Chairman Holdman and Members of the State and Native TaxA tax is a compulsory cost or cost collected by native, state, and nationwide governments from people or companies to cowl the prices of normal authorities companies, items, and actions.
Evaluation Process Drive:

Thanks for the chance to current earlier than the Process Drive right this moment to debate numerous points of Indiana’s tax construction and alternatives to additional enhance the state’s tax competitiveness. We’re Andrey Yushkov and Katherine Loughead, Senior Coverage Analysts on the Tax Basis, the place we concentrate on state tax coverage.

The Tax Basis is a nonprofit, nonpartisan tax coverage analysis group that has superior sound tax coverage on the state, federal, and worldwide ranges for over 85 years. Our crew engages with tax coverage points in all 50 states, and you might be aware of two of our hottest annual publications, Information and Figures and the State Enterprise Tax Local weather Index.

To supply a little bit of background about us personally, Andrey not too long ago earned his PhD in public coverage from Indiana College, and Katherine earned her undergraduate diploma at Indiana Wesleyan College. We vastly respect this chance to come back again to Indianapolis to take part on this essential dialog about Indiana’s tax construction and additional alternatives for enchancment, particularly given Indiana’s sturdy monitor file as a pacesetter in pro-growth tax reform over the previous couple of a long time.

In the present day, we’ll stroll by means of every of Indiana’s main tax income sources, figuring out the place the state is very aggressive and the place there’s room for additional enchancment.

We consider state tax codes ought to be easy, clear, and impartial whereas producing a secure income; the suggestions we provide right this moment can be in keeping with these 4 key rules of sound tax coverage.

Indiana’s Present Tax Panorama

We wish to start our presentation right this moment with an outline of Indiana’s present tax panorama. Indiana’s tax system is already extremely aggressive nationally. On our 2023 State Enterprise Tax Local weather Index, a research that evaluates the competitiveness of states’ tax constructions throughout greater than 120 tax coverage variables, Indiana ranks 9^th general and has the very best rating amongst its geographic neighbors. Notably, Indiana has maintained a aggressive rating of both 9^th or 10^th on the Index for the previous 10 years.[1] The Hoosier State performs properly on the Index as a result of it has some of the environment friendly property taxA property tax is primarily levied on immovable property like land and buildings, in addition to on tangible private property that’s movable, like automobiles and tools. Property taxes are the one largest supply of state and native income within the U.S. and assist fund faculties, roads, police, and different companies.
techniques within the nation and likewise has comparatively well-structured particular person and company earnings taxA company earnings tax (CIT) is levied by federal and state governments on enterprise income. Many firms should not topic to the CIT as a result of they’re taxed as pass-through companies, with earnings reportable below the particular person earnings tax.

es, with charges decrease than any of its neighboring states.[2] Amongst Indiana’s neighbors, Michigan and Kentucky are its closest opponents on the Index, rating 12^th and 18^th, respectively.

Sources of State and Native Tax Income

American federalism permits states to construction their tax codes in quite a lot of methods. Some states rely nearly completely on earnings taxes, whereas others rely extra on Gross Sales and use taxes. Indiana’s income construction has been secure over the past decade. From 2014 to 2023, the gross sales and use tax accounted for about 50 % of normal fund revenues, whereas the share of the particular person earnings taxA person earnings tax (or private earnings tax) is levied on the wages, salaries, investments, or different types of earnings a person or family earns. The U.S. imposes a progressive earnings tax the place charges enhance with earnings. The Federal Revenue Tax was established in 1913 with the ratification of the sixteenth Modification. Although barely 100 years outdated, particular person earnings taxes are the largest supply of tax income within the U.S.
fluctuated between 34 and 38 %. All different sources of income have been comparatively insignificant in comparison with these two main taxes. The company earnings tax was probably the most risky income, fluctuating between 5 and seven % of normal fund revenues. The share of all different taxes, together with wagering taxes and excise taxAn excise tax is a tax imposed on a selected good or exercise. Excise taxes are generally levied on cigarettes, alcoholic drinks, soda, gasoline, insurance coverage premiums, amusement actions, and betting, and sometimes make up a comparatively small and risky portion of state and native and, to a lesser extent, federal tax collections.
es on gasoline and cigarettes, accounted for lower than 10 % of the final fund.

