Larry DeBoer: A ticking time bomb on revenue

Larry DeBoer Submitted photo

Indiana school districts were relieved when the governor announced that the state would not be cutting aid in the coming fiscal year. With the COVID recession, state sales tax revenues were 15% below forecast in both April and May, and income tax revenues were down more. State agencies and universities had been told to reduce their budgets. But the state will find a way to maintain state aid to schools through mid-2021.

State school aid looks secure. Property taxes are the other big revenue source for schools. It’s big for counties, cities, towns and other local governments, too. Will the recession affect property taxes? As always with the property tax, the answer is: “It’s complicated.”

Property taxes are collected based on the assessed value of property. During a recession, new construction slows down, businesses buy less new equipment, and the selling prices of property stop rising or even fall. The tax base grows slowly or declines. That happened during the Great Recession of 2007-09, and it may be happening now. Indiana construction employment and home building permits are down.

That won’t affect revenues this year. Tax bills this year are based on assessments from last year, and the due date for the first installment was in May. If revenues fall this year, it will be because property owners can’t pay what they owe, not because property values are lower.

County assessors revise property assessments each year, so any drop in values this year will cause lower assessments next year. After the last recession, statewide assessments fell from 2010 to 2012. Assessments fell at least once in two-thirds of the counties.

Tax bills are based on the previous year’s assessments. If property values fall in 2020, assessments will fall in 2021, and that will affect tax bills in 2022. The full effect of the recession won’t hit schools and other local governments for two years.

When sales fall, sales tax revenues fall. When incomes fall, income tax revenues fall. When property assessments fall, property tax revenues might fall. Or they might not. Again, “complicated.”

Property tax revenues are called “levies,” and local governments set their levies based in part on how much the law allows. The state controls levy growth with a “maximum levy growth quotient.” It’s based on the growth of Indiana income, averaged over six years, with another two-year lag. Levy growth in 2022 will be limited by the growth of income during the years 2015 to 2020. If income falls in 2020, the growth quotient will be lower, but it will still be positive. Levies will go up.

To collect higher levies on lower assessed values, property tax rates must rise. That can happen automatically, since rates are calculated by dividing the levy by assessed value.

But now come the property tax circuit breaker caps. Homeowner tax bills are limited to 1% of assessed value; taxes on rental housing and farmland to 2%; and business land, buildings and equipment to 3%. More taxpayers will hit their tax caps with assessments down and tax rates higher. Taxpayers get a credit when their tax bills exceed their caps. That’s part of the tax bill that they don’t have to pay. That’s part of the levy that local governments don’t collect.

Schools and other local governments may levy taxes that they will not collect. This is especially true where tax rates are already higher, so lots of taxpayers are already at their caps, or nearly there. Tax rates are highest in cities and towns, because taxpayers pay those rates in addition to the school, county and township rates that everyone pays.

Evidence from recent years shows that tax rate increases of 20 cents per $100 assessed value, in places with total tax rates above $3, can cut after-credit revenue growth by 5% or more. That’s enough to wipe out any levy increase.

The property tax is more stable than the sales or income taxes. The recession may have little effect on revenues in places with tax rates under $2. But for cities and towns, and the school districts in those cities and towns, property tax collections are vulnerable to recession. Just not until 2022.

Larry DeBoer is a professor and extension specialist in agricultural economics at Purdue University. He worked with the Indiana Legislative Services Agency on tax and finance issues from 1988 to 2014 and studies state and local government public policy. Send comments to [email protected].