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Larry DeBoer on Budget Deficits and the National Debt

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Everybody’s Favorite Economist (tm), Larry DeBoer, has a good post at Capital Comments about the nation’s budget deficits, the national debt, and the likely consequences of austerity measures during a recession.

Big future deficits are a problem. Big deficits now, not so much. They’re the result of the recession. Tax revenues are way down because of all that unemployment. Spending is up, partly because of added entitlement payments, and partly because of the government’s stimulus spending. But deficits during a recession help. The extra spending and reduced taxes increase the sales of goods and services, which give businesses a reason to employ more people. Without the deficits, unemployment would be even higher.

With unemployment near 10 percent it wouldn’t do to try to reduce the deficit now. The federal government tried that during 1937-38. With the unemployment rate still at 14 percent, the Roosevelt administration cut spending, and Social Security taxes were first collected. The deficit was reduced to near zero – and the economy dropped into recession. Unemployment rose to 19 percent.

We do need a long-range plan to reduce deficits to less than 3 percent of GDP. We need to balance the budget eventually. But not now.

Indiana’s Shifting Tax Policy

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Meranda Watling, writing for the Lafayette Journal & Courier, has an outstanding summary of the tax situation for local government over the past decade. And, even better, one of her sources was Everybody’s Favorite Economist, Larry Deboer.

To summarize even more briefly, the property tax situation became destabilized back in 1998 when, due to the Town of St. John litigation started back in 1993, the Indiana Supreme Court ordered an overhaul of the way Indiana handled its property taxes. (See Dagney Faulk’s “How We Got Here from There.”) The way Indiana handled its assessments was pretty artificial. There were formulas that ended up undervaluing certain properties. For example, expensive old homes had relatively low assessments. (Hence, I believe, the anger among the Indianapolis Meridian crowd.)

Switching to a market based assessment resulted in an upheaval. Those with undervalued assessments suddenly saw a sharp increase in their property tax burden. The General Assembly scrambled with a variety of approaches, including a significant property tax replacement credit for homeowners and property tax caps. Where we stand now, homeowners have a similar tax burden, landlords are paying more, and businesses are paying somewhat less. And, we are shifting from reliance on a fairly predictable property tax to a more volatile sales tax. The shift was assisted by a 16% increase in the sales tax which accompanied the property tax caps.

I think this quote summarizes the feeling of many local officials:

“I’d like to see the whole system stabilized,” said Kim Fox, Tippecanoe School Corp. chief financial officer. “There’s such a push not to increase taxes. But at least make it so we know what we’re getting and it can come in on time.”

Not only have local officials been subjected to uncertainty about what revenues would be available, but also uncertainty as to when they would be available. The desire of some, mostly state level, officials to blame the problem on overspending by local government is unfortunate. There has been a tectonic shift in how we finance government and, since fecal matter runs down hill, the most local levels of government seem to be left cleaning up the mess.

Hopefully the next decade will be marked by a more predictable tax system. I wish I could remember the quote, but there was a Supreme Court Justice who wrote something along the lines of “it is some times more important that the law be clear than that it be entirely correct.” In the tax field, I think that’s often the case. Even where constant wrangling over tax policy leads to slightly better policy, those gains can be more than offset by the lack of predictability.

Priorities

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Now that the legislature has to go into a special session, Gov. Daniels finally joined the budget conversation in earnest. The AP has an outline of his budget cuts:

Financial aid (+3%)
K-12 (+2%)
State police (flat)
Prisons (flat)
College (-4%)
State parks (-8%)
“Faith based & community initiatives” (-10%) (In quotes b/c I don’t know what these programs are.)
Homeland security (-10%)
Environmental Management (-11%)
BMV (-11%)
Health (-12%)
Libraries (-15%)

I wonder what this means for the state’s Medicaid appropriation. As I recall, it’s usually one of the (if not the) highest single line item in the budget, but I’m not sure how much control the General Assembly has over it.

Incidentally, Everybody’s Favorite Economist, Larry DeBoer had a Capital Comments column in April about Indiana’s revenue shortfall, the stimulus, and what it means for Indiana’s budget. It’s either pain now or pain later, or both. When it’s time to cut, we can really identify our priorities as a community. I’m not sure I’ll enjoy what the true priorities of our leaders are, but it’s probably time to find out.

