales tax is estimated at 22% (Table 1). Some business to business sales are exempt from taxation--particularly sales of products used in the direct manufacture of other products--but many other business purchases are taxable. Purchases of tangible goods by service sector firms, for example, are subject to the sales tax. The sales tax is regressive, as shown by the negative RICH/POOR index of -2.3. A family with an income of $15,000 pays 2.3% more of its income to the sales tax than a family with an income of $100,000. This occurs mainly because poorer families save a smaller share of their incomes, and so a higher share is spent on taxable consumption. The sales tax is the most regressive of the major taxes.

Growth/Stability. Sales tax GROWTH has been at a moderate 6.4%. VARIABILITY as measured by the standard deviation of growth rates is also moderate, at 6.5. The income ELASTICITY is in the middle of major taxes at 0.9. The sales tax responds to inflation, because inflation adds to the prices of taxable products. Since the sales tax is a percentage of price, sales tax revenues rise directly with inflation. The sales tax also responds to economic growth. As incomes rise people spend more, and sales tax revenue rises. However, as incomes rise people save a higher percentage of their incomes, so spending does not rise in proportion to income. This accounts for the income elasticity less than one, and the low to moderate variability. Likewise, when incomes slow or fall in recession, people often maintain their spending by drawing upon their savings. This also reduces variability.

Capacity/Effort. Indiana's low per capita income relative to the nation means the state has relatively low spending on taxable goods as well. The CAPACITY index is less than 100. Indiana's sales tax EFFORT is shown at 80, well below the national average. This is due in part to the fact that Indiana does not use local sales taxes, which are included in the national sales tax average. If local sales taxes were excluded from the effort measure, the state's index would be nearer the national average of 100.

Other Issues

Mail order sales have grown rapidly in recent years. Mail order sales are taxable under the use tax portion of the Indiana sales tax, but U.S. Supreme Court decisions prevent states from requiring most mail order companies to collect and remit sales taxes. This concerns in-state retailers, who see themselves at a competitive disadvantage since they must charge sales taxes. Some analysts are concerned that the inability to tax growing mail order sales will reduce the growth of sales tax revenue. In Fall 1993 the Indiana Department of Revenue sent letters "reminding" taxpayers of their obligation to pay sales taxes on out-of-state sales. Use tax collections more than doubled to $1.1 million, but this is only a fraction of the estimated $55 million which is owed (ACIR 1994; Bennett 1994)

Services are growing as a share of total sales. Like most states, Indiana exempts most services from the sales tax. Of 161 categories of services examined by the Federation of Tax Administrators (1991), Indiana taxed only 17. Eleven states taxed fewer services, while only six taxed more than 100. Some analysts are concerned that sales tax revenue growth will slow because an increasing share of sales is untaxed (Snell 1993). About $800 million could be added to Indiana sales tax collections if a broad range of services were taxed, though the figure is only $400 million if medical and legal services are not included (Mundt and DeBoer 1994).

Some analysts look at rich/poor incidence in lifetime terms. Savings which are untaxed now are eventually taxed when they are spent. This implies that richer families delay but do not avoid sales taxes, so that the sales tax is closer to proportional than regressive--the rich/poor index would be near zero (Barthold 1993).

State Corporate Income Taxes

Description. The state of Indiana collected $950 million from its three corporate income taxes in fiscal year 1995. The three corporate income taxes are the gross income tax (GIT), the adjusted gross income tax (AGIT), and the supplemental net income tax (SNIT).

The gross income tax is paid on the gross receipts from Indiana businesses. The tax rate is 1.2% on receipts from rentals, service income, utility services, interest, and passive income. The tax rate is 0.3% on receipts from wholesale and retail sales, display advertising, commercial printing and dry-cleaning.

