October 17, 2018

Low Tax for Whom? Indiana is a “Low Tax State” Overall, But Not for Families Living in Poverty


State legislators often lock themselves into a race to the bottom in pursuit of being labeled a “low tax state.” Analysis of data from the U.S. Census Bureau appears to lend support to Indiana’s reputation as a “low tax state.” Specifically, Indiana ranks 35th nationally in taxes collected as a share of personal income.[1]

But this narrow lens does not provide a full picture, as it overlooks the fact that Indiana’s tax system has vastly different impacts on taxpayers at different income levels. For instance, the lowest-income 20 percent of Hoosiers contribute 12.8 percent of their income in state and local taxes — considerably more than any other income group in the state. For low-income families, Indiana is far from being a low tax state; in fact, it is the eighth highest-tax state in the country for low-income families. [2]

Upside-Down Tax Code

According to the most recent data from the Census Bureau and Bureau of Economic Analysis, the state and local tax contributions of Indiana taxpayers total 9.1 percent of personal income. This relatively small share of personal income collected in state and local taxes is 10 percent below the national average, affording Indiana a reputation as a “low tax state.” But the state tax code is upside-down, that is, it requires taxpayers with the lowest earnings to contribute a larger share of their incomes in state and local taxes than the wealthiest taxpayers.

Analysis from the sixth edition of Who Pays? by the Institute on Taxation and Economic Policy (ITEP) finds the lowest-income 20 percent of Indiana taxpayers — who earn an average income of $11,400 per year — contribute 12.8 percent of their income in state and local taxes, the eighth highest state and local tax bill for this income group in the country. Similarly, among the next 20 percent of taxpayers — whose average income is $27,800 — state and local taxes are the sixth highest nationally and, on average, account for 11.3 percent of their income. Indiana offers relatively few tax benefits for low-wage workers. Although the state offers a refundable Earned Income Tax Credit (EITC) at just nine percent of the federal credit and a refundable income tax credit for very low-income elderly filers or caretakers, it does not offer a property tax credit or a child-related credit to help offset the costs of child and dependent care.[3]

Meanwhile, the top 1 percent of households in the Hoosier State — a group with an average income over $1 million — contribute just 6.8 percent of their income in state and local taxes. Compared to the rest of the country, Indiana’s state and local tax levy on the top 1 percent is the 24th lowest (or 28th highest).

Low, Flat Personal Income Tax and High Reliance on Sales and Excise Taxes

Indiana has a low, flat personal income tax rate of just 3.23 percent for all filers with no standard deduction and personal and dependent exemptions of just $1,000. This means that many lower- and middle-income Hoosiers face the same marginal income tax rate as the wealthiest families in the state.

But having low personal income taxes comes at a high cost. To pay for state and local government services, Indiana derives 42 percent of its tax revenue from sales and excise taxes — significantly above the national average of 35 percent. As a share of statewide personal income, Indiana’s sales and excise taxes are eight percent above the national average, ranking the state 17th highest in the country by this measure. According to ITEP’s Who Pays?, the lowest-income 20 percent of Indiana households spend 7.1 percent of their income on sales and excise taxes, compared to just 1 percent of income spent on these taxes by the top 1 percent.

Indiana’s upside-down tax code is pushing the state’s impoverished taxpayers deeper into poverty. The state’s low, flat personal income tax has been a major contributor to its reputation as a “low tax state,” but it comes at a steep price as the state relies heavily on sales and excise taxes that fall hardest on low-income families. Moreover, the state’s refundable EITC and low-income credit are not substantial enough to offset the very high sales and excise taxes that it levies on families working hard to make ends meet.

[1] ITEP analysis of data from the U.S. Census Bureau and Bureau of Economic Analysis: U.S. Census Bureau. “2016 State and Local Government Finance Historical Datasets and Tables,” Sep. 12, 2018. https://www.census.gov/data/datasets/2016/econ/local/public-use-datasets.html.

Bureau of Economic Analysis. “State Personal Income and Employment,” Accessed Oct. 15, 2018. https://apps.bea.gov/regional/docs/DataAvailability.cfm.

[2] Meg Wiehe, Aidan Davis, Carl Davis, Matt Gardner, Lisa Christensen Gee, and Dylan Grundman. “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States, 6th Edition,” Institute on Taxation and Economic Policy, Oct. 17, 2018. https://www.whopays.org

[3] Aidan Davis and Misha Hill. “State Tax Codes as Poverty Fighting Tools: 2018 Update on Four Key Policies in All 50 States, Sep. 17, 2018. https://itep.org/state-tax-codes-as-poverty-fighting-tools-2018/.