Tax Restructuring

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Seth Slabaugh, writing for the Muncie Star Press, has an article on the tax restructuring bill passed by the legislature earlier this year. In a bit of what appears to be editorializing, he describes it as the “landmark property-tax-reform bill.” Of course, “landmark” and “reform” are in the eye of the beholder. Landmark is probably less controversial than reform, I suppose. Whatever the legislature did, it was pretty big.

Everybody’s favorite economist ™, Larry DeBoer, points out that the legislation passed by state legislators gives a tax credit to taxpayers (the property tax circuit breaker) at the expense of local government without funding the credit.

What makes this different from every other credit offered by the state is this one is not going to be funded by the state,” said Larry DeBoer, an economist at Purdue University. “If your property tax bill comes in over the circuit breaker limit, you will get a credit for the difference, and that amount you will not pay to your local government, and your local government will have to do without. They will actually take the hit. They will suffer the revenue loss.”

Professor DeBoer also suggests that the legislation is complicated enough that not every County Auditor is going to be equipped to do the fiscal analysis required by the bill. It’s likely to be a major boon for fiscal consultants around the state.

In addition to the property tax circuit breaker, the legislation also raised the sales tax about 17%; shifted local responsibility for some school and welfare costs to the state; imposed restrictions on local government ability to engage in capital projects; imposes advisory duties on county councils with respect to non-school taxing units; and requires county assessors to absorb many of the duties of most elected township assessors.

With respect to the circuit breaker, Prof. DeBoer points out local units have even less control over their own destinies:

The tax rate that matters for the circuit breaker is the sum of all rates — libraries, towns, cities, counties — so no taxing unit has control over this,” DeBoer said. “If the sum of all the rates pushes the taxpayer above the credit limit, and the tax bill is not paid, the lost revenue is distributed among all taxing units in that area.”
So the new law makes all local budgets in a county interdependent.

“Everybody’s budget depends on everybody else’s budget,” DeBoer said. “That’s going to be a challenge. Certainly, this is going to have some complicated consequences.”

Interesting times.

Property Taxes: Cui Bono

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Lesley Stedman Weidenbener has an article in the Louisville Courier Journal analyzing the property tax restructuring plan being considered by the General Assembly. According to Everybody’s Favorite Economist ™, Larry DeBoer, “The savings would be greatest among people who are “income poor and property rich,” a group that tends to include retired households.” The median household with an income of about $52k and a house worth about $121k would experience an overall tax savings of about $145 assuming that their county does not increase the local income tax; probably an unrealistic assumption in many locations.

Renters are losers under most variations of the plans because they don’t enjoy the property tax savings but they still pay the sales tax. Under provisions inserted by the House to assist low income Hoosiers, such renters break even if they make less than $25,000 per year.

People who are income rich and property poor will be the biggest losers.

It looks a little like we’re preferring people who are living beyond their means and penalizing people who haven’t over-committed on real estate relative to their resources. Certainly mid-income and high income renters are getting screwed.

History of Indiana’s Property Tax Situation

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(H/t Blue Indiana ) Anita Munson, writing for the South Bend Tribune has an article entitled Indiana schools may face project cutbacks. It features Everybody’s Favorite Economist ™, Larry Deboer, and his explanation of how we got to where we are.

He’s been over it before, and this blog has pointed to his explanations before, but still they bear repeating lest the actual reasons get lost in the finger pointing:

1. In 1998, the Indiana Supreme Court issued a decision which took effect in 2003, holding that the old tax assessment system was not fair. (Thanks Town of St. Johns!) Basically, the old system was an artificial assessment system that undervalued old, residential homes (even, presumably, those on the nicer parts of Meridian Street). Meanwhile, business real estate was valued at something that was probably close to its actual value, resulting in a subsidy for owners of older residential properties.

2. Elimination of the inventory tax. The inventory tax was eliminated. The last year to get rid of inventory taxes was 2007, but county governments were permitted to do away with them earlier. County governments were also permitted to impose an income tax to make up for lost inventory tax revenue. Failure to impose such an income tax would result in the inventory tax burden being shifted onto property tax payers.

3. Trending. The 2003 reassessment was based on 1999 values. Recently, rules were imposed that required property values to be “trended” — meaning updated annually. The first step in trending was catching up property values – 1999 values were updated to 2005 values, meaning 6 years of appreciation having to be absorbed in one shot. Business owners weren’t hit as hard as residential properties. First, business equipment is supposed to be updated annually anyway, so there wasn’t a 6 year catch up on such equipment. Second, there was not a whole lot of data for assessors to go on to update values of big factories, for example. They just don’t get sold that often. If residential property gets updated while business property effectively is not, that results in a shift of the tax burden from business payers to residential payers.