The adjusted gross income tax is paid on the part of a corporation's federal taxable income apportioned to Indiana. If a corporation operates only in Indiana the whole of federal taxable income is taxable by AGIT. If a corporation operates in Indiana and elsewhere, the portion of nationwide federal taxable income taxable by AGIT is determined using a "three factor formula". Corporations calculate the percentage shares of their total property, payroll, and sales which are located in Indiana. As of 1995, the apportionment percentage will be calculated by taking twice the sales percentage, plus the property and payroll percentages, and dividing by four. The resulting percentage is multiplied by total federal taxable income to give the share of income taxable in Indiana. The AGIT tax rate is 3.4%.

Corporations calculate their liabilities under both the gross and adjusted gross income taxes, and pay the higher of the two. All corporations pay the supplemental net income tax. Its base is calculated by subtracting the GIT or AGIT payment from the apportioned federal taxable income. The SNIT rate is 4.5%.

Subchapter S corporations are exempt from Indiana corporate income taxes. Income earned by their stockholders are subject to the individual income tax. "Special-C" corporations are small corporations meeting certain guidelines defined in Indiana law. They are exempt from the gross income tax, but pay AGIT and SNIT.

Incidence. The BUSINESS SHARE of corporate taxes is of course 100% (Table 1). The incidence among rich and poor of corporate income taxes is controversial. Since corporations are owned by stockholders, who tend to have higher than average incomes, the taxes are paid initially out of the incomes of high income people. However, corporate taxes may be passed on to customers in higher prices, or to employees in lower wages. If so, the corporate income taxes may not be so progressive. The measures used here give a RICH/POOR index of 0.1, meaning high and low income people pay similar percentages. Tax "exporting" reduces the apparent progressivity of the corporate income taxes. Taxes are exported when they are paid by residents of other states. A large percentage of corporate taxes are exported because of tax payments by the many out-of-state stockholders, and from taxes passed on in higher prices to out-of-state customers. Exporting reduces apparent progressivity because many of the upper income people who pay corporate taxes live out-of-state. The rich/poor index counts only in-state taxpayers.

Growth/Stability. Corporate tax GROWTH has been relatively slow, averaging 4.1% over 1974-93. Although tax rates of all three corporate taxes have changed during the past 20 years, no tax rate adjustment is made to the growth rate. This is because the corporate gross rate has fallen enough to approximately offset tax rate hikes in AGIT and SNIT. The corporate income tax is the second least stable of the major taxes, with a VARIABILITY index of 11.4. AGIT and SNIT are taxes on corporate profits, which vary a great deal in expansions and recessions. Unlike the sales and income taxes, corporate tax revenues fell absolutely in the recession of the early 1990s. The income ELASTICITY is low at 0.4. Before the 1980s this elasticity exceeded one, meaning corporate tax revenue responded readily to income growth. Since 1980 this response has been much smaller. The reason for the change is unknown. Among the possibilities are changes in the Federal corporate income tax base, the exemption of Special-C corporations from the GIT, and the switch in corporate financing from taxed equity investment to untaxed debt investment.

Capacity/Effort. Indiana's corporate tax CAPACITY is slightly smaller than the national average, with an index of 95. However, Indiana's corporate tax EFFORT is above the national average, at 126. This implies that the combination of the three corporate taxes puts a larger burden on corporate taxpayers in Indiana than in the average state.

Other Issues

Indiana is one of the few states to use a corporate gross income tax. Some analysts regard GIT with disfavor, because it taxes firms regardless of their profits or losses. Also, it is similar to a sales tax since it is a percentage of the volume of sales. Like the sales tax, it is likely passed on in higher prices to customers. Products that pass through several corporate transactions (for example, iron sold to a steel manufacturer, steel sold to an auto maker, autos sold to customers) will have had the GIT rate added to their prices several times. On the other hand, GIT is probably the most stable of the three corporate taxes.

During the period 1973-86 gross income tax rates were reduced. It was intended that the tax would be phased out completely by the end of the century, but the phase out was suspended after 1986.

Multi-state and international corporations may use accounting devices to reduce their reported profits in a state or nation with relatively high taxes. The accounting method is called "transfer pricing" (Snell 1993). The share of corporate businesses which are international or multi-state is increasing, causing some analysts concern that corporate tax revenue may grow more slowly.

