Indiana Should Use Surplus to Expedite Rate Cuts, Index Exemptions for Inflation

With the Indiana General Assembly gaveled in this week for a special session called by Gov. Eric Holcomb (R), one of the issues is how to allocate portions of the $6.1 billion budget surplus for the fiscal year that ended June 30.

The House, Senate, and governor agree that some of the extra revenue should be returned to Hoosiers through tax relief, but policymakers must decide what form that tax relief will take. Various proposals have been offered, including another round of income tax refund checks (as proposed by the governor and included in the House bill), as well as increases to the exemption for dependent children, a new exemption for adopted children, and a sales tax exemption for children’s diapers.

Meanwhile, the Senate bill provides a much smaller amount of temporary sales and excise tax relief, including suspending for six months the sales tax on residential utilities services, undoing the gas tax inflation adjustment that took effect July 1 (and freezing it at FY 2022 levels until July 2023), as well as capping the gasoline use tax at 29.5 cents per gallon until July 2023. Current economic forecasts project the gasoline use tax rate will not reach the capped amount, meaning this provision is unlikely to have any real impact.

While well-intended, most of these measures—especially the temporary ones proposed in the Senate bill—would provide households with only modest, short-term relief from inflation. And while income tax refunds are more efficient forms of one-time relief than sales tax exemptions, an additional infusion of cash would add to the inflationary pressures in the economy more broadly without promoting long-term economic growth in Indiana.

A better approach would be for policymakers to dedicate some of the state’s surplus revenue toward accelerating or enhancing the permanent Indiana income tax rate reductions that were enacted earlier this year, as well as indexing Indiana’s personal and dependent exemptions for inflation. This would provide permanent tax relief to Hoosiers while making Indiana’s tax code even more competitive and further promoting long-term economic growth.

Under legislation enacted in March, Indiana’s flat individual income tax rate is scheduled to be reduced from its current 3.23 percent rate to 3.15 percent for tax years 2023 and 2024. In subsequent years, the law uses tax triggers to reduce the rate further if general fund collections grow by at least 2 percent year-over-year (in specified years) and the Indiana Public Retirement System’s Pension Stabilization Fund balance is sufficient to pay liabilities without additional appropriations. Under current law, if all triggers are met, the rate would be reduced to 3.1 percent in 2025 and 2026, 3 percent in 2027 and 2028, and 2.9 percent in 2029 and beyond.

To enhance these reforms, policymakers could first consider reducing the rate below 3.15 percent starting January 1, 2023. Then, modifications could be made to reach the target rate of 2.9 percent sooner than planned, or to reduce the future target rate to below 2.9 percent. Simultaneously, policymakers could consider modifying the trigger mechanism to tie future tax cuts to specific inflation-adjusted revenue targets instead of single-year revenue growth, averting the possibility of an undesirable outcome in which a tax cut is triggered by a recovery from an economic downturn in which overall revenues remain below the desired baseline level.

Additionally, the House bill proposes raising the exemption for dependent children from $1,500 to $1,600 and doubling the exemption to $3,200 for the first year in which a taxpayer is eligible to claim an exemption for that child, including for infants and newly adopted children. Increasing the exemption for dependent children would be a structurally sound reform to consider, but to provide longer-term inflationary relief, policymakers also ought to consider indexing the major provisions of the state’s tax code for inflation, such as the personal exemption, dependent exemption, and additional exemption for dependent children, among others. These exemption amounts have remained static for many years and have therefore lost much of their real value over time.

The income tax rate reductions enacted earlier this year will help reinforce Indiana’s coveted position of having one of the best-structured tax codes in the country, but there is always room for improvement. Expediting the Indiana income tax rate reductions and indexing major income tax provisions for inflation are two of the most important tax policy changes policymakers could make to provide meaningful tax relief to Hoosiers both now and in the years to come.

Sophie Tremblay

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