Budget reforms that could lead to lower taxes and more transparency
Nobody likes to pay taxes, but is it really possible to eliminate Hoosiers’ income taxes? It should be, as long as the General Assembly takes strategic steps to make that aspiration a reality.
Some contend that it isn’t possible. A recent commentary began with the fact that income taxes generate roughly $8 billion for Indiana’s state government, but then assumed that eliminating the tax requires gouging spending. That is a misleadingly reductionist view of the challenge, and quite unhelpful for legislators. Still, Indiana spends far more per person than, for example, Missouri and Tennessee.
But even if the income tax is particularly damaging to Indiana’s economy, that doesn’t mean that the legislature should simply eliminate it and sort out the details later.
When considering how to reduce Indiana’s income tax rate, legislators shouldn’t think only about where to cut for offsets. They should also address the budget process, as well as Indiana’s tax structure. Doing these things would not only allow for responsible offsets for lower income tax rates, but they would, more simply, give everyone a better sense of how Indiana is taxing and spending in the first place.
An important thing Indiana can do is include revenue policies in its budget bill. The state’s budget isn’t just spending accounts; tax rates, bases, exclusions, deductions, and credits are all as much a part of the budget as traditional line items. The state should intentionally include these areas in its budget bill, and as a result legislators could consider the budget holistically instead of piecemeal — maximizing the opportunities to find ways to lower the income tax.
Another reform that would add transparency is introducing Truth in Taxation at the local level. Truth in Taxation simply requires local governments to report the revenue-neutral tax rate and explain any increase in revenue due to higher rates or a larger base. This mechanism encourages greater fiscal discipline at the local level, which can reduce dependence on transfers from the state coffers, especially if it also requires local governments to disclose revenue NOT collected due to special breaks.
A third reform is changing how the state balances its budget, moving from a requirement for annual balance to one based on a rolling average, called “structural balance.” This kind of change would smooth out revenue fluctuations and give lawmakers the flexibility to make positive structural changes to the budget without having to respond immediately to economic volatility.
These budget reforms would increase both transparency and confidence, allowing legislators to pursue changes to the tax structure itself.
The ideal tax rate is low and flat, covering a broad swath of society, with few carveouts for special interests. That kind of tax structure keeps the burden fair and minimal. Shifting to a more robust sales tax is one way of spreading out the burden, but better would be to increase the base of items and services that fall under the sales tax. Americans are purchasing services at a higher rate than any other time in history and expanding the sales tax onto services is one way to help offset reductions in the income tax.
A path forward
All these changes would create more transparency, uncover savings, or generate revenue — all of which contribute to the legislature’s ability to reduce the income tax rate responsibly. This is a worthy goal, as the income tax burdens and distorts the economy in ways that few other taxes do. It reduces the incentive to work while encouraging people to move to lower-tax areas. Sales taxes, in contrast, don’t have these problems.
But even if the income tax is particularly damaging to Indiana’s economy, that doesn’t mean that the legislature should simply eliminate it and sort out the details later. Such a drastic shift would be irresponsible. Indiana’s legislators absolutely need to find appropriate offsets for an income tax reduction, and continuing the use of phased reductions could be an appropriate strategy.
The claim that it’s impossible, however, is wrong. We can find out by first making budgetary reforms that give us a better sense of how our whole budget system works, and then reforming our tax code based on what we learn.
The result wouldn’t just be lower income tax rates. It would also give us a more transparent, responsible, and better functioning government — and that outcome is essential for everyone’s prosperity, both now and for decades to come.