State Motor Fuel Taxes

Description. The state of Indiana collected $608 million in motor fuel taxes in fiscal 1994. The major motor fuel taxes include the gasoline tax, at $0.15 per gallon of gasoline, the special fuel tax, at $0.16 per gallon of special fuels (mostly diesel fuel), and the motor carrier surcharge tax, at $0.11 per gallon of fuel used by commercial motor vehicles operating on highways in Indiana.

Motor fuel tax revenue is distributed by formula to the State Police, Bureau of Motor Vehicles, State Department of Transportation and to counties, cities and towns. The bulk of the revenue is used for state and local highway construction and maintenance.

Incidence. BUSINESS SHARE is relatively large at 47% (Table 1). This is because a substantial part of fuel taxes are on special fuels like diesel, which are used in heavy vehicles mainly owned by businesses. The RICH/POOR index is -0.4, which shows the motor fuel taxes to be regressive. As with the general sales tax, this is because lower income people spend rather than save a high percentage of their incomes, so a larger part of their incomes go to taxes on spending.

Growth/Stability. Motor fuel taxes have grown more slowly than any other major tax source, with a GROWTH percentage of 1.3%. Part of the reason may be the increasing fuel efficiency of motor vehicles. The fuel taxes have moderate VARIABILITY at 7.3. Motor fuel taxes grow proportionally with income, as shown by an ELASTICITY of one. As income grows, people may drive more, or buy bigger less fuel efficient vehicles. Commerce expands with income growth, so there is more commercial vehicle traffic and fuel consumption.

Capacity/Effort. Indiana has more motor fuel sales per capita than the national average. The CAPACITY index is 116. This may be because of the concentration of interstate highways in Indiana. Indiana's motor fuel tax rates are slightly above the national average, with an EFFORT index of 104.

Other Issues

The distribution formulas for motor fuel taxes are a source of controversy. Two changes are frequently proposed in the General Assembly. The highway, road and street fund receives part of its revenues from gasoline taxes, and is distributed by formula to the state Department of Transportation, counties, cities and towns. The county distribution depends in part on the number of automobile registrations in the county. Registrations of pickup trucks are not counted in the formula. Rural counties would gain revenue, and urban counties would lose revenue if pickup trucks were included. The motor vehicle highway fund also distributes funds to the state, counties, cities and towns. However, prior to the distribution the state police receive funds--$36 million in fiscal 1993. If the state police did not receive fuel tax funds, more would be available for state and local road spending. The state police would have to be funded from another source, such as the state general fund.

The increasing fuel efficiency of motor vehicles limits the growth of fuel tax revenues. All else equal, each 10% rise in average automobile miles per gallon reduces gasoline gallons sold by about 5% (DeBoer and Sperlik 1993).

The motor fuels taxes may be regarded as benefits taxes. Vehicle owners buy fuel and use roads, and fuel tax revenue supports road maintenance. While the link between road use and fuel tax payments is not perfect, it is probably the closest use-payment link among the seven big taxes.

Local Property Tax

Description. Indiana local governments levied $4,406 million in gross property taxes for calendar year 1995. After state property tax replacement credits, local governments levied $3,747 million in net property taxes. The tax base of the Indiana property tax is the assessed value of taxable property. The total revenue collected is the tax levy. The property tax rate is calculated by dividing the levy by the assessed value in each jurisdiction. Rates usually change each year.

Assessed value includes real and personal property. Real property is land and structures; personal property is mostly business, farm and utility equipment and inventories. Property is assessed locally, by township and county officials, using rules established by the State Board of Tax Commissioners. Utility personal property is assessed by the state. Assessment of real property structures is based on the estimated cost required to replace the structure, plus the estimated value of land, with modifications for age, condition and quality. Assessment of residential, commercial and industrial land is based on estimates of sales prices. Assessment of farm land is based on a statewide fixed price, modified by the land's productive capacity, forest cover, grade, and other factors. Real property was reassessed most recently for taxes payable in 1980. The next reassessment will be for taxes payable in 1996. Assessment of personal property is done annually by property owners based on purchase prices, with modifications for depreciation.