Whereas a complete dialogue of the deserves of various sources of tax income is past the scope of this testimony, we wish to spotlight the foremost benefits and downsides of earnings taxes and gross sales and use taxes. Some economists argue that earnings taxes (when solely wages are taxed) and consumption taxA consumption tax is usually levied on the acquisition of products or companies and is paid instantly or not directly by the buyer within the type of retail gross sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an earnings tax the place all financial savings is tax-deductible.
es are theoretically equal.[3] Nevertheless, there’s little disagreement that the sensible implications of earnings and consumption taxes differ significantly.

Each particular person earnings taxes and gross sales taxA gross sales tax is levied on retail gross sales of products and companies and, ideally, ought to apply to all remaining consumption with few exemptions. Many governments exempt items like groceries; base broadening, akin to together with groceries, might maintain charges decrease. A gross sales tax ought to exempt business-to-business transactions which, when taxed, trigger tax pyramiding.
es have broad and simply outlined tax baseThe tax base is the full quantity of earnings, property, property, consumption, transactions, or different financial exercise topic to taxation by a tax authority. A slim tax base is non-neutral and inefficient. A broad tax base reduces tax administration prices and permits extra income to be raised at decrease charges.
s and signify main sources of state and native income. Nevertheless, particular person earnings taxes are sometimes not restricted to wages, which suggests that they will disincentivize saving and investing. Whereas earnings taxes are simply adjustable to varied particular person and household traits (e.g., variety of dependents, complete household earnings, and many others.), these changes within the type of exemptions and tax credit scoreA tax credit score is a provision that reduces a taxpayer’s remaining tax invoice, dollar-for-dollar. A tax credit score differs from deductions and exemptions, which scale back taxable earnings, slightly than the taxpayer’s tax invoice instantly.
s sometimes add to the complexity of the tax system and will result in the issue of horizontal inequity. Thus, particular person earnings taxes in observe usually violate the rules of simplicity and neutrality.

Company earnings taxes are much more problematic since they’re sometimes risky (with tax revenues declining in periods of financial shock), nonneutral and dangerous for companies, and, in a aggressive federalist context, result in ubiquitous tax avoidance and evasion. Gross sales and use taxes, when designed appropriately, are much less distortive than earnings taxes.[4] Normally, they solely tax present consumption and thus incentivize labor, financial savings, and future consumption. Nevertheless, the design of gross sales and use taxes is critically essential. As an illustration, if enterprise inputs are included within the gross sales tax base, this will result in tax pyramidingTax pyramiding happens when the identical remaining good or service is taxed a number of instances alongside the manufacturing course of. This yields vastly completely different efficient tax charges relying on the size of the availability chain and disproportionately harms low-margin corporations. Gross receipts taxes are a first-rate instance of tax pyramiding in motion.
. Additionally, if solely items are taxed, whereas companies are tax-exempt, this results in the erosion of the gross sales tax base and the necessity to enhance tax charges in the long term.

Why Tax Reform?

As Indiana already scores excessive in nationwide rankings, the pure query for Hoosiers could also be: “Why do we have to change our tax system in any respect?” There are a number of causes, however the first and most essential is that the state and native tax panorama is quickly altering and turning into more and more aggressive, and states that stand nonetheless threat falling behind.

The Tax Reform Panorama Has Grown Extremely Aggressive

Between 2021 and 2023, 26 states decreased their particular person earnings tax charges, with many of those states decreasing their charges greater than as soon as, together with Indiana, which enacted earnings tax cuts each in 2022 and earlier this 12 months. Two of the opposite tax-cutting states, Arizona and North Dakota, have charges decrease than Indiana’s, with Arizona at a flat fee of two.5 % and North Dakota with a prime marginal fee of two.9 % that’s scheduled to drop to 2.5 % in 2024. Many of those states are on their solution to decreasing tax charges even additional, generally unconditionally, and generally topic to tax triggers which can be contingent upon income availability. Indiana’s latest progress to make its particular person earnings tax fee extra aggressive is laudable, however every of Indiana’s regional opponents in addition to Illinois has additionally decreased earnings tax charges prior to now few years, so that is no time for Indiana to relaxation on its laurels.

