Gov. Mike Braun has signed the contentious Senate Bill 1 into law. This legislation was neither as good, nor as bad, as anyone claims. That is how legislative compromise works. But, there are some hidden, and probably unanticipated, economic consequences.

SB 1 cut residential property taxes. About two-thirds of Hoosier families will see cuts of under $100 per year, and about half of those will see no property tax cuts. The wealthiest third of households will see cuts of $250-$300 per year.

These residential tax cuts are very modest, but the business tax cuts are large.

The legislation raises the minimum threshold for filing business property taxes from $80,000 to $2 million, phased in over a couple of years. This will exempt the vast majority of Hoosier businesses from any property tax.

A business with $80,000 in personal property should be paying about $2,400 per year in property taxes. A business with $2 million would pay $60,000 per year. So, the new minimums will radically reduce business taxes in Indiana.

For context, a firm with $80,000 or less in personal property might be a small law firm or a plumber. A firm with $2 million would be a large restaurant or dental office. At the high end, these firms will each get a tax cut equivalent to the total cuts to maybe 400 middle class families.

But there are even bigger cuts.

When businesses buy equipment, they can depreciate it over several years, so their tax liability shrinks each year. But, under previous law, they had to continue to pay taxes on a minimum of 30 percent of the purchase value so long as they had the equipment. That ensured that there was a stable tax base.

Under SB 1, that 30-percent floor is discontinued for any equipment bought after the start of this year. In the short run, this will have very little effect on local property tax revenues. But, over the long run, say 10 to 12 years, it will devastate local government budgets in dozens of counties and cities with large manufacturing presence, like Kokomo, Gary, Elkhart, Indianapolis, and Fort Wayne.

The bill authors knew this. That’s why they exempted oil refineries, petrochemical plants and any property in a tax-increment finance district or linked to municipal bonds.

Altogether, this leaves a budget shortfall of more $1.4 billion in local government in Indiana over the next three years. Given that local government employment as a share of total jobs is now lower than it has been in 50 years, it is safe to say this is a very big cut.

However, there are two unanticipated business effects of this legislation that may not have been considered in the legislature.

The first is that raising the minimum personal property taxes to businesses with $2 million will distort capital purchase decisions in many firms. Restaurants will be careful to avoid expanding their dining areas or kitchens to bring their total capital investment over $2 million. The physician’s practice will be careful not to buy that ultrasound machine or lab equipment. The small building contractor will be careful not to buy an extra vehicle or two in fear they might slide over the $2-million tax threshold, causing a large liability.

So, SB 1 actually creates a fiscal incentive for Hoosier businesses to stay small and less efficient. I’m sure that was not the plan.

Second, the elimination of the 30-percent minimum on depreciated capital is a huge boon to the financing of workplace automation. An economic study of a similar proposal in Ohio (see https://journals.sagepub.com/doi/full/10.1177/0891242417732123) found that similarly sized tax cuts would accelerate automation of manufacturing workplaces to the tune of almost 20,000 jobs lost per year.

The effect on Indiana would probably be a bit smaller because Hoosier manufacturers already pay the fourth-lowest total tax rate in the nation. Still, if, like me, you trust free markets to optimally substitute capital for labor, there’s little good reason to accelerate the process, as SB 1 does.

The final unintended consequence falls on households.

The legislature was well aware that the combination of modest residential and very large business tax cuts places a major burden on some local governments—particularly public schools. In my county, Delaware, funding cuts will be around $335 per student by 2028. This is a large contribution to the annual funding cuts that have plagued Indiana schools annually since 2010. Despite what you may hear from overly happy budget discussions, these cuts are well documented by my research (see https://michaeljhicks.substack.com/p/educational-attainment-workforce) and that of my colleagues (see https://projects.cberdata.org/200/school-district-responses).

To account for that, SB 1 includes a provision that permits more flexibility in local government finance. This legislation permits local governments to raise their own local income tax to offset their lost property taxes. The new local income taxes can be raised by 1.8 percent to include municipal or county government, public safety and other local governments, such as schools and libraries.

I welcome increased fiscal flexibility, but it is important to know that for the typical Hoosier family, the new income tax could be over $1,250 in additional income taxes per year. The distributional effect of this tax change is the unintended consequence.

The new law cuts property taxes with disproportionate gains to families who own more expensive homes, are older than 65 and disabled veterans. As an increasingly older disabled veteran, I say thanks, but wonder why I personally merit this tax cut.

But, with large cuts to local governments that will be made up by new income taxes, we should expect most Hoosier households to ultimately see a tax increase as a result of SB 1. In contrast, almost every Hoosier business will see big cuts.

That’s not quite what was advertised. But there may be some long-term benefits of this legislative adventure.

This new legislation revealed the intellectual immaturity of the anti-property tax movement. That is a conspicuous benefit, which will be further revealed as local governments debate the implementation of the new income taxes.

SB 1 also means that every county, city, school and library district in Indiana will now have the chance to debate the value and cost of local public services. We will get to hear about the importance of schools, libraries and police to families, and how much these services cost. Some communities will choose wisely, crafting places that people wish to build their lives in. Other places will choose poorly. Then, we’ll all get to see the results.