Tax levies are set by local governments--counties, townships, cities and towns, school corporations, library districts and other special districts--subject to state tax control rules. The control rules state that civil government general fund taxes may rise by 5% per year, unless the average increase in assessed value for the most recent three years exceeds 5%. In that case, levies can rise by the three year average percent increase to a maximum of 10%. Reassessment years are excluded from the average percent increase calculation. Civil government cumulative funds have maximum rate limits, and most are also included within the levy ceiling. Debt service levies are not limited, though the Board of Tax Commissioners can approve or reject local bond issues. School corporation general fund levies are limited by rules set by the state school aid formula, which usually changes every two years. Currently school tax rates are set by the formula, and may not rise annually by more than $0.15 per $100 assessed value. School debt service levies are uncontrolled, though again the Tax Board can approve or reject bond issues. The school capital projects fund has a maximum rate of $1.25 per $100 assessed value. School transportation fund levies are not controlled.

The state gives local governments property tax replacement credits, equal to 20% of levies excluding cumulative funds, debt service incurred after 1984, and some other levies.

Incidence. The BUSINESS SHARE of the property tax is 64%, second highest after corporate taxes. Industrial, commercial, utility and agricultural businesses own almost two-thirds of Indiana assessed value. As with the corporate tax, however, property taxes on businesses are probably passed on to customers or employees, at least in part. In particular, landlords probably pass property tax hikes on to tenants as higher rents. Since tenants have, on average, lower incomes than homeowners, this tends to make the property tax regressive. The RICH/POOR index is negative, -1.4, meaning that families with incomes of $100,000 pay 1.4% less to property taxes than do families with incomes of $15,000. As with the corporate taxes, a large part of the property tax is exported. Much business property belongs to businesses with out-of-state owners. Exporting increases the apparent regressivity of the rich/poor index, since many of the upper income people who pay Indiana property taxes live out-of-state. The rich/poor index counts only in-state taxpayers.

Growth/Stability. Property tax levy GROWTH has been moderate at 7.0% per year since 1974, though it has accelerated in the 1990s. It is the most stable of the major taxes with a VARIABILITY measure of only 3.4. Its income ELASTICITY is less than one at 0.6, second lowest after the corporate taxes. Property tax stability is due to both assessment and tax control procedures. Assessed value does not change much in recessions, since people try to maintain their property during periods of unemployment and slow income growth. Also, declines in property values during recessions are usually not reflected in real property assessments because reassessments occur infrequently. Property tax rates adjust to stabilize revenue growth. The controls allow the bulk of non-school levies to rise 5% per year, and rates will adjust to deliver such a revenue increase whatever the change in assessed value. One reason that the income elasticity is low is the failure of the property tax to respond to inflation. Indiana incorporates inflation into real property values only in reassessments, which are infrequent, and the controls do not allow levies to increase with the jump in assessed values in reassessment years. During rapid inflation, such as in the 1970s, incomes rise much more rapidly than the property tax levy.

Capacity/Effort. Indiana's property tax CAPACITY is lower than the national average, at 84. This is because Indiana's residential values are low compared to places like California and New York. Commercial, industrial and agricultural property values are near the national average. Indiana's property tax EFFORT is close to the national average at 102. On average, the state's property taxes are neither very high nor very low compared to other states.

Other Issues

Some analysts view the property tax as a benefit tax. They argue that jurisdictions use zoning to restrict property uses which have assessed values too low to generate the tax revenue needed to support the government services that the property's owners will use. An example might be zoning out mobile homes, since the assessed value is not high enough to support the extra spending required for the owners' school children (Fischel 1992). This assures that new residents add enough tax revenue to pay for the services they demand.

