Indiana has caps on property taxes. This year the caps
reduced property taxes by about $768 million or 11 percent.
And the state has local option income taxes that counties
adopt to reduce property taxes some more. All counties now have local income
Common sense says that when a county adopts a tax-relief
income tax on top of tax-reducing caps, taxes will be even lower – but wrong
again, common sense!
Sometimes the combination of tax caps and local option
income taxes can increase total tax bills and local government revenues. It’s
the paradox of LOITs.
Here’s what happens: Property taxes are capped at 1 percent
of gross assessed value for homeowners, 2 percent for other residential housing
– such as rentals or vacation homes — and farmland, and 3 percent for business
property. Gross assessed value is the estimated market value of most properties
before deductions are subtracted.
Local governments set their tax rates at the end of the
budget process. If the rate results in a tax bill higher than a property’s cap,
a tax cap credit is applied to reduce the bill to the cap amount.
Here’s the key fact: The tax cap is the taxpayer’s last
defense against high tax bills. All deductions and credits are subtracted before
the tax cap credit is applied. This includes the credits from local option
Indiana’s LOITs apply to Indiana taxable income, the same as
the state income tax. When a county adopts a LOIT for property tax relief, the
income tax rate increases, and then the property tax bill is reduced by a LOIT
credit. The income tax revenue replaces this lost property tax revenue for local
Counties can distribute tax relief in three ways or in
combinations of the three. On average, across the state, if the LOIT is adopted
at 1 percent and the relief is offered only to homeowners, the homestead credit
will be about 51 percent.
If the county distributes the relief to all residential
property, the credit averages 31 percent. If it goes to all property, the credit
averages 17 percent.
Consider a homestead valued at $200,000 and a property tax
rate of $3 per $100 assessed value at 3 percent. Deductions usually would
subtract $102,250, leaving taxable assessed value of $97,750. The tax bill would
But taxes are capped at $2,000, which is 1 percent of the
gross assessed value. The taxpayer gets a credit of $933 and pays $2,000. That
$933 credit is lost revenue for local governments.
Now suppose the county adopts a local option income tax at 1
percent and distributes the tax relief to all property. The LOIT credit is 17
The tax caps come at the end of the tax bill calculation, so
the 17 percent credit applies to the tax bill of $2,933. That’s a credit of
$499, and the remaining property tax bill is $2,434.
The tax cap still is $2,000, but the tax cap credit now is
only $434. This homeowner pays the same capped property tax bill, even after the
But the homeowner pays the local income tax, too. Most
people who own $200,000 houses also have Indiana taxable income, so they’ll pay
more income tax with the added 1 percent LOIT rate.
An income tax designed for property tax relief has increased
total property plus income taxes. Paradox explained.
Taxpayers with lower-valued property or with lower property
tax rates will see the full tax reduction and may pay less in total taxes.
Taxpayers with property at the caps don’t see the full tax reduction because the
LOIT credit substitutes for the tax cap credit.
But all of the income tax revenue still is distributed among
the county’s local governments. Put another way, the LOIT credit reduces the
property tax revenue lost from the tax cap credits. Local government receives
It’s hard to say if this is what the General Assembly
intended, since the LOITs were invented before the tax caps. One of the reasons
for LOITs, though, was to shift local taxes away from property and toward
Local governments know that LOITs can reduce their tax cap
revenue losses. That’s an incentive to adopt. And that shifts taxation toward
income, which is what many legislators had in mind.