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Are property tax caps a bad idea for Hoosiers?

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The good thing about politicians? If you don't like how they're performing, you can always vote them out of office a few years later.

But on Nov. 2, Hoosiers will enter the voting booth with a choice that's not so easily undone. By way of a public referendum, Hoosiers will have the opportunity to vote a simple "yes" or "no" on whether or not to make property tax caps more or less permanent.

The referendum would enshrine in the Indiana State Constitution a set of property tax caps that formed the centerpiece of a comprehensive tax restructuring rolled out by state legislators in 2008 and put into full effect in 2009 – a bold measure that, like any constitutional amendment, would require two General Assembly votes and another public referendum to undo.

Unsurprisingly, the caps have been popular among homeowners in need of relief in a tough economy. But vital city and county services statewide that depend on property taxes have suffered since the caps went into effect last year. From schools to libraries to police departments, budget shortfalls – created by a triple-whammy of caps, plummeting home values and skyrocketing foreclosures – have forced layoffs, service reductions and facility closures statewide.

The caps have drawn sharp criticism from city, county and township officials who have struggled to make ends meet in an economy already stacked against them.

"Clearly property tax caps have decimated local government budgets," said Democrat Joanne Sanders, minority leader of the Indianapolis City-County Council.

"They are a way to get a buzz going and make it look like the state is being proactive, but the truth is, only a small percentage of homeowners really get a break," Sanders added. "Local governments will have to begin to cut essential services in the next few years as the impact further reduces local revenues."

One-two-three punch

Property tax caps came along at a time when property tax rates were going through the roof. Property assessments had gone unperformed around the state for a generation, and home and business owners had continued paying taxes based on assessments that were, in many cases, decades old.

Suddenly, many property owners were paying several times what they had just paid a year before.

The rate spike was a political albatross for anyone associated with it – or anyone perceived to have been associated with it. The downfall of former Indianapolis Mayor Bart Peterson is widely attributed to the spike, among other things.

Known as a "one-two-three cap," the caps limit property tax payments to 1 percent of gross assessed value for homeowners; 2 percent on agricultural land, apartments and some other types of land, like trailer parks; and 3 percent on non-residential property – most of it businesses.

To offset the caps, the state assumed responsibility for funding school operating budgets – formerly supported by local property taxes – and raised the state sales tax from 6 to 7 percent in attempts to make up for lost revenue.

But the increased sales tax could only go so far. Reduced consumer spending in a dismal economy meant huge state budget shortfalls, requiring major cuts to the education budget (among other things) those sales taxes were supposed to save.

Last winter, the state cut $297 million from schools for the current two-year budget – cuts that could get deeper if the latest state revenue numbers are any indication.

This summer, the Indiana State Budget Agency announced state revenues for the 2010 fiscal year – which ended in July – had come up nearly a billion dollars short. For the moment, Gov. Mitch Daniels has indicated further education cuts won't be necessary, but has made roughly $600 million in cuts to other sectors like transportation and corrections, and drawn about $644 million from the state's $831 million reserve to close the gap.

Experts and the governor's office expect next year to be worse, though they remain hopeful.

"The state remains solvent because we've made hard decisions about spending and been fiscally responsible," said Jane Jankowski, a spokeswoman for the governor. "More difficult decisions are ahead next year when the new budget is crafted."

School administrators worry that pinning school operating budgets to state revenues is a risky gambit.

David Holt, Chief Financial Officer of Warren Township schools, said he worried that state sources of income were inherently less stable than property taxes. Warren Township schools are faring relatively well compared to many other school districts. But the district also had to close two schools and start school at the beginning of August to get there.

"Property taxes, historically, have been a much more stable source of revenue," Holt said. "When you pin your funding to, really an economic tax, when the economy drops, your funding drops. Property values have had some changes in the last few years, but they were still much more stable than what the recession and the economic taxes through sales and income taxes have done in the last couple years."

What's at stake?

Although the property tax caps were pushed by the Daniels administration, and placed on the ballot by officials in the Indiana General Assembly, the current and future problems created by the caps are almost exclusively local.

The State of Indiana makes most of its revenue collecting income tax and sales tax, with additional revenue from things like gambling, cigarette and alcohol taxes. In return, the state pays for things like roads, select social welfare services like food stamps and Medicaid and, as of 2009, the operating budgets of public schools.