Indiana is one of the few states that does not use "market value assessment", which means the state does not use property sales prices to set assessed values. Some analysts favor market value assessment because it allows homeowners to audit assessors by comparing their assessments to their home values. Assessment quality should improve. Some are against market value assessment because they believe that taxation of unrealized capital gains is unfair. Property taxes will rise if people happen to live in an area with rising property values, even if they never sell their property. The State Tax Board will complete a study of market value assessment in 1996.

The property tax is usually regarded as the tax which is "least fair" in the annual survey of taxpayers by the Advisory Commission on Intergovernmental Relations (ACIR 1991). There are many possible explanations. Many pay the tax in a lump sum, rather than through withholding like the income tax, or bit by bit like the sales tax. The assessment process is a mystery to many taxpayers. If taxpayers realize that the tax is partially passed on in higher rents, perhaps they object to its burden on the poor. This is an objection on ability-to-pay grounds. Or, perhaps they don't like a tax paid by property owners being used to pay for services provided to non-property owners. This is an objection on benefit tax grounds.

Local Individual Income Taxes

Description. Local governments in Indiana collected $561 million from individual income taxes in calendar year 1995. There are three local income taxes: CAGIT, the county adjusted gross income tax, COIT, the county option income tax, and CEDIT or EDIT, the county economic development income tax. The base of each local income tax is the same as for the state individual income tax. It is paid on income earned by individuals, partners, subchapter S corporation stockholders, trusts and estates. The local income taxes are not corporation income taxes, so income earned by regular corporations is not taxed. Counties may adopt either CAGIT or COIT, but not both, and may adopt CEDIT alone or in addition to CAGIT or COIT.

CAGIT is adopted by the county council at a rate of 0.5%, 0.75% or 1%. All but one of the 51 counties that used CAGIT in 1993 had a rate of 1%. Revenue is distributed to all jurisdictions within an adopting county. School corporations share in revenue generated by the first one-quarter of one percent, while other jurisdictions share in all revenue collected. More than half of CAGIT revenue must be used for property tax relief. It is either directed subtracted from the property tax levy, or it causes a reduction in a jurisdiction's maximum levy. The remaining revenue is spendable, for any purpose.

COIT is adopted by the COIT council, which is a combination of the fiscal bodies of the county, and the cities and towns within the county. Votes on the COIT council are distributed based on shares in total county population, with the county's votes based on population in unincorporated areas. Twenty-four counties used COIT in 1993. COIT is adopted at a rate of 0.2% in the first year. The rate can rise by one-tenth of a percent per year to a maximum of 1%. Revenue is divided among all jurisdictions in an adopting county except school corporations. All COIT revenue is spendable, though a portion can be used for property tax relief for homeowners if the COIT council desires.

CEDIT is adopted by the county council if the county has CAGIT, the COIT council if the county has COIT, and either body if the county has neither. CEDIT was used in 33 counties in 1993. Only 4 counties use CEDIT without also using CAGIT or COIT. CEDIT can be adopted at rates up to 0.5%, but the combined CAGIT and CEDIT rates in counties with both taxes cannot exceed 1.25%, and the combined COIT and CEDIT rates cannot exceed 1%. Revenue is divided among the county, cities and towns, and must be used for economic development or public capital projects.

Local income tax revenue is collected by the state Department of Revenue and distributed back to the adopting counties. In mid-summer of each year the Department, after consulting the State Budget Agency, announces each county's certified distribution, which is the amount of income tax revenue the county will receive in the coming calendar year.

Incidence. The incidence of the local income taxes is identical to the incidence of the state income tax, since the taxes are applied to the same income. The BUSINESS SHARE is 12%, the same as the state income tax, and the RICH/POOR index shows mild progressivity, at 0.3.

