TAX POLICIES: Indiana’s regressive tax structure and ongoing cuts could hurt all Hoosiers, experts warn

Indiana lawmakers passed a bill in 2023 that will reduce the state’s income tax rate from 3.15% to 2.9% by 2027. (Photo/Pexels.com)

By Marilyn Odendahl
The Indiana Citizen
August 9, 2024

At the Indiana Statehouse and on Capitol Hill, taxes will likely be a major topic in 2025 and most of the discussion will focus on cuts, but experts warn that Hoosiers shouldn’t expect to get what they’re not willing to pay for.

Wesley Tharpe, a senior adviser for state fiscal policy at the Center on Budget and Policy Priorities, highlighted the link between tax revenue and public services. State and local taxes, he said, are the primary funders of schools, health care, transportation systems and correctional facilities. Tax cuts mean there is less money available for services that create “opportunity and a high quality of life” in Indiana communities, he said.

“Everyone needs to have access to some degree of quality education, roads, etc., so you’re going to have to eat broccoli,” Tharpe said.

Tharpe and Neva Butkus, state policy analyst at the Institute on Taxation and Economic Policy, discussed Indiana’s state and local taxes Tuesday during a webinar titled “Indiana’s Fiscal Inequalities: How to Secure Revenue for Indiana’s Future and Who Pays.” Prosperity Indiana hosted the event and Hale Crumley, Prosperity’s policy manager, moderated the discussion.

Taxes are a part of almost every election year, as Indiana Republican gubernatorial candidate Mike Braun recently demonstrated when he offered a property tax proposal. But in 2025, Republicans and Democrats could clash even more on the issue.

When the Indiana General Assembly returns in January 2025 to craft another two-year state budget, the tax debate could get an added boost from a report by the Indiana State and Local Tax Review Task Force. The committee, created by the legislature in 2023, is scheduled to present its assessment of the state’s tax code and recommendations for changes later this year. The task force initially focused on potentially eliminating the state’s income tax, Crumley said, but the group has shifted its attention to property taxes.

In Congress, lawmakers are expected to face off in what has been dubbed the “Super Bowl of taxes.” They will have to deal with the expiration of many of the tax cuts, exemptions and relief included in the Tax Cuts and Jobs Act, enacted in 2017 during the Trump administration. If Capitol Hill does not take action next year to prevent or at least mitigate the fallout caused by the expiration of the cuts, 62% of taxpayers would see their taxes rise, according to a report by The New York Times.

What Indiana residents will pay in taxes will depend, as usual, on whether they are at the low or high end of the income scale.

Butkus said Indiana has a regressive tax structure, with the lowest-income households shouldering most of the tax burden. The lowest-income 20% of earners in Indiana — households making less than $22,600 a year — pay an effective tax rate of 13.3%, while the highest-income 1% of earners in households making more than $574,200 a year pay 6.2%, he said.

Indiana’s heavy reliance on sales and excise taxes to generate revenue is a key factor contributing to the state’s regressive tax structure, Butkus said. All Hoosiers, regardless of income, pay the same 7% sales tax, he said, so those with lower wages lose a larger share of their income when purchasing food, school supplies or other household necessities.

“Because wages are low, Hoosiers with very low incomes tend to have to spend almost all of their income to get by,” Butkus said. “There’s not a lot to save. There’s not a lot to set aside or invest. They’re just trying to get by paycheck to paycheck, and because of that, they spend a large percentage of their income on sales taxes.”

Temporary growth, permanent cuts

A brief report in the August issue of the Indiana Fiscal Policy Institute identifies a mix of good and bad news in the state’s newly released report for fiscal year 2024.

The report notes that Indiana brought in $21.9 billion in revenue in fiscal year 2024, a 1.49% increase over fiscal year 2023, but the state spent $21.5 billion, a 19.4% jump from the previous fiscal year. Additionally, while personal and corporate income tax revenue increased to $9 billion in fiscal year 2024 from $8.8 billion collected in the last fiscal year, it was still below the $9.7 billion received in fiscal year 2022.

Indiana closed the fiscal year with $2.5 billion in reserves, down from previous years but still accounting for 11% of revenue.

Tharpe noted that Indiana, like many states with strong revenues and budget surpluses, has cut taxes in recent years. The legislature approved a tax cut in 2023, which is being phased in gradually and will reduce the income tax rate to 2.9% by 2027. This tax cut, she said, will eventually reduce state revenue by $800 million a year.

While surpluses and revenue growth are temporary, Tharpe said, tax cuts are permanent. So lawmakers should ask “a lot of tough questions” when debating tax cuts, she said. They should look at what public services will have to be reduced or discontinued and which income group — working families or higher-income earners — will benefit most from the cuts.

“I think it’s fair to say that in many states, policymakers aren’t thinking clearly enough about what those trade-offs are in terms of lost service revenue,” Tharpe said.

‘Broad overall impact’

Reducing tax revenue not only jeopardizes current public services, but could cripple another service or stifle an investment or initiative in years to come, Tharpe said. Such cuts, she said, tend to disproportionately hurt low-income households and neighborhoods, as well as communities of color.

But while the poorest may bear the brunt of the tax cuts’ impact, residents across the state will be hit hardest.

“In addition to that, (we) should also think about the broader impact of cuts to public services that really underpin the state’s economy,” Tharpe said. “So if you reduce access to quality public education, (and make) cuts to infrastructure, cuts to quality of life, there’s really a broad overall impact on residents of the state of all backgrounds, as well as the overall attractiveness of the state and its ability to retain and attract residents and businesses.”

Butkus said Indiana has the ability to raise revenue in a “more equitable way.” He suggested closing corporate tax loopholes; enacting inheritance and estate taxes so wealthy families don’t “pass down tons and tons of money” from one generation to the next; and taxing capital gains at a higher rate than wage income.

According to Butkus, Indiana is already helping to address some of the tax inequality with the Earned Income Tax Credit. The EITC is actually a federal program, but Indiana offers a 10% match to Indiana households that qualify for the tax credit, which can “really tip the balance,” he said, and help working families remove some of their largest tax burden.

Even a relatively small amount can help, she said. For example, if an Indiana family receives $6,200 from the federal EITC, the state would add $620.

“It’s nothing to sneeze at,” Butkus said. “Six hundred dollars can go a long way for a low-income family. It’s enough to get tires changed, get to work every day and catch up on some utility bills.”

Dwight Adams, an editor and writer based in Indianapolis, edited this article. bHe was a content editor, copy editor and digital producer at The Indianapolis Star and IndyStar.com, and a scheduler for other newspapers, including the Louisville Courier Journal.

Indiana Citizen is an independent, nonprofit platform dedicated to increasing the number of informed and engaged Indiana citizens. We are managed by the Indiana Citizen Education Foundation, Inc., a 501(c)(3) public charity. If you have questions about the story, please contact Marilyn Odendahl at [email protected].