Senate Enrolled Act 436 passed the General Assembly on the last day of the session, April 29, 2015. The vote was unanimous in both houses. The bill was signed by the Governor as Public Law 249 on May 6. The bill made many changes to property tax procedures. For agriculture, the most important change was the method used to calculate the base rate of farmland for property tax assessment.

Surging Farmland Taxes with the Old Formula

The base rate is the dollar figure per acre set by the Indiana Department of Local Government Finance (DLGF) each year. It’s the starting point for the assessment of farm acreage for property taxes. The base rate has increased from $880 per acre in 2008 to $2,050 per acre for taxes this year, and was projected to rise above $3,000 per acre for taxes in 2018. These assessment increases caused a 47% increase in total agricultural property taxes during this period, at a time when total property taxes were falling by 6%.

The base rate has been calculated using a capitalization formula, which divides the net income from an average acre by a rate of return. The big base rate increase was due to rising corn and soybean prices and rising rents, which increased net income in the numerator of the formula, and due to falling interest rates which reduced the rate of return in the denominator. The data entered the formula with a four-year lag—meaning data from 2006 through 2011 were used to calculate the base rate for taxes in 2015. Purdue Agricultural Economics Report articles from April 2015 and August 2014 explain the workings of the capitalization formula in detail. See, https://ag.purdue.edu/agecon/Documents/PAER.Ap ril.2015.pdf.

Slower Increases with the New Formula

The General Assembly addressed the farmland assessment problem in SEA 436. Here’s the text: SECTION 7. IC 6-1.1-4-13.2 is added to the Indiana code as a new section to read as follows:

When the legislature starts a bill with “notwithstanding,” it means that the new law replaces any previous laws or regulations. In this case, the act says (twice) that this new rule replaces the existing guidelines of the DLGF. The base rate capitalization formula will be replaced.

The act mentions the 2015 assessment date. That’s the base rate for taxes to be paid in 2016. Likewise, the 2016 assessment date is for taxes paid in 2017. We often use the phrase 2015-pay- 2016 to keep this straight. The changes in this act take effect for taxes paid in 2016.

The base rate will be $2,050 for taxes in 2016. That’s the same base rate being used for taxes this year, 2015. The base rate will be frozen for one year.

A new formula will be used for taxes in 2017 and for every year after that. The act as passed and signed makes a permanent change in the base rate formula.

The percentage increases in the base rate for taxes in 2017 and after will be based on the assessed value growth quotient (AVGQ). This is the six-year average of Indiana non-farm personal income, with a two-year lag. The AVGQ determines the annual increase in the maximum property tax levy for most local government funds.

The calculation excludes farm income in order to lessen big swings in maximum levy percentage changes. Farm income is more variable than other income. Using the AVGQ means that farmland assessments will be based on non-farm income. Of course, sometimes the farm and non-farm economies perform very differently.

For 2016 the AVGQ is expected to be 2.5%. After that the negative income growth rate from the recession year 2009 will drop out of the formula, and the AVGQ will be closer to 4% per year.

So, the base rate will be unchanged for taxes in 2016, and will increase by about 4% per year for taxes in 2017 and after.

Comparing Old and New Formulas

The figure shows projections of the results of the two base rate formulas for 2015 to 2025. Later we explain the methods and sources for these projections. Of course, no one knows what will happen to prices, rents, interest rates or incomes over the next ten years, but these projections are based on the best estimates currently available. The results offer some idea of how the two formulas differ.

Under our estimates, the base rate per acre from the old capitalization formula continues to rise until 2019 when it is projected to peak at $3,090. After that, the lower prices starting in 2013 and the estimated lower rents and higher interest rates starting in 2015 begin to enter the formula. The base rate begins to fall in 2020. By 2025 it’s projected to be back near its value in 2011, at $1,340.

The new AVGQ formula increase is estimated to be between 3.9% and 4.5% per year from 2017 to 2025. Note that these are ​long term projections of average income growth. No one tries to predict recessions so far in advance. In 2018 the AVGQ base rate is projected to be $2,219, 27% less than the capitalization projection of $3,050. However, the AVGQ base rate keeps increasing—the AVGQ has always been a positive number. In 2021 the two formula estimates meet at $2,500. After that, the AVGQ base rate is projected to be higher than the capitalization base rate. It is important to note that the act does not say “choose the lower base rate from the two formulas.” Rather the AVGQ “replaces” the capitalization formula. Thus, sometime in the early 2020’s, the AVGQ is anticipated to move base rates higher than if the capitalization formula had stayed in place.