Growth/Stability. Since the state and local income taxes share the same tax base, they ought to grow at the same rates. GROWTH and ELASTICITY are shown as the same as the state income tax, 7.1 and 1.2, respectively. Growth rates and elasticities will vary by county. Statewide, local income tax revenue has grown rapidly because more and more counties have adopted, 80 as of 1993, starting from zero in 1973. What may seem odd at first is that the local income tax is much less stable than the state income tax. The figure shown in Table 1 for VARIABILITY is for Elkhart County, the largest county to adopt CAGIT when it first became available in 1974. The variability index is 13.5, highest of the major taxes. The Department of Revenue certifies local income tax distributions to counties six months before the start of the calendar year, 18 months before all collections are in. The Department has apparently used conservative collection estimates, in an effort to assure that collections at least match distributions. As collections exceed distributions, county balances accumulate. Now and then these extra balances are released to counties, causing large single year increases in revenue. The pattern of revenue growth for many counties is thus a year or two or three of little or no growth, followed by a year of high growth. This makes local income tax revenue less stable than state income tax revenue.

Capacity/Effort. CAPACITY for the local income taxes is the same as for the state income tax, since they tax the same income. Indiana has relatively low per capita income, so the capacity index is less than 100. The ACIR does not make a separate tax effort calculation for local income taxes. Since so few states use local income taxes (most allow local sales taxes instead), Indiana's local income tax revenue effort must be well above the national average, so the EFFORT index would be above 100.

Other Issues

Some non-residents pay county income taxes. People who work in a county with an income tax, but live in a county without a tax, pay CAGIT at 0.25%, COIT at one-quarter of the resident rate, and CEDIT at the full resident rate. Since most counties have an income tax few non-residents are taxed. Out-of-state residents who work in an adopting county do pay non-resident rates, however.

Local Motor Vehicle Excise Tax

Description. Indiana local governments collected $522 million in motor vehicle excise taxes in calendar year 1994. Excise taxes are paid by owners of automobiles, motorcycles and light trucks. Payments are annual, and fixed per vehicle. The payment schedule varies by 18 classifications of vehicle price when new, and ten classifications of age. Payments vary from $12 per vehicle per year for the oldest, cheapest vehicles, to $1,063 for a new vehicle priced above $42,500. Revenue is collected by the Bureau of Motor Vehicles and its license branches, and distributed to all local units based on property tax rates. A taxpayer's excise tax payment is distributed among the local units in which he or she lives based on the percent of each unit's property tax rate in the total rate.

In calendar year 1991 Indiana devoted $72 million in lottery receipts to a reduction of motor vehicle excise tax rates. The average payment reduction was about 15%. Excise tax replacement was suspended in 1991. In 1995 the General Assembly passed a bill to reduce excise tax rates by half by the end of the decade, using lottery and riverboat gambling funds to replace most, but not all, revenues lost to local governments.

Incidence. The BUSINESS SHARE of the motor vehicle excise tax is small, estimated at 5%. Most of this is fleet vehicle registrations by businesses. The motor vehicle excise tax is slightly regressive, with a RICH/POOR index of -0.3. This is true despite the large difference between new, expensive vehicle tax payments and old, cheap vehicle payments. Even the lowest income person owning the cheapest, oldest car must pay a $12 minimum tax. However, Indiana probably has the most progressive vehicle taxation system among the 50 states. That is, most other states have vehicle taxation much more regressive than Indiana's almost-proportional excise tax (Pritchard and DeBoer, 1992).

Growth/Stability. Motor vehicle excise tax GROWTH has been most rapid among the major taxes, averaging 7.7% per year. VARIABILITY is moderate, with a standard deviation of growth rates of 7.4. The income ELASTICITY is very high, at 1.9 the highest among the major taxes. There are two elements of the motor vehicle excise tax that influence its growth and stability. On the one hand, a large share of revenue comes from new car registrations, since new cars are taxed at the highest rates. New car purchases vary a lot in recession and expansion. They fall substantially in recessions, as people postpone the large expense of auto purchase. They rise substantially in expansions, as people make the new car purchases they had postponed. This accounts for the high elasticity of the excise tax. The bulk of excise tax revenue comes from taxation of existing, older cars, however. In recessions people refrain from buying new cars, but they do not abandon driving altogether. Instead, they keep their older cars, which are taxed. This accounts for the moderate stability of the motor vehicle excise tax.