Along with the 26 states that decreased particular person earnings tax charges between 2021 and 2023, 13 states reduce company earnings tax charges, and two states (New Mexico and South Dakota) decreased their gross sales and use tax charges. Many different states have made structural enhancements to their tax codes, together with newly providing full expensingFull expensing permits companies to instantly deduct the complete price of sure investments in new or improved expertise, tools, or buildings. It alleviates a bias within the tax code and incentivizes firms to take a position extra, which, in the long term, raises employee productiveness, boosts wages, and creates extra jobs.
for equipment and tools investments, eliminating throwback and throwout guidelines from their company earnings tax techniques, elevating nonresident earnings tax submitting and withholdingWithholding is the earnings an employer takes out of an worker’s paycheck and remits to the federal, state, and/or native authorities. It’s calculated primarily based on the quantity of earnings earned, the taxpayer’s submitting standing, the variety of allowances claimed, and any extra quantity of the worker requests.
thresholds to adapt to an more and more cellular economic system, decreasing reliance on capital inventory taxes and tangible private property taxes, and broadening the gross sales tax to use to traditionally untaxed shopper companies—which boosts neutrality and may also help pay down extra pro-growth reforms elsewhere.

Individuals Are Shifting from Excessive- to Low-Tax States

Moreover, there is a crucial latest migration development that carries implications for tax reform: Individuals are more and more shifting from high- to low-tax states, particularly states with low earnings taxes (or that forgo a person earnings tax fully).[5] Florida and Texas, states that don’t tax wage earnings, persistently rank among the many prime states when it comes to GDP development, inhabitants development, and adjusted gross earnings (AGI)Adjusted gross earnings (AGI) is a taxpayer’s complete earnings minus sure “above-the-line” deductions. It’s a broad measure that features earnings from wages, salaries, curiosity, dividends, retirement earnings, Social Safety advantages, capital features, enterprise, and different sources, and subtracts particular deductions.
development. Moreover, states with excessive prime marginal charges persistently lose residents, on internet, to states with low prime marginal particular person earnings tax charges, a flat taxAn earnings tax is known as a “flat tax” when all taxable earnings is topic to the identical tax fee, no matter earnings degree or property.
, or no earnings tax.

Notably, this development has implications for Indiana as properly. As demonstrated in Desk 1, Indiana has constructive internet migration (that means inbound migration is larger than outbound migration) with Illinois, Kentucky, Ohio, and California, however Indiana has adverse internet migration with Florida, Arizona, Texas, and Michigan, states that every one both haven’t any particular person earnings tax or levy a flat earnings tax at a low fee. Though many components have an effect on relocation choices (e.g., job market, climate, housing availability, price of residing), taxes clearly play an essential position: the common all-inclusive tax burden within the former states is 11.50 %, whereas the common tax burden within the latter states is 8.95 %, greater than 2.5 proportion factors decrease.[6] As of 2022, Indiana’s tax burden was 9.3 %, barely larger than in Florida, Michigan, and Texas, however nonetheless permitting Indiana to have the 14^th-lowest state and native efficient tax fee within the nation.

To stay aggressive in an more and more cellular economic system, states ought to take into account how numerous provisions of their tax code both appeal to or deter people and companies. Within the time we’ve got remaining, we’ll focus on Indiana’s particular person earnings, company earnings, gross sales, and property tax constructions, highlighting each what Indiana is doing properly and the place there’s room for enchancment. If Indiana desires to keep up its environment friendly tax system and proceed to enhance its tax competitiveness each nationally and internationally, a number of extra pro-growth reforms are value contemplating.

Indiana’s Particular person Revenue Tax Construction

Indiana is at the moment one in all 11 states with a single-rate particular person earnings tax construction, generally often called a “flat tax.” With a flat fee of three.15 %, Indiana has one of many lowest charges among the many states that tax wage and wage earnings. Nevertheless, different states are rising more and more aggressive by reducing charges and consolidating brackets. Actually, extra states enacted legal guidelines to transform from a graduated-rate tax construction to a flat particular person earnings tax construction in 2021 and 2022 alone than did so in your complete 109-year historical past of state earnings taxation up till that time. Particularly, Arizona, Idaho, and Mississippi applied flat taxes this 12 months, and Georgia is on monitor to take action in 2024, adopted by Iowa in 2026. The concept of shifting to a flat tax has additionally been a subject of great deliberation in Kansas, North Dakota, Missouri, Ohio, and Oklahoma.

