Income tax revenue replacement ‘remains to be seen,’ state budget director says

Indiana State Budget Director Zac Jackson (photo provided)

As Republican leaders in the Indiana General Assembly look to reduce and possibly eliminate the state’s individual income tax, one of the state’s top fiscal analysts says there is no clear replacement for a revenue stream that brings in about $8 billion a year and makes up about a third of the state’s overall tax revenue.

The comments from Indiana State Budget Director Zac Jackson came during a virtual panel discussion Thursday on how an economic recession would affect state and local governments. The event was organized by the Volcker Alliance, a New York City-based not-for-profit founded by former Federal Reserve Board Chairman Paul Volcker, and the Penn Institute for Urban Research at the University of Pennsylvania.

In the most recent legislative session, lawmakers created a task force to review, among other topics, the individual income tax, including methods to reduce or eliminate the individual income tax.

“Although reducing the individual income tax is a goal of this committee, it remains to be seen how the state would deal with that $8 billion loss in revenues,” Jackson said. “Does that mean we will cut spending by a third out of our general fund, or does that mean that we will make it up in other tax types?”

Another complicating factor, he said, is that Indiana also allows municipalities to collect local income taxes, which brings in between $3 and $4 billion a year.

In the committee’s first meeting last month, lawmakers and budget analysts heard testimony from Americans for Prosperity, a conservative political advocacy group, and former Republican state Sen. Brandt Hershman, who advocated for repealing the corporate income tax.

The task force is scheduled to meet again in September and October before releasing its recommendations by Nov. 1.

Senate Tax & Fiscal Policy Committee Chair Travis Holdman, R-Markle, has argued that repealing the income tax by 2030 would help Indiana compete with states like Florida, Tennessee and Texas that don’t have a state income tax and have seen economic and population growth in recent years.

In 2022, lawmakers passed a tax-cut package that gradually reduced the income tax rate over the next seven years, from 3.23% to 2.9%, with the stipulation that state tax revenue must have grown at least 2% in the previous budget year. It was the state’s first income tax cut since 2013, and it was Holdman who added language to the bill to tie any income tax decrease to overall revenue growth.

In the budget bill passed in April, lawmakers further accelerated those cuts to occur by 2027 and removed the 2% trigger requirement. Indiana’s current income tax rate sits at 3.15%.

Indiana finished the 2023 fiscal year on June 30 with $2.9 billion in reserves.

Lt. Gov. Suzanne Crouch, who is running for governor, has been a vocal supporter of eliminating the personal income tax, which she said would help Hoosier families and small businesses while helping to attract companies to move or expand here.

Crouch said the loss of income taxes could be absorbed by instituting a number of measures, including by returning budget and reserve fund surpluses to taxpayers that are “beyond necessary levels:” modernizing the state’s tax code; limiting the growth and cost of Indiana government to necessary levels; and limiting expenditures to a 2% inflation adjusted growth rate.

The four other leading candidates for the GOP nomination have expressed tepid support for the idea, though some question how Crouch would replace the lost revenue stream.

Other states that have eliminated their income tax have had to offset the losses by raising property taxes, increasing sales tax rates or taxing services, or creating a new tax altogether.

In Alaska, a state that repealed its income tax in 1980, a severance tax on the oil and natural gas industry keeps the government solvent, while Texas has higher-than-average property tax rates, and Florida brings in billions of dollars a year in tourism development taxes. Tennessee has the same state sales tax rate as Indiana at 7%, but local jurisdictions can enact their own sales tax, making the rate as high as 10% in some places.