Reforming Indiana Sales Taxes: Exemptions or Credits?

Indiana's sales taxes are an important reason why the state's tax system is regressive, hitting low-income families especially hard. A new policy brief on the "Fair Tax Indiana" website describes two very different policy options for making the sales tax less unfair.

One option described in the brief is the traditional one currently used by Indiana and many other states: exemptions. Exemptions allow anyone buying (for example) groceries to pay no sales tax on purchases of groceries. Because exemptions are across-the-board reductions in a regressive tax, they make the tax system less unfair overall-- but do so at a large cost because they are made available even to the wealthiest consumers. When states that have enacted a grocery tax exemption find later on that the cuts cost too much, they sometimes end up increasing the sales tax rate on all other taxable items (as North Carolina and New Mexico have done in recent years). It's hard to see why this ends up being a good deal for low-income families.

The second alternative discussed in the brief is a "refundable tax credit," which allows certain taxpayers to apply for a tax rebate. This rebates offer one very important advantage over exemptions: they can be targeted to whichever income groups or family types are deemed most in need of tax relief. The most obvious benefit of this approach is that targeted tax credits cost far less than universal sales tax exemptions.

The main shortcoming of the targeted credit approach? You have to apply for it, while exemptions are granted automatically. And as fans of the Earned Income Tax Credit now, a substantial public-private outreach program is necessary to ensure that low-income families who are eligible for these tax credits will actually apply for them.

Read the policy brief in full right here.