States with particular person earnings tax charges extra aggressive than Indiana’s embody Arizona, North Dakota, and Pennsylvania. Arizona enacted sweeping tax reforms in 2021 that transformed a graduated-rate tax construction right into a flat tax fee of two.5 %, and reforms enacted in North Dakota this 12 months will convey the two.9 % prime marginal fee to 2.5 % in 2024. Moreover, Pennsylvania’s flat tax fee has remained at 3.07 % for fairly a while. Additionally it is essential to understand that 9 states, together with Florida, Texas, and Tennessee, are extra aggressive than Indiana since they don’t tax wage or wage earnings in any respect.

Regardless of having a low, flat fee, Indiana’s particular person earnings tax has some structural shortcomings that impede competitiveness and stop the state from rating larger on our Index. Most notably, Indiana permits native governments to impose their very own earnings taxes and is among the many six states the place native earnings taxes are a major supply of native tax income.[7]

In comparison with various income sources, like actual property taxes and gross sales taxes, native earnings taxes are usually extra complicated to manage and adjust to, extra economically dangerous, and generate a much less secure income. Whereas Indiana’s native earnings taxes are extra streamlined than in lots of different states since they’re administered on the state degree, the shortage of fee uniformity creates complexity and might result in financial distortions when people and companies transfer or regulate their decision-making to keep away from larger taxes in sure counties. Native earnings taxes additionally current an extra administrative burden for nonresidents who earn earnings in Indiana and subsequently must pay taxes to each the state and county.

Presently, native earnings tax charges in Indiana vary from 0.5 % in Porter County to three % in Randolph County.[8] Lately, offsetting a gradual decline within the state’s particular person earnings tax fee, a number of counties have dramatically elevated their native earnings tax charges. Particularly, between 2014 and 2023, native tax charges elevated from 1.5 to three % in Randolph County, from 2 to 2.65 % in Clinton County, and from 1.06 to 2.04 % in Monroe County. Because of this, in most counties, the mixed state and native particular person earnings tax burden has not decreased regardless of Indiana’s latest and ongoing state earnings tax fee reductions.

Actually, a median-income family in Randolph County faces the next efficient state and native earnings tax fee than its counterparts in Georgia or North Carolina the place state earnings tax charges are a lot larger than in Indiana. Native governments ought to be cautious of excessive native earnings taxes: the financial literature gives some proof that high-income people are delicate to adjustments in native earnings tax charges and usually tend to relocate to a different locality when their tax burden will increase.

Second, Indiana has a comparatively low private exemption of $1,000 per taxpayer, partner, and dependent, and this private exemption is just not listed to inflationInflation is when the final value of products and companies will increase throughout the economic system, decreasing the buying energy of a foreign money and the worth of sure property. The identical paycheck covers much less items, companies, and payments. It’s generally known as a “hidden tax,” because it leaves taxpayers much less well-off on account of larger prices and “bracket creep,” whereas growing the federal government’s spending energy.
. Whereas retaining deductions, exemptions, and tax credit at low ranges (or avoiding them altogether) helps promote simplicity and neutrality, Indiana’s private exemption is decrease than the mixed commonplace deductionThe usual deduction reduces a taxpayer’s taxable earnings by a set quantity decided by the federal government. It was practically doubled for all courses of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers to not itemize deductions when submitting their federal earnings taxes.
and private exemption in all neighboring and most comparable states (barely decrease than in Illinois and Kentucky, and considerably decrease than in Michigan, Georgia, and Arizona).[10] If Indiana policymakers determine to step by step scale back reliance on earnings taxes whereas growing reliance on consumption taxes, modestly growing the non-public exemption is a method to take action with out growing the tax burden on lower-income people.

Particular person Revenue Tax Reform Options

Indiana is at the moment on monitor to additional scale back its particular person earnings tax fee to three.05 % in 2024, 3 % in 2025, 2.95 % in 2026, and a couple of.9 % in 2027 and past. It is a affordable path ahead to proceed enhancing Indiana’s earnings tax competitiveness. Nevertheless, if Indiana policymakers want to proceed decreasing the person earnings tax fee sooner or later, offsetting reforms elsewhere within the tax code could turn into needed, akin to making use of the gross sales tax to sure shopper items and companies which can be at the moment exempt. Alternatively, well-designed tax triggers may very well be used to cut back earnings tax charges additional over time every time precise tax collections exceed sure particular inflation-adjusted targets.[11]

Whereas phasing out the state particular person earnings tax over a few years could also be a worthwhile purpose for policymakers to set their sights on, such a change is very unlikely to happen efficiently within the close to time period. Many states have considerably lowered earnings tax charges or transitioned to a flat earnings tax in recent times, however most of those adjustments have been incremental, not abrupt. Actually, no state has ever phased out a broad-based tax on wage and wage earnings. Alaska is the one state to have ever repealed its particular person earnings tax, doing so in 1980 through the oil increase that enabled the state to considerably enhance reliance on severance taxes to offset the elimination of the person earnings tax.

