my article this morning in the Wall Street Journal on Indiana property taxes

Indiana Tax Fight

By D. ERIC SCHANSBERG
July 28, 2007; Page A8

INDIANAPOLIS -- On July 4, hundreds of tax protestors showed up in front of the governor's mansion here. They've been back several times since. As a result, Gov. Mitch Daniels has been scrambling and the city's mayor has ordered a hiring freeze and a 10% cut in his budget. There have even been calls for a special session for the legislature and even a state constitutional convention.

Runaway property taxes are an issue wherever property values have shot up in recent years. But now Indiana may be at the forefront of a homeowner rebellion against a tax system that has come to be seen as arbitrary, unfair and unpredictable. What's driving this angst is the first reassessment of property values in six years. In Marion County (the city of Indianapolis), average property taxes increased by 34%. Across the state, the average increase is 24%. Many homeowners' bills have increased much more.

One thing that is really stirring anger: Marion County businesses mostly avoided an increase this year, while almost all homeowners got nicked. To cool tempers, Mr. Daniels, a Republican, ordered another reassessment. In the meantime, there will be a property tax freeze in Marion County, delaying increases for at least six months. He has also given counties a few months to rethink whether they'd like to increase local income taxes to offset the need for higher property tax revenues. And taxpayers will now be able to pay their property taxes on an installment plan.

All of this is a nice start. But none of what the governor has done so far gets at the underlying problem: Taxing property at a value that periodically increases can stick homeowners with a surprisingly high bill. The system punishes those who made smart (or lucky) decisions with their home purchases and can force people out of the neighborhoods they've raised their families in.

Property taxes also, at the margin, lower property values. Retired Indiana University economist Morton Marcus calculates that for every $1,000 increase in property taxes, the value of a home falls by almost $12,000. Moreover, high and uncertain property taxes make it more difficult to attract workers and capital investment to the state.

Gov. Daniels should not be singled out for hoping that a quick fix will do the trick. House Speaker Patrick Bauer, a Democrat from South Bend, wants to use some of the state's budget surplus to issue qualified homeowners a tax rebate. But the state is already scheduled to implement another band-aid (thanks to Mr. Bauer's leadership last year): paying out some $300 million in property tax abatement. Indy Mayor Bart Peterson, also a Democrat, wants to borrow $75 million to pay for cutting property tax increases. And he has proposed to hike local income taxes by 65%.

Perhaps the most promising short-term fix being considered would accelerate a "circuit breaker" to cap a total property tax bill at 2% of a property's assessed value. The legislature passed this last year, but didn't schedule it to go into effect until next year. Implementing it a year early could mitigate the current crisis.

But politicians may not be able to finesse their way out this time. They've been tinkering with the system since 1973, when lawmakers faced similar problems with property taxes and tried to fix them by, for example, allowing local governments to impose income taxes and doubling the state's sales tax. Indiana's property tax may be so flawed -- and the public sufficiently cynical -- that changes to the system may not gain necessary public support. The best option might be to toss the property tax out the window and replace it with higher income, sales or consumption taxes.

This would dismantle an unwieldy system where some 1,008 town assessors evaluate property values and pass their assessments on to 92 county assessors, who then pass their assessments to state officials. Property taxes are, of course, useful in that they provide a stable and independent revenue source for local government. They are also highly visible, and remind homeowners how big a bite they take, because they are paid only once or twice a year -- unlike income taxes, which are automatically deducted from regular paychecks.

Nevertheless, the public backlash is producing some interesting political results. Mayor Peterson faces voters in the fall, which may explain why he has reacted so swiftly. Speaker Bauer wants to protect a slim majority in the House after next year's elections, which may explain why he's eager to put his name on tax rebates for homeowners.

For his part, Mr. Daniels has called on his staff to brainstorm for ideas, has encouraged them to meet with affected people, and is weighing whether to call the legislature back into town to enact reforms. He has expressed interest in eliminating the property tax. And he seems quite interested in another significant issue -- reducing the number of local governments in the state. Indiana has 2,730 local taxing authorities. Eliminating some of these may improve efficiency and therefore reduce property taxes, but the history of government consolidation is not encouraging.

Mr. Daniels is favored to win a second term as governor next year. But if he's not careful, he could stumble. Eric Miller, Mr. Daniels's 2004 primary opponent and a vociferous property tax opponent, might be tempted to challenge him again. And a set of seemingly weak Democratic challengers could suddenly become competitive against a governor unable to handle such a thorny issue.

Will Mr. Daniels play it safe on property taxes or work for significant change? Now that the public has spoken, will Mr. Daniels listen?

Mr. Schansberg is a professor of economics at Indiana University (New Albany), an adjunct scholar for the Indiana Policy Review and the author of "Turn Neither to the Right nor to the Left: A Thinking Christian's Guide to Politics and Public Policy" (Alertness Books, 2003).