Counties, municipalities and townships, on the other hand, rely mostly on property taxes levied on homes and businesses (though, like in Indianapolis, they may also rely on things like food and restaurant taxes and hotel taxes). In return, these smaller units of government provide most of what could be characterized as day-to-day services.

A quick look at what those services include in Indianapolis provides a glimpse of what's at stake when property tax revenues are cut short:

– Fire departments, including firefighter pensions and fire department-related capital and equipment costs

– Police departments and other law enforcement jobs (like the County Prosecutor)

– The Indianapolis Health and Hospital Corporation

– Public libraries

– Public transportation

– City sanitation services

– Local flood control

– City parks and recreation

– Emergency communication services

– Capital development and redevelopment projects

– Non-operating funds for schools, including funds for bus replacement, maintenance and fuel, pensions, capital projects and technology upgrades

City, county and township services are already feeling the effects of the caps. According to data from the Marion County treasurer's office, Indianapolis and Marion County took in $75 million less in property tax revenues than it had budgeted for 2010.

The problem came into sharp public focus last spring, when the Indianapolis Marion County Public Library (IMCPL) announced it might have to close six branches around the city to make ends meet. IMCPL derives roughly 80 percent of its revenues from property taxes – nearly $37 million in 2009 – and projected huge losses for the foreseeable future: up to $2.6 million in 2010, $3.1 million in 2011 and $3.2 million in 2012. Branches were not closed, in the end, but services were cut back significantly to fill the gaps.

Other departments took in significantly less revenue than expected as well, even after sweeping budget cuts for 2010. Indianapolis public transportation, after budgeting for nearly half a million less in property tax revenues in 2010 than 2009, still received roughly $1.5 million less than initially budgeted. Police, after trimming $1.6 from its 2010 property tax levy came up nearly $1.6 million short.

The outlook for the near future doesn't look any rosier. According to an outside analysis commissioned by the city controller's office, property tax revenues are projected to continue to fall even shorter than budgeted in 2011 – this time, to the tune of nearly $103 million.

C. Kurt Zorn, professor of public and environmental affairs at Indiana University Bloomington and former chairman of the State Board of Tax Commissioners, said the idea of making property tax caps a part of the constitution was "flat-out awful policy" and a "poor substitute for the legislature and the executive branch governing correctly."

Zorn said he worried that local legislatures would have their hands tied permanently every time the economy took a turn for the worse.

"The Constitution is not a place to put policy," he said. "Just because there is some concern that the legislative and executive bodies won't have the guts to maintain a certain policy doesn't mean that it makes sense to put it in the Constitution."

Cognitive dissonance

Despite a hobbled budget, Republican Mayor Greg Ballard says he supports the property tax caps. At a city-county council meeting, he defended the caps while introducing the 2011 city budget – a budget that sought to address not only property tax losses, but a full $50 million shortfall in income tax revenue.

Council Democrats walked out on the mayor's speech before it began.

"In 2010, we felt the full effect of property tax caps, creating what was one of our toughest budget years to date," Ballard told the councilors who remained. He cited a 33 percent drop in property taxes for Marion County homeowners compared to three years ago.

"We championed this much-needed relief in the legislature, because the people who live here deserve a consistent, predictable tax structure," he said. "It was the right thing to do, and it continues to be a positive measure for our city."

But the irony of touting the success of the tax caps amidst a speech presenting a budget which sought to close a $50 million revenue gap wasn't lost on Council Democrats.

"Perhaps there are local governments who believe in the structure of the Greek city-state and they anticipate that the State of Indiana will take care of all their needs, or perhaps they are willing to consolidate to the point of no longer being recognized as a government entity, " Minority Leader Sanders told NUVO. " More likely, they bought the political line that [a property tax cap] is the only way to build a new and progressive Indiana."

Asked specifically about the property tax caps, and whether they would be feasibile over the long term, Ballard said they would be – just under different circumstances.

"Certainly, if we were not in this national recession that has been going on – and I think is going to continue, frankly – I think we would have handled that very well, honestly," Ballard said. "It looks like, from the numbers, to me, we would have been able to hold that for a long, long time."