4. Shift from State to Local Government. The State apparently reduced total tax credits by about 8% for property owners.

5. Increase in levies by local taxing units. This is the “increased spending” component of the equation. But, according to Mr. DeBoer, the property tax increase is a relatively small part of the equation. Only about 25% of the 24% average increase (6% then, I suppose) has to do with local tax levies. The remaining 18% of the average increase has to do with a shift in the tax burden (from State to Local and from Business to Residential).

The State is going to issue rebates of about $225 million once it gets paid licensing fees from two race tracks (Shelbyville and Anderson) that have been allowed to add slot machines to their facilities. Another $225 million in tax relief will be provided by the state from the gambling licensing fees in the form of an addition to the homestead credit next year. In addition, local governments have been given the option of raising income taxes to provide property tax relief.

First, a local income tax can be imposed if the property tax levy is frozen at its current level – normally, a locality is permitted by the State to raise its upcoming tax levy by a certain percentage of its current levy. Another local income tax can be imposed to provide relief from existing property taxes. The “relief” provided by this local income tax can be targeted at: a) all property owners; b) only homesteads; or c) all residential properties (including rental units). Finally, if income taxes #1 and #2 are imposed, then an additional income tax can be imposed to fund public safety. (Marion County was apparently given special dispensation to impose the public safety income tax without first imposing income taxes #1 and #2).

So, who or what exactly is responsible for raising property taxes?

The following account for 90 percent of the increase, DeBoer said:

Schools general fund, 25 percent; schools debt, 13 percent; cities/towns general fund, 12 percent; county general fund, 10 percent; schools’ capital projects, 9 percent; schools’ transportation, 6 percent; county welfare, 5 percent; special districts (such as solid waste), 4 percent; cities/towns, other funds, 3 percent; and libraries, general fund, 3 percent.

John Hill, superintendent of Plymouth Schools, has suggested that the State is increasingly putting more of the burden of funding schools on the backs of local government. In addition, the State apparently provides payments to schools in an untimely fashion, resulting in the Schools having to borrow money against the promised payments by the State, resulting in interest expenses.

Prof. DeBoer notes that, while the instability of Indiana’s property taxes are a problem, Indiana does not have high property taxes compared with the rest of the nation. In 2005, Indiana ranked 35th in the nation with “$1,079 as the median homeowner property tax payment.” Meanwhile, Michigan ranked 18th at $1,846 and Illinois ranked 7th at $2,904. Most of the states with lower property taxes than Indiana are in the South where “lawmakers have historically used sales taxes more than property taxes for funding.” (And, the article does not say this, but the South also tends to have the States that rank last in things like education.)

[tags]property taxes[/tags]

Why Property Taxes are going up

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Why are property taxes going up? Once again, Larry DeBoer, everybody’s favorite economist, has the answers.


Step One: For decades prior to 1998, Indiana had given homeowners a tax break by under-assessing houses relative to business property. The Town of St. John challenged this practice, and the Supreme Court required assessments based on market value.


Step Two: In 2002-03, reassessment was based on market value and tax bills on older homes jumped. The General Assembly provided about a billion dollars in property tax relief to ease the pain.

Step Three: The General Assembly found this level of property tax subsidy unsustainable for the State budget and decided to cap it. According to Prof. DeBoer, the cap accounts for about 4% of the recent 24% increase.

Step Four: Part of the 2002 tax reform with the huge property tax subsidy was elimination of the inventory tax. The last 51 counties eliminated their inventory taxes this year. (Other counties had done so in prior years.) The inventory tax shifted to other taxpayers and hit particularly hard in places, such as Indianapolis, with a lot of inventories. On average, the inventory tax reduction accounts for another 4%.


Step Five: Trending. Trending requires assessors to keep up with assessed value. In the past few years, assessed values were to be based on what a property was worth in 1999. This year, residential property values were to play catch up by going from 1999 levels to 2005 levels. Business property values were already subject to trending and, therefore, the changes in assessed value for business property values were not as dramatic. In Marion County and some others, however, business assessments were not trended. According to Prof. DeBoer, trending accounted for about 10% of the 24% statewide increase.


Step Six: Rising local tax collections account for about 6% statewide. Places with big government construction projects have higher increases and those without tend to have lower increases.