Capacity/Effort. The ACIR does not calculate capacity or effort indexes for vehicle taxation. However, the number and value of automobiles owned varies with income, and Indiana has a lower than average per capita income. Probably, the per person value of Indiana cars, light trucks and motorcycles is below the national average. The CAPACITY index would be less than 100. The tax paid on new, expensive vehicles in Indiana is among the ten highest in the country. But the tax paid on older, cheaper vehicles is among the ten lowest in the country. Overall, the EFFORT index would probably be greater than 100, meaning vehicle taxes are above the national average.

Other Issues

Some suspect that many Indiana residents illegally register their vehicles in other states to avoid Indiana's high motor vehicle excise tax (DeBoer and Sperlik 1988). In 1989 the tax was made a "listed tax", allowing the Department of Revenue to collect delinquent excise taxes. Several million dollars in delinquent taxes have been collected. It is uncertain whether this new enforcement procedure has lessened out-of-state registrations, but in 1990 the number of taxable vehicle registrations jumped 200,000, perhaps due to more vigorous enforcement.

Counties may adopt a motor vehicle excise surtax on top of the statewide excise tax. Revenue must be used for road maintenance and construction. Only 16 counties have adopted. This tax is often known as the wheel tax, because a wheel tax on heavy vehicles must be adopted simultaneously with the surtax.

Taxes and Economic Development

Another important feature of taxes is their effect on economic development. Do high taxes discourage firm location and investment? Do low taxes encourage development? Not much is known about the effects of individual taxes on development. Instead, research has concentrated on the effects of the combined burden of taxation. Recent research has found that taxes can have a significant impact on firm location and investment. For instance:

Wassmer and Fisher (1992) reviewed several studies and found clear evidence that taxes matter for firm location and investment. Tax differences matter more over shorter distances (that is, Indiana's tax burden relative to Michigan's affects investment more than its burden relative to Maine). Tax effects vary for different industries.

Bartik (1991) reviewed dozens of studies and found that, on average, a ten percent rise in state and local taxes caused a 1.5% reduction in business activity.

Rainy and McNamara (1992) found that low county property and income tax rates were associated with more manufacturing firm locations in Indiana during 1985-90. Higher tax rates appeared to discourage firm locations.

DeBoer (1989) found that high property tax rates, and to some extent adoption of the county option wheel tax, were associated with lower per capita heavy vehicle registrations in Indiana counties in 1987.

Luce (1994) found that both higher property taxes and higher local income taxes discouraged job growth in the Philadelphia metropolitan area from 1970 to 1980. Effects varied by industry. More local government spending on infrastructure and public safety encouraged job growth, but the net effect of taxes raised to finance spending was negative.

Papke and Papke (1986) found that taxes had significant effects on the rates of return earned by businesses on their investments. Firms had lower rates of return in higher tax localities. Industries in states with higher after-tax returns--because of lower taxes--were more likely to invest and expand. Direct business taxes, such as property and corporate taxes, had the greater effect on rates of return.

Wasylenko and McGuire (1985) found that states with higher overall tax efforts (as measured by the ACIR index shown in EFFORT) had lower employment growth in manufacturing, retail trade and services during 1973-80. Education spending increased employment growth, but welfare spending did not.

Helms (1985) found that taxes raised to fund education, highways, public health and safety and business services had a favorable impact on business location. Taxes raised for welfare spending had a negative effect.

This evidence leads to several tentative conclusions. High taxes appear to discourage business location and investment, though the effect may be relatively small. Tax effects vary by industry. Tax differentials relative to close neighbors have a greater effect than differentials relative to far-away jurisdictions. Direct business taxes, especially corporate and property taxes, may matter more than taxes on individuals, though local income taxes appear to affect firm location decisions within local regions. Added spending on functions like education, highways and business services may encourage investment, but the amount may or may not be enough to offset negative tax effects. Added spending on welfare does not encourage investment, so taxes raised for welfare spending probably discourage investment.