Moreover, Alaska relied much less on particular person earnings taxes as a supply of state authorities income than Indiana at the moment does. Earlier than its repeal, Alaska’s particular person earnings tax generated roughly one-quarter of the state’s tax collections. In contrast, in fiscal 12 months 2021, particular person earnings taxes generated roughly 39.7 % of Indiana’s state tax collections and 12.2 % of Indiana’s native tax collections. The share of Indiana’s normal fund income generated by the state particular person earnings tax has not fallen under 35 % since 2015.

With no main reform of the gross sales tax (e.g., gross sales tax base broadeningBase broadening is the enlargement of the quantity of financial exercise topic to tax, normally by eliminating exemptions, exclusions, deductions, credit, and different preferences. Slender tax bases are non-neutral, favoring one product or trade over one other, and might undermine income stability.
), changing this important income supply could be practically unimaginable to do in a brief time frame with out growing reliance on much more economically dangerous taxes, which might defeat the aim of eliminating the person earnings tax within the first place. Most states that forgo particular person earnings taxes have larger gross sales tax charges and broader gross sales tax bases than Indiana.[12]

One other coverage resolution that would make Indiana’s earnings tax system extra aggressive nationally is to reform native earnings taxes by imposing a tighter restrict on most statutory earnings tax charges. Below present legislation, counties could enact a normal native earnings tax fee as much as 2.5 % (2.75 % in Marion County), and counties may also enact a fee of 1.25 % for property tax reduction functions, for a mixed most native fee of three.75 %.[13] Moreover, sure counties could levy a particular objective native earnings tax for sure specified functions.

A most native fee of three.75 % is notably permissive, particularly provided that the utmost fee is considerably larger than the charges most counties at the moment levy, and better than the state fee. Policymakers ought to take into account tightening this cover to forestall native governments from merely offsetting any state earnings tax fee reductions with corresponding will increase in native earnings tax charges. For taxpayers, continued native earnings tax fee will increase might imply no actual discount of their state and native earnings tax legal responsibility. For the state, this could imply its efforts to extend competitiveness by means of state earnings tax fee reductions may very well be thwarted.

A second possibility is to contemplate changing native earnings taxes with a neighborhood possibility gross sales tax. This feature requires additional detailed dialogue past the scope of this testimony, however localities in lots of comparable states, together with Illinois, Tennessee, Georgia, Arizona, North Carolina, Oklahoma, and Nebraska, depend on native possibility gross sales taxes however forgo native earnings taxes. Typically, well-designed consumption taxes generate fewer financial distortions than earnings taxes since they don’t have an effect on saving and funding choices and solely tax present consumption. They’re additionally simpler to manage and fewer more likely to have an effect on people’ and companies’ location choices.

Indiana’s Company Revenue Tax Construction

Indiana’s flat 4.9 % company earnings tax is already one of many lowest within the nation. The state is very aggressive amongst its Midwestern neighbors: Illinois, Michigan, and Kentucky have larger company earnings tax charges than Indiana (9.5 %, 6 %, and 5 %, respectively), whereas Ohio imposes a dangerous gross receipts taxA gross receipts tax is a tax utilized to an organization’s product sales, with out deductions for a agency’s enterprise bills, like prices of products offered and compensation. Not like a gross sales tax, a gross receipts tax is assessed on companies and apply to business-to-business transactions along with remaining shopper purchases, resulting in tax pyramiding.
that’s burdensome to companies with excessive revenues however low revenue margins.

Indiana additionally makes use of a single gross sales issue apportionmentApportionment is the dedication of the proportion of a enterprise’ income topic to a given jurisdiction’s company earnings or different enterprise taxes. U.S. states apportion enterprise income primarily based on some mixture of the proportion of firm property, payroll, and gross sales situated inside their borders.
components and, in contrast to Illinois, Wisconsin, and Kansas, doesn’t impose an economically inefficient throwback rule. Throwback guidelines overtax company earnings and make states much less engaging to in-state companies.

