INDIANAPOLIS — It’s not up for debate anymore whether Indiana legislators should cut taxes. Leadership in both chambers has made clear this will happen in the new state budget.
The question remains, though: Which tax cut would have the most effect on the Hoosier economy?
“There’s no economist who disagrees that if you reduce taxes in the short run, it will cause economic activity to grow. It’s pure arithmetic. Tax cuts induce economic activity,” said Michael Hicks, professor of economics at Ball State University.
However, Hicks added of the tax cuts: “Very few economists agree that they would pay for themselves.”
Legislators have until April 29 to finalize a decision.
Gov. Mike Pence has been pushing an individual income tax cut that would save Hoosiers about $500 million annually, while legislative Republicans have focused on greatly reducing or eliminating the state inheritance tax.
At times, the political battle hasn’t been pretty.
But there are other taxes to be considered, such as sales and corporate taxes.
Matt Will, associate professor of finance at the University of Indianapolis, said it is generally accepted that for every dollar cut in taxes, there will be an increase in economic activity.
But that doesn’t mean legislators should just get rid of a bunch of taxes.
“Democrats need to realize that every dollar you increase in taxes, you reduce growth in the economy,” he said. “Republicans need to realize you have to have taxes in a civilized society.”
Will said cutting taxes generally spurs the economy because people and businesses will spend that extra money on a product or maybe hire a new employee. Even if people put the extra cash in savings, he said, it has some impact; for example, financial institutions can lend the money for a business startup or someone buying a home.
Pence sent a letter to legislators from noted economist Larry Lindsey, who has served under three Republican presidents.
Lindsey made the case for the income tax cut in part because roughly 90 percent of the businesses in the state are pass-through entities, with profits taxed at the individual level.
“State income taxes directly reduce the cash flow of existing businesses, … therefore a reduction in the level of state income taxation leaves more cash flow in the hands of the owner to be deployed as he or she sees fit,” the letter said.
Will points out that 90 percent of employers doesn’t equate to 90 percent of the jobs. House Ways and Means Chairman Tim Brown, R-Crawfordsville, argued that a greater effect would result from cutting the inheritance tax, which often causes people inheriting family farms and small businesses to sell them just to get money to pay the taxes.
While the inheritance tax might affect only a few thousand estates annually, he said there are three times that many beneficiaries of the estates. Some older residents also move their assets to states without an inheritance tax.
Brown said a repeal of the tax would reduce an entire section of administrative burden.
“So not only are we putting money back into the economy, we are reducing regulation,” he said.
Overall, Hicks said Indiana’s tax collections are in the bottom third of the country on a per capita basis, evidenced in a lean state government.
He and Will agree that lawmakers shouldn’t focus on sales tax as a target at all. While Indiana’s state rate of 7 percent is among the highest in the nation, other states have additional local sales tax rates, so fair comparisons can’t be made.
And Indiana’s low cost of living makes the sales tax factor even less important.
Hicks said if he had his choice – and could put politics aside – he would further cut the Indiana corporate tax.
Legislators already started a phased reduction of the tax, which initially stood at 8.5 percent. That compares with the individual income tax rate of 3.4 percent. It has already dropped once and is set to be 7.5 percent in the coming fiscal year.
But even at its reduced rate, the imbalance stands out in a bad way for Indiana.
“I would cut corporate tax,” Hicks said. “I think it’s more an equity issue. I don’t think we should treat two businesses different because of how they are organized.”
Will also said that if forced to choose, he would cut the corporate tax over an individual income tax reduction.
“If you want a quick injection into the economy, you cut the corporate tax. That will create jobs,” he said. “When you cut the cost of doing business, they invest.”
Ironically, though, he is concerned about the idea of cutting taxes at all.
“You’re talking to a guy who is a tax cut fanatic,” said Will, who still thinks the economy is fragile. “If we have a rebound recession, then what are you going to do? Raise taxes? Keep taxes where they are and build a surplus. We have unfunded obligations.”
And to stimulate the economy instead, he would plow money into tax incentives and abatements, luring every company the state could to Indiana.