On Tuesday, the U.S. Bureau of Economic Analysis (BEA) released state-by-state personal income data for the first quarter of 2020. Indiana’s anemic 1.2% growth from the end of 2019 ranks 46th in the nation; this highlights the obvious hardships Hoosiers face from COVID-related disruptions…but it’s also a warning sign to local governments across Indiana of a longer-term limit on their budgets.
First, a primer on personal income, which combines three components – net earnings (wages and salaries paid to workers), property income (interest, dividends, and rent) and transfer payments (government benefits like social security, unemployment, social assistance and tax credits).
The data captures the start of the economic shutdown that accompanied the COVID pandemic in March, hitting net earnings as unemployment began its climb towards today’s double-digit level. Indiana earnings dropped by 1.2% as the U.S. registered a miniscule 0.3% uptick. The state’s property income grew 2% (versus 2.3% for the U.S.), and transfer payments spiked 8.5% (compared to 10.1% nationally) as public sector support for displaced workers and non-essential employers began to flow.
I’m not offering an analysis of why Indiana’s personal income grew at just over half the national pace from January through March – those are deeper economic questions. I’d like to spotlight a more specific issue, a formulaic connection among personal income, property taxes and the ability of local communities to repair roads, hire police and firefighters and maintain school buildings for the next decade.
Since the 1970s and Governor Otis Bowen, Indiana has enacted various policies to control the burden of property taxes on homeowners, farmers and business owners. Today, constitutional property tax caps restrict the amount paid to a percentage of assessed value – 1% for primary residences, 2% for farmland and multi-family developments, and 3% for commercial properties.
So if property values grow, tax bills can also grow…but only up to a point. Local governments have also lived within a maximum property tax levy as one of those ‘70s era reforms; once taxing units in a county reach the maximum levy, increases in assessed value don’t generate more revenues (lowering tax rates instead).
The maximum levy grows every year, now based on a formula called the Maximum Levy Growth Quotient (MLGQ), which isn’t calculated with any measure of property values. It’s simply based on the six-year average of non-farm personal income growth statewide, a way to ensure that a red-hot real estate sector doesn’t allow property tax bills to soar past what a typical Hoosier could afford (even under the tax caps).
But if personal income declines in Indiana this year because of the COVID recession, it means local governments will face a tougher climb back to ‘normal,’ even with a healthy housing market and economic recovery. Personal income dropped in 2009 (the Great Recession), depressing the maximum levy until 2017.
Local governments have become more dependent on income taxes over time, but property taxes still make up the majority of local revenues (with the exception of school districts, where state funding now dominates). Most counties already operate at or near the maximum levy.
It’s one fiscal challenge among many facing state and local budgets from the pandemic: High unemployment means less taxable income, and sales tax revenue (which makes up half Indiana’s general fund and plays a vital role in school funding) suffers as consumers have less money to spend and fewer places to spend it. Social distancing has taken an obvious toll on gas tax collections, food and beverage taxes and gaming revenues.
Local governments have a longer timeline for COVID-related turmoil. Local income taxes are distributed with a delay: This year’s income losses are reflected on next year’s tax returns, which are used to calculate how much each county receives in 2022. Property taxes are on a similar schedule – a drop in real estate this year will show up on next year’s property assessments and 2022 tax bills.
But the six-year MLGQ formula means the budget effects of COVID could linger until 2027 and beyond. Hopefully, these are years of economic growth, but could Indiana’s recovery be compromised by a tighter maximum levy that crowds out potential investments in infrastructure, public safety, school construction and economic development priorities?
Personal income could be positive by the end of 2020, and federal stimulus money (which counts as ‘transfer payment’ income) will also help prop up the numbers even if earnings plummet with sustained unemployment. But state and local officials should recognize and plan for the potential for lower property tax levies turning up the pressure on cities and towns, counties and school corporations.