Company Revenue Tax Reform Options

Though Indiana has the bottom company earnings tax fee amongst its neighbors following a decade of fee reductions between 2012 and 2021, a number of competing states have applied main company tax reforms in recent times and have decrease charges than Indiana, together with North Carolina (2.5 %), Oklahoma (4 %), and Utah (4.65 %). With a view to stay aggressive nationally and appeal to new companies to the state, Indiana policymakers ought to take into account incrementally decreasing the company earnings tax fee additional.

One other extremely worthwhile reform to contemplate is to undertake a bonus depreciationBonus depreciation permits corporations to deduct a bigger portion of sure “short-lived” investments in new or improved expertise, tools, or buildings, within the first 12 months. Permitting companies to write down off extra investments partially alleviates a bias within the tax code and incentivizes firms to take a position extra, which, in the long term, raises employee productiveness, boosts wages, and creates extra jobs.
allowance for companies’ equipment and tools investments, permitting companies to deduct most or all the prices of these investments within the 12 months these bills are incurred. Presently, Indiana is an outlier in that the state doesn’t provide any type of bonus depreciationDepreciation is a measurement of the “helpful life” of a enterprise asset, akin to equipment or a manufacturing unit, to find out the multiyear interval over which the price of that asset might be deducted from taxable earnings. As a substitute of permitting companies to deduct the price of investments instantly (i.e., full expensing), depreciation requires deductions to be taken over time, decreasing their worth and discouraging funding.
allowance just like the federal bonus depreciation allowance supplied below IRC Part 168(ok).

Below the 2017 federal tax reform legislation, till 2023, companies might deduct 100% of the prices of qualifying investments within the 12 months these bills have been incurred. Nevertheless, this provision is now phasing out, with solely 80 % bonus depreciation allowed in 2023, 60 % in 2024, and so forth, till bonus depreciation ends fully in 2027. Given the continuing phaseout of the federal provision, Oklahoma and Mississippi are actually providing a everlasting full expensing allowance of their very own, and different states are more likely to comply with swimsuit. Adopting such a measure would make Indiana extra engaging as a vacation spot for enterprise funding and enhance productiveness and the state’s future financial development prospects. Whereas Indiana does provide a restricted expensing provision for small companies in partial conformity with IRC Part 179, Indiana’s $25,000 expensing allowance is considerably decrease than the $1 million federal allowance that almost all different states conform to, so Indiana’s Part 179 allowance is one other space for potential enchancment.

Indiana’s Gross sales and Use Tax Construction

When discussing gross sales and use taxes, it is very important take into account each charges and bases in addition to each the state and native levies. When solely state gross sales tax charges are in contrast, Indiana is tied with Mississippi, Rhode Island, and Tennessee for the second-highest gross sales tax fee within the nation (7 %), decrease solely than California (7.25 %). Nevertheless, since Indiana at the moment doesn’t authorize its localities to impose native possibility gross sales taxes, Indiana’s mixed state and common native gross sales tax fee is far more aggressive, with Indiana tied with Mississippi for the 25^th-highest mixed state and common native gross sales tax fee within the nation.

As of fiscal 12 months 2021, Indiana’s gross sales tax breadth[14] was 38 %,[15] with a base broader than many neighboring states however considerably narrower than an excellent gross sales tax system the place all remaining private consumption is taxed.

In Indiana, groceries and plenty of private companies are exempt from the gross sales tax. Usually, some argue that exempting groceries and different requirements from the gross sales tax reduces tax regressivity. Nevertheless, as identified by the late Professor John Mikesell of Indiana College, the draw back of “family consumption exemptions is that they supply reduction for every purchaser no matter earnings degree. Because of this, an unlimited quantity of tax reduction goes to the prosperous, thus creating appreciable income loss with out gaining any socially fascinating impact.”[16]

Our analysis helps this declare and exhibits that, given states’ current gross sales tax exemptionA tax exemption excludes sure earnings, income, and even taxpayers from tax altogether. For instance, nonprofits that fulfill sure necessities are granted tax-exempt standing by the IRS, stopping them from having to pay earnings tax.
s for purchases made with SNAP and WIC advantages, the poorest decile of households experiences roughly 9 % extra gross sales tax legal responsibility with a gross sales tax exemption for groceries than they might if groceries have been taxed and the final gross sales tax fee have been decreased commensurately.[17]