But even if the mayor's assessment is correct, some say the current recession – and the massive budget shortfalls it has created – is a perfect example of why tax caps should not be made permanent.

"Schools lose, libraries lose – and taxpayers don't really win," Sanders said. "More referenda will be required to assist schools and libraries in the future, relieving some elected officials of their responsibility to actually make the tough decisions they were elected to make."

Principle of diminishing returns

Property taxes in Indiana, first introduced during the 1930s, have always been a means for local governments – from counties to townships to municipalities – to raise money for local needs. Historically, this has always made sense, particularly in times when communication and travel were more difficult. If a road needed fixing, a school needed building, or trash needed dispensing, who else but local governments could identify the problems? And who else could address them in ways custom-tailored to the needs of the local community?

But things changed over time, and the preeminence of localized governments diminished. Local reliance on property tax revenues diminished along with it. Hence, the history of taxes in Indiana is, generally speaking, two stories in one: The first, the decline of home rule; the second, a gradual shifting away from local property taxes and toward taxes collected by the state – namely, sales tax and income tax.

In a 2004 study, Dagney Faulk, an economics professor at Indiana University Southeast, traces the history of Indiana tax reform to the Bowen tax package of 1973. Like the Daniels tax reform package of 2008, the Bowen package arose in direct response to rising local property taxes, but made up for its losses by increasing sales tax statewide (in this case, they doubled, from 2 percent to 4 percent).

As Faulk's report indicates, numerous reforms since then have continued the trend – eroding the ability of local governments to create revenues, while strengthening state powers of collection and governance. Daniels' reform is a perfect example: It capped property taxes, stripping millions per year from local revenue streams; in return, the state took over financial responsibility for school operating budgets and raised the sales tax.

Professor Zorn said the Daniels tax caps were another in a long line of measures that have weakened fiscal home rule – a "distasteful" measure that would further disempower citizens from shaping their own communities if it were made permanent by referendum.

"I have this old fashioned notion that the ballot box actually works, and that if I don't like what somebody's doing, and if a majority of people don't like what somebody is doing, they can vote folks out of office," he said. "This is clearly an example of the distrust that state officials have of local officials. For whatever reason, they don't think that local officials are capable of carrying out their responsibilities correctly."

Studies of past examples of property tax cap legislation indicate that efforts in other states like California and Oregon have struggled because property tax cuts didn't stimulate the economy enough to make up for lost revenues. However, tax cap supporters around the state have cited a recent study produced by Ball State's Center for Business and Economic Research, which predicts the caps will create jobs and economic prosperity across all income groups over time.

Using a complex model that crunches factors like projected income levels, capital supply levels, employment and state economic output, the study's authors conclude that the caps will "increase the disposable income of households as they pay less property tax," leading to increased capital investment which, in turn, creates jobs and more household income.

In the short term, the study says, lower-income families stand to lose household income because they would benefit less from decreased property taxes (particularly those who do not own property), while still having to pay the one percent sales tax increase enacted to help pay for schools.

In the long term, however (defined as three to five years), the study argues that "the economy performs better than in the short run, [and] net household income is higher in all household groups due to the increase in returns to labor."

Specifically, the analysis projects a net growth of household income of nearly $4 billion in the long run, and the creation of nearly 97,000 jobs.

But, on closer inspection, the study has major shortcomings when applied to the real world – caveats the authors willingly admit in their concluding remarks, though tax cap supporters who cite the study tend not to.

For starters, the study assumes capital supply, wage rates and rental rates will remain relatively fixed over time. As a result, major economic shifts like the current recession – driven by national and global boom-and-bust cycles, along with unpredictable regulatory changes and patterns of corporate risk-taking – aren't taken into consideration.

Like Mayor Ballard's logic – that tax caps would work if it weren't for this pesky recession – it only really works in a vacuum. But come November, if the tax caps are enshrined in the Indiana state constitution, Indiana could wind up gasping for air every time there's an economic hiccup.

"This is going to severely limit the flexibility and the creativity of local government officials," Zorn said. "I can actually imagine that there may be a time in the future where we'll have citizens clamoring for local and state officials to raise their taxes because things are going to get so bad."

Keelee Hurlburt contributed reporting for this article.

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