A tight economy: Trying to repair a dead end road?

By Michael J. Hicks

By many accounts, Indiana’s two most vexing legislative matters in this session involve the financing of highways and pre-kindergarten education.

While there are many important questions about both issues, the real problem is Indiana’s shrinking tax base. This challenge will only worsen with time, so it is useful to understand what the trouble is, and how it may be remedied.

The financing of Indiana roads is primarily done through a gasoline tax. This is an excise tax, levied on each gallon sold. Vastly better fuel efficiency combined with alternative fueled vehicles means that revenues from this tax no longer cover the costs of infrastructure improvements and maintenance.

Worse still, even a doubling of the gas tax may leave the state cash-strapped in a decade if alternative fueled vehicles become price competitive. This is a real problem that we have not clearly prepared taxpayers to face, but it is small relative to the grand problem of sales taxes.

Expanding pre-K education is important in a state that continues to suffer embarrassingly low educational attainment. While I think the smartest option is a limited expansion to perhaps one-third of households, the argument for universal pre-K is not without merits.

Still no matter what scale of pre-K is chosen, we face a very tenuous tax environment. Indeed, it is fair to say our state tax revenues are built upon the quicksand of the sales tax base.

Indiana sales tax includes only some goods and not any services. This is a curious choice for a state that prides itself on making things. But worse than the intellectual vacuity of this approach is the fact that that Hoosier households are spending a declining share of their earnings on goods.

Today, each additional dollar in household income results in about a 30 cent increase in spending on goods. This trend, which dates back to the Great Depression, means that we are ever raising sales tax rates to capture enough revenues run government.

If you search for an amusing visual metaphor for the Indiana legislature facing the declining sales tax and gas tax bases, imagine a dog chasing a constantly shrinking tail. Even when you catch it, it won’t be enough.

It is astonishing that despite a growing economy, the state has a tax system that cannot meet its future needs due to entirely predictable problems. So what to do?

For transportation, we must tax congestion. That can be achieved through tolls and mileage taxes. A gas tax can even be part of the mix, but cannot do it alone. The challenge here is the inconvenience of tolls along with the technical and privacy worries of a mileage tax. But this is nothing compared to the sales tax problem.

By taxing the ever shrinking consumption of goods, Indiana faces a long-term budget crisis. As services comprise an increasing share of income, our reluctance to tax such things as medical treatment, legal advice, amusements and accounting services dooms us to an endless budget worries. It also leaves us a tax system that overburdens the poor and middle class, and distorts our consumption choices.

There may be legitimate concerns about taxing consumer services, but I haven’t heard them yet. The Legislative Services Agency has estimated that we could raise the same tax revenues with a sales tax of 3.1 percent instead of the 7 cents we now pay, this would seem to be an easy choice for the legislature. So, why hasn’t the legislature acted?

Well, the fact is that extending a sales tax to services, while cutting the rate on goods, would make almost all Hoosiers better off, and those whom it would hurt comprise a particularly powerful voice in the state. Lawyers, accountants and other high earning professionals will face taxes they have thus far dodged. I expect that is why the issue will have a hard time getting a solid hearing at the statehouse.

Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to letters to awoods@tribtown.com.