A comparatively slim tax base nearly all the time drives tax charges up in the long term. As companies, most of that are tax-exempt, have grown significantly as a share of private consumption expenditures (from lower than 40 % within the early Nineteen Fifties to greater than 65 % within the 2020s),[18] the gross sales tax base has turn into narrower in nearly each state.[19] Because of this, the statutory median gross sales tax fee throughout the United States elevated from 3 % within the Seventies to six % within the 2010s. Indiana adopted the identical development: the gross sales tax fee elevated from 2 % in 1963-1973 to five % in 1983-2002 to 7 % from 2008 onward.[20] To forestall additional will increase in statutory gross sales tax charges, states, together with Indiana, ought to take into account broadening their gross sales tax bases to extra types of remaining private consumption, together with each items and companies. In any base-broadening effort, policymakers ought to be cautious to keep away from exposing extra enterprise inputs to the gross sales tax, as this causes tax pyramiding, the place gross sales taxes on enterprise inputs are handed alongside to customers within the type of larger costs for items and companies offered, after which the retail gross sales tax is levied on prime of that embedded tax.

Gross sales and Use Taxes Reform Options

If Indiana policymakers want to broaden the gross sales tax base to offset tax reductions elsewhere within the tax code, there are a number of products and companies to which the gross sales tax may very well be newly utilized.

For instance, making use of the gross sales tax to groceries would enhance the gross sales tax base by about $20 billion, that means gross sales tax collections would enhance by about $1.4 billion a 12 months if the present 7 % fee have been utilized to groceries and about $800 million a 12 months if a preferential gross sales tax fee of 4 % fee have been utilized.[21] If the state supplied a grocery tax credit score of $100 per taxpayer with adjusted gross earnings of $50,000 or much less, this could solely scale back the potential income achieve by about $230 million.[22]

Moreover, if the state chooses to incorporate some private companies within the tax base, gross sales tax collections will enhance, enabling Indiana to both decrease the gross sales tax fee or proceed reducing the person earnings tax fee at an accelerated tempo. As an illustration, together with leisure companies akin to membership charges in non-public golf equipment, sport facilities, theaters, and museums ($2.3 billion) and private care and clothes companies ($1.7 billion) might enhance the gross sales tax base by about $4 billion, that means gross sales tax collections would enhance by roughly $280 million a 12 months. Together with extra private companies akin to audio-video companies and a few skilled companies (that aren’t enterprise inputs) within the tax base can enhance tax collections even additional.

Considered one of Indiana’s neighbors, Kentucky, has not too long ago applied a large-scale gross sales tax base broadening reform. In 2018 and once more in 2021, Kentucky enacted laws considerably growing the gross sales tax base by making greater than 30 private companies taxable whereas retaining the gross sales tax fee fixed at 6 %. Because of this, actual (inflation-adjusted) gross sales and use tax collections within the state grew by 31.5 % in six years. In Indiana, which didn’t implement base broadening, gross sales and use tax collections elevated solely by 13.5 % throughout the identical interval.

This instance illustrates that gross sales tax revenues are more likely to enhance significantly because of base broadening, permitting the state to decrease the gross sales tax fee or reform different taxes, relying on lawmakers’ coverage priorities. For instance, Kentucky had a prime marginal particular person earnings tax fee of 6 % in 2018, however, on account of gross sales tax base broadening and financial development, Kentucky’s earnings tax fee was decreased incrementally and is now a flat 4.5 %.

It is very important word, nevertheless, that Kentucky’s latest base-broadening reforms should not an ideal instance to comply with. They captured a number of companies which can be primarily bought as enterprise inputs, in addition to some companies which can be usually bought each by companies and people, each of which exacerbate tax pyramiding. When designing any gross sales tax base-broadening reforms, policymakers ought to embody solely items and companies that represent remaining private consumption, not intermediate consumption.

An extra coverage possibility with respect to gross sales and use taxes is to change the definition of financial nexus for the needs of gross sales tax assortment and remittance obligations for distant sellers. After the U.S. Supreme Courtroom’s choice in South Dakota v. Wayfair, each state with a gross sales tax has adopted financial nexus necessities for distant out-of-state sellers. These necessities sometimes included the full quantity of gross sales and/or the variety of transactions a vendor with out a bodily presence in a state performs in that state.

In Indiana, financial nexus is at the moment outlined as $100,000 i