Impact on Farmland Property Taxes

The Indiana Legislative Services Agency estimated in its fiscal note for SEA 436 that the switch to the AVGQ base rate formula will reduce farmland property taxes compared to what they would have been by $52.4 million in 2016, $86.5 million in 2017 and $111.1 million in 2018—a three year total of $250 million. So, farmland taxes will be lower compared to what would have happened under the capitalization formula for the next three years! However, it is important to note that the act does not reduce current farmland tax bills. It does mean that under the new formula, farmland property taxes will not rise rapidly, as they have in recent years, but farmland property taxes will not fall.

Under the AVGQ formula for the next several years, assessed values will be lower than they would have been. This means tax rates will be higher than they would have been. And, that means that the tax bills of other taxpayers will be higher. The LSA estimates that homeowners will pay $92 million more than they would have over the years 2016 to 2018. Tax rates will rise more where farmland is a larger share of the tax base, so the tax shifts will be greater in rural areas. In addition, higher tax rates mean that more taxpayers will be eligible for credits under the tax caps. Tax cap credits are lost revenue for local governments. LSA estimates the total revenue losses for 2016-18 at $67 million.

Real people won’t be comparing their tax bills to what would have happened under an alternate formula. That’s for policy analysts. Real people look at their tax bills year to year. For taxpayers under the AVGQ base rate, instead of big increases in farmland taxes and smaller increases (or decreases) in homeowner taxes, there will be similar increases in the taxes on all kinds of property.

In 1999 the Indiana Supreme Court issued a decision that defined the Constitutional assessment standard as “objective measures of property wealth.” Capitalization is a recognized method of measuring the value of assets. The AVGQ formula is not. We won’t know whether the AVGQ formula is Constitutional in Indiana until there is a court case that ask the courts to make that evaluation.

The act makes the change to the AVGQ formula permanent, but at least some members of the Indiana General Assembly must think this is not the final word. Section 35 of SEA 436 reads:

The topic has been assigned to an interim study committee. There likely will be hearings about farmland assessment in the State House during the summer and fall of 2015.

How We Estimated Farmland Base Rate Estimates to 2025?

For the projection of the farmland base rate using the capitalization formula we used long-term forecasts from the University of Missouri’s Food and Agricultural Policy Research Institute (FAPRI) publication, U.S. Baseline Briefing Book: Projections for Agricultural and Biofuel Markets. The publication includes forecasts for price, yield and variable costs by crop from crop year 2014/2015 to crop year 2024/2025. These figures for corn and soybeans are included directly into the capitalization formula.

Estimates for Government Payments

In recent years, price or revenue safety net government programs in most cases have not been triggered for corn and soybeans. Only direct payments have entered the capitalization formula. However this changed with the 2014 Farm Bill. Direct payments are no longer used and in their place are basically two alternatives for farmers: Average Revenue Coverage and Price Loss Coverage. FAPRI has estimated the adoption rate for the two different programs both in corn and soybeans as well as the payments under each program over the next ten years. A weighted average based on the forecasted adoption rate of the two different programs was calculated for both corn and soybeans each year to estimate the government payments received for the capitalization formula. The corn and soybean average payments were then averaged to come up with an average total government payment for the given year.

Overhead Costs

Aside from a few outlier years, overhead costs have risen on average by 3% per year. This growth rate was used to forecast the overhead costs through 2025.

Cash Rent

The cash rent number used in the capitalization formula is the average cash rent for the state as reported by the Purdue Land Value and Cash Rent Survey less DLGF’s estimate of the average property taxes per acre. To come up with this value we projected rent and average property tax separately.

For cash rent, we used Purdue’s Michael Langemeier’s projections for a west central Indiana farm taking the projected change in the west central Indiana cash rent and applying it to the state average.

For property taxes per acre, we ran a simple regression of the base rate on the property taxes per acre as estimated by DLGF. This equation was then used to estimate the property taxes per acre through 2025. The forecasted cash rent less this property tax estimation was used in the capitalization formula.

Capitalization Rate

The average farm real estate and farm operating interest rates are closely correlated with the ten-year Treasury bond rates. In January 2015 the Congressional Budget Office projected the ten-year Treasury rate will reach its long-term level of 5.0% in 2019. On average during 1993-2014, the farm rate exceeds the ten-year Treasury rate by 2.8 percentage points. We assume that the long-term farm rate will be 7.8%, that this rate will be reached in 2019, and that it will rise by annual six-tenth increments from 2014 to 2019.

Indiana Non-Farm Personal Income

The assessed value growth quotient (AVGQ) is based on the 6-year average of annual Indiana non-farm personal income growth. Non-farm income forecasts for Indiana were not available, so total income forecasts were used. Real Indiana income growth for 2015-17 was taken from the Indiana State Budget Agency’s April 2015 Indiana budget forecast. Long run real income growth for Indiana was estimated at 2.15% per year by the State Utility Forecast Group in 2013. Nominal personal income growth is the sum of real growth and inflation. Inflation rates were taken from the Congressional Budget Office’s ten-year economic projections from January 2015.