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Business tax replacements doomed to fail

Our governor and legislature have been calling for the elimination of the business personal property tax, which has led to panic among local government officials because of the $1 billion negative effect on local revenue.

The governor’s response was, “Any reform of the business personal property tax can’t shift business tax to hard-working Hoosiers and cannot result in unduly burdening local governments.” I take that to mean that the intent is to replace the lost revenue with some other type of business tax. But when you consider our current tax structure and also the Indiana Constitution, this is impossible.

To illustrate I’ll use the three different tax buckets the state could draw from to replace the revenue: property taxes, sales taxes and income taxes.

Our property tax policy is limited by two major factors. First, property taxation must be uniform. We cannot tax business property using a different rate than that used for residential property. Therefore, if the revenue replacement comes through property taxes, some portion of the effect would fall on non-business taxpayers (hard-working Hoosiers). The second factor is the combination of large-value deductions for homestead real property coupled with the tax caps in the Indiana Constitution. While the deductions could be reduced by a statutory change, it is unlikely to happen and would only make it more likely for taxpayers to hit the tax cap and reduce local revenue. A property tax revenue replacement is not workable.

Sales taxes, while partially paid by businesses, are primarily a tax on individuals. If the statement that they do not intend to burden hard-working Hoosiers with the reduction of a business tax is true, sales taxes are not a workable revenue replacement.

That only leaves income taxes to work with as a revenue replacement mechanism, which creates an interesting dilemma. Indiana has a large number of businesses that operate as “pass-through entities” (LLCs, LLPs and subchapter s corporations) where business income is reported on an individual’s income tax return. Since the Indiana income tax return begins with federal adjusted gross income, it is hard to know how much of the individual income tax is based on business pass-through income and how much is investment income or employee wages. If the revenue replacement mechanism only applies to C corporations, a large number of businesses will see a reduction in property taxes with the increase in income taxes only paid by C corporations. That flunks the fairness test.

The only way to fix that issue without a complete overhaul in our income tax methodology is to set a progressive income tax rate or surcharge above some arbitrary amount of assumed business income. Progressive income tax rate structures have been rejected each time that they came up, but it may be the only way to get anything close to a fair revenue replacement, even though the taxation threshold could only be based on a guess.

The bottom line is that there is no revenue replacement mechanism within our current tax policy structure that meets the stated goal of revenue replacement from business taxpayers that does not affect individual taxpayers. The bills pending in the legislature do not include their revenue replacement mechanism because it does not exist.

Mike Claytor is a retired certified public accountant and a Democratic candidate for state auditor. He wrote this for Indiana newspapers.