Homeowner tax bills are increasing mostly because of tax shifts, from businesses to homeowners, and from the state budget to local taxpayers. In most places, big homeowner tax hikes are not the result of large increases in tax collections. Big increases in government spending are not the main problem.
. . .
Property assessment is the way we divide up the cost of local government among taxpayers. Market-value assessment says that homeowners should pay more than they did under our old system. Homeowners don’t think that’s fair.

Perhaps it’s time to step back from the year-to-year tax crises and ask ourselves, “What is a fair way to divide up tax payments?” Perhaps that’s one topic the governor’s new commission will take up. If so, the question will be, “Can we agree on what’s fair?”

(Emphasis added).

[tags]property taxes[/tags]

Band-aid or surgery for Indiana property taxes

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Everybody’s favorite economist, Larry DeBoer, has column entitled Capital Comments which appeared in the Carroll County Comet. As always, he does a good job of explaining the implications of legislative tax policy.

Again, he explains why the increase in local taxes. First, property taxes on inventories will be eliminated in 51 counties this year. That means the tax burden shifts from taxpayers with inventories to other taxpayers. Another policy change is trending — updating assessed values each year to keep up with changing sales prices. Since they’re playing catch up this time around, 1999 sales prices are being “trended” to 2005 selling prices. In the future, this should make for more gradual assessment changes, but this year it can be rather jarring. Prof. DeBoer says that so far it looks like home assessments are being trended upward a lot more than business assessments, thereby shifting the tax burden toward homeowners.

He notes the legislative Band-aid solution this year — “racino” income. Race tracks are paying big bucks for the right to have slot machines. The racino licensing money is being used to subsidize property taxes, thereby lessening the increase. He pointed out a practical (in addition to the political) reason for the much maligned rebate strategy. Instead of just reducing tax bills with the race track subsidy, the legislature required that homeowners get a rebate in November or December. The practical reason for that is that the the State won’t have the casino money until then.

Prof. DeBoer goes on to look at who wins and who loses under various new taxing options given to municipalities by the legislature. First, local government can use an income tax of up to 1% that would be used as a dollar-for-dollar offset of property taxes. The local government has three options for distributing revenues from this tax: a) for all property owners; b) for homeowners only; or c) for homeowners and rental-housing owners.

Under option “a” – all property owners, all property taxes would go down about 20%. Renters and employed homeowners would see their income taxes rise more than their property taxes were lowered. Farmers, retired homeowners, and corporate businesses would pay less overall.

Under option “b” – just homeowners, homeowner property taxes would be cut by about 50%. Almost all homeowners would see their overall tax burden reduced. Other property owners who earn income in the county would pay more.

Under option “c” – homeowners and landlords, homeowner taxes would drop by 1/3 and most would see an overall reduction in taxes.

[tags]property taxes[/tags]

HB 1478 – Property taxes

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By a vote of 44 to 5, the Senate adopted House Bill 1478. Voting “no” were Senators Rogers, Simpson, Skinner, Smith, and Tallian. This is Senator Kenley’s bill designed to ease the property tax hit — expected to be a 15% increase if the legislature does nothing — and to shift local government’s reliance on property taxes to something else.

I have to admit, my brain seized up about half way through the digest. It’s been a long day, sure, but i’s also a pretty complicated bill. But, in general, it accomplishes this by having the state assume some of the expenses traditionally borne by local government — such as juvenile detention fees and department of child services fees. In exchange, the state will phase out the property tax replacement credit — currently the mechanism by which the state essentially subsidizes the county property tax burden. It also allows local government to reduce property taxes by replacing them with a county adjusted gross income tax or county option income tax.

That’s my dumbed down version, anyway.

Also, if you want a very readable explanation of why property taxes will probably go up this year, check out the March 22, 2007 edition of Capital Comments by everybody’s favorite economist, Larry DeBoer. His guess (absent action by the General Assembly): a 17.5% increase. He lists five major items that will affect your property tax bill. Among those, there is the issue of trending — currently property taxes are based on the value of the property on March 1, 1999. Assessors are now required to “trend” the property — basically use recent data to adjust the value every year. Year-to-year, that might not be a big thing, but this year, they’ll have to use the March 1, 2005 value — a 6 year jump. There is also the issue of the property tax replacement credit – that big subsidy the state used to pay to local government to reduce the need for property taxes. A lot of the 2004 budget was balanced by substantially reducing the amount of that replacement credit. The State shifted its burdens down onto the counties.

So, I expect legislators to be very motivated to protect their constituents against a 17.5% property tax increase and would, therefore, be surprised if some version of this bill does not pass.
[tags]HB1478-2007, taxes[/tags]