Appendix: Methods and Calculations for Table 1

BUSINESS SHARE. Figures are taken directly from DeBoer (1992), Table 1, page 10.

RICH/POOR. Figures reported in Table 1 are from four sources, Citizens for Tax Justice (CTJ, 1991), Congressional Budget Office (CBO, 1990), DeBoer (1993) and Papke (1987). For income, sales, corporate and property taxes the results of Papke and CTJ are used. The difference between the percentage of incomes paid by families with incomes of $100,000 and $15,000 in each study are averaged. There are differences in the Papke and CTJ results, due to differences in incidence assumptions, coverage by each tax category, and the year of the data used. Nonetheless, Papke and CTJ results are broadly similar: sales and property taxes are regressive, corporate income taxes are proportional. Results for the income tax disagree. Papke reports results for the Indiana motor fuel taxes, and additional results are derived from national data presented by CBO. Expenditures on motor fuel by families in 1990 are divided by the average gas price in 1990 to get gallons, multiplied by 15 cents, the Indiana tax rate, and divided by average income of the group of families. DeBoer reports results for the motor vehicle excise tax.

GROWTH and VARIABILITY. GROWTH is the average annual percentage change in tax revenue, VARIABILITY is the standard deviation of the difference between each year's change and the average percent change. GROWTH is derived by regressing the natural logarithm of tax revenue on a constant and a time trend. The coefficient on the time trend (times 100) shows the average annual growth in the tax. VARIABILITY is taken to be the standard error of regression of the growth regression. The actual standard deviation of the differences from trend will vary slightly from this figure. Data on tax revenues for income, sales, corporate, property, Elkhart local income, and motor vehicle excise taxes for the 1974-93 period were used. Income tax and sales tax revenue data were divided by the tax rates used in each year to approximate the tax base (taxable income, taxable sales). Corporate tax revenue is not adjusted for rate changes. Rate increases in AGIT and SNIT have been approximately offset by rate decreases in GIT since 1974, so the overall corporate tax rate has not varied by much. Property tax rates change in most jurisdictions in most years. These rate changes are a source of stability in the property tax, so an accurate measure of its characteristics should include rate changes. Elkhart adopted CAGIT in 1974 at 1%, and has not changed its CAGIT rate (though it added CEDIT at 0.25%). Motor vehicle excise tax rates have not changed, though the rate table has expanded to include higher valued vehicles. No rate adjustment can be made, so the GROWTH and VARIABILITY of the excise tax may be overstated. Data on gallons of gasoline for 1974-92, and special fuels for 1974-90 were used for fuel taxes. GROWTH and VARIABILITY results shown are weighted averages based on the 1993 shares of gasoline and special fuels in total motor fuels revenue, about two-thirds gasoline, one-third special fuels.

ELASTICITY. Figures are calculated by the author. The logarithm of revenues are regressed on the logarithm of Indiana income, tax rates and other appropriate indicators. The elasticity for motor fuels reflects only gasoline taxes. Elasticities for income, sales and corporate taxes are based on nominal income, elasticities for property, motor fuels and motor vehicle excise taxes are based on inflation-adjusted income.

CAPACITY and EFFORT. Figures are taken from ACIR (1993b), with modifications. The ACIR counts the corporate GIT as a sales tax. The proportion of GIT in total GIT and sales taxes is subtracted from the ACIR EFFORT index for the sales tax, and added to the EFFORT index for the corporate taxes. The ACIR includes local income taxes with state income taxes. The proportion that local income taxes are of state plus local income taxes is subtracted from the ACIR EFFORT index for the income tax.

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Advisory Commission on Intergovernmental Relations. Significant Features of Fiscal Federalism, vol. 1: 1993. M-185. Washington, D.C.: ACIR, February 1993a.

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