May 2014

Indiana: Building on Past Tax Reform

 by Amy K. Frantz

Indiana adopted tax cuts in 2013 to build on tax reform approved under the previous Governor. In May of last year Indiana Governor Mike Pence (R) signed a two-year budget bill into law that includes “the largest state tax cut in Indiana history.”[1]  The individual income-tax rate will fall from the current 3.4 percent to 3.3 percent in 2015 and 3.23 percent in 2017.[2]  While a flat income-tax rate of 3.4 percent was already one of the lowest rates in the country, Governor Pence, “well aware of the burden put on citizens by the federal tax hike on January 1 and by the looming costs of Obamacare,…was determined to do what he could to ease the pain for Hoosiers.  ‘He felt pretty strongly that what he could do as Governor was to reduce the price of living and working in our state,’ explains Ryan Streeter, a top Pence adviser.”[3]

The budget bill also repealed the state’s inheritance tax retroactive to January 1, 2013. Previous Governor Mitch Daniels (R) adopted legislation to phase out Indiana’s inheritance tax by 2022, but the May 2013 budget bill repealed the tax beginning in 2013 rather than continuing the phase-out over the next nine years.[4]  Indiana’s inheritance tax had a top rate of 20 percent before the tax was repealed.[5]

Additionally, the budget bill let stand a reduction in the state’s corporate-income tax that was adopted in 2011. That legislation reduced the corporate-income tax from 8.5 percent to 8 percent on July 1, 2012, 7.5 percent on July 1, 2013, 7 percent in 2014, and 6.5 percent in 2015, with “each reduction tak[ing] effect on July 1 of each year.”[6]

Research shows that states with no income tax outperform the states with the highest personal-income-tax rates, with greater growth rates in population, gross state product, non-farm payroll employment, and state and local tax revenue.  While the last state to completely eliminate the income tax was Alaska in 1980,[7] several states are working their way towards that goal with incremental income-tax-reform plans.

States, including Iowa, should consider reforms to lower the income-tax rates and decrease the complexity by reducing the number of tax brackets. Reformers should consider “the deep-seated fundamentals of a solid tax system – one that is simple and transparent, with broad-based taxes that provide a balanced revenue stream, spread the tax burden fairly, and heighten the chance of compliance.”[8]

However, here in Iowa, any income-tax reforms must take care to maintain federal deductibility. Iowa taxpayers are currently able to deduct their federal income-tax payments from their net income when filing an Iowa income-tax return. Ultimately, one of the most important reasons to maintain the federal income-tax deduction on state tax returns is fairness. If the deduction were eliminated, Iowans would be forced to pay tax on money that has already been taken by the federal government. It is simply not fair to ask Iowans to pay a tax on a tax.

Iowa should follow the example of Indiana, and other states, and adopt income-tax reform.

Amy K. Frantz is Vice President of Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation.  They are brought to you in the interest of a better-informed citizenry.

[1] Bob Cox, “Pence signs state budget in Crawfordsville,” Journal Review Online, May 9, 2013, <http://www.journalreview.com/news/article_f7f9c554-b852-11e2-9f0e-0019bb2963f4.html> accessed November 6, 2013.

[2] Katrina Trinko, “Governor Pence’s Indiana-Tax Win,” National Review Online, May 7, 2013, <http://www.nationalreview.com/article/347500/governor-pence%E2%80%99s-indiana-tax-win#!> accessed November 7, 2013.

[3] Ibid.

[4] Joseph Henchman, “Indiana Approves Income Tax Reduction,” Tax Foundation, The Tax Policy Blog, May 14, 2013, <http://taxfoundation.org/blog/indiana-approves-income-tax-reduction> accessed November 6, 2013.

[5] “Inheritance Tax Rates and Exemptions, 2012-2013,” Tax Foundation, May 1, 2013, <http://taxfoundation.org/article/inheritance-tax-rates-and-exemptions-2012-2013> accessed November 7, 2013.

[6] Scott Drenkard and Joseph Henchman, “2014 State Business Tax Climate Index,” Tax Foundation Background Paper, October 2013, No. 68, p. 53, <http://taxfoundation.org/article/2014-state-business-tax-climate-index> accessed November 6, 2013.

[7] Joseph Henchman, “Trend #6: Tax Abolition,” Tax Foundation, Fiscal Fact, No. 308, June 8, 2012, <http://taxfoundation.org/article/trend-6-tax-abolition> accessed July 17, 2013.

[8] Katherine Barrett and Richard Greene, “Growth & Taxes,” Governing Magazine, January 2008, <http://www.governing.com/topics/mgmt/Growth–Taxes.html> accessed November 8, 2013.