There have been a lot of Op-Ed pieces about Indiana’s tax system these past few weeks. A common theme is that our tax system is hard to understand and full of unnecessary complexities. There was a time when I too worried excessively about the intricacy of the tax system. But that was when I was younger, knew less about the world and expected simple answers to all the world’s problems. Now that I am a bit older, know a bit more about tax and spending and have come to expect that simple answers are usually only helpful for simple problems, my concern for state taxes has abated. Here’s why. 

The real angst about taxes (which has appeared in papers statewide over the past few weeks) is about the difficulty in understanding how the system works and how different taxes do different things. This is mostly misplaced worry. 

There is some truth to tax complexity, but it lies only in the completion of forms, not the administration of taxes. The complexity of the tax system reflects the complexity of economic life. A more simple tax system would be as unfair (by that I mean in distorting taxpayer behavior) as any combination of taxes currently around in the U.S. Let’s take Indiana as an example. 

Hoosiers pay income, property, sales and use taxes along with assorted fees. Most all our transactions involve taxation of some sort. Let’s review some basic principles.

Higher taxes cause people to do less of the activity. In economic jargon, this means they act as a disincentive to all things from working harder to buying a more expensive house. However, the level of distortion changes both with the type of item taxed and the rate of the tax. 

Generally, the lower the tax rate, the less consumers care about taxes. Also, the more important the item is to us, the less tax policy alters our purchasing patterns. So, a 7% sales tax rate is less than half as distortionary as a 14% sales tax rate. And, we care less about taxes on insulin than we do about taxes on soda pop. 

Taxes also affect folks in different times of their lives. Retirees, who spend more proportionately on food and travel but make less money, may favor income taxes over property taxes. While younger workers, who make more income, but have less valuable homes may prefer property taxes. (This might also speak to the demographics of the property tax debate). 

Different types of taxes also affect government administration. Property taxes in particular focus tax revenues to the locations where costs are incurred (the household). Nothing holds government accountable like local property taxes.

To economists, the mantra is “broad tax, low rate.” To do this requires many different tax instruments that reflect the complexity of our free markets. Calls for a simple “flat tax” or simple tax policies are too good to be true.