Gov. Paul LePage railed against the two-year state budget that took effect July 1 for a number of reasons. Chiefly, though, the Republican governor vehemently objected to the budget’s temporary sales, meals and lodging tax hikes.
“I don’t know how you recover from a tax increase when you’re one of the worst states to do business in,” LePage told reporters last month after the House and Senate overrode his budget veto. He says he’ll propose legislation in January to repeal those tax hikes.
While he opposed it, LePage can claim some tax policy successes in the budget that passed the Legislature. Republican-championed income tax cuts passed in 2011 that lowered the state’s top income tax rate remained in place over objections from majority Democrats.
But the high-income earners who benefit most from those tax cuts will see part of their benefit disappear due to a tax provision in the new budget that LePage himself proposed. The new budget will limit the value of deductions taxpayers can subtract from their taxable income to $27,500 — a change that falls disproportionately on high-income earners.
The cap on deductions raises about $65.1 million for state coffers over the next two years, but the state budget uses most of it to pay for the state to conform with new provisions in the federal tax code.
According to a Maine Revenue Services analysis, the top 1 percent of taxpayers — who earn more than $326,000 — will see their 2014 state income taxes rise $1,483 on average due to the LePage-proposed changes. That $1,500 increase will take away from an average $3,021 tax reduction from the 2011 income tax cuts.
“From the administration’s point of view, it’s a revenue-neutral proposal,” said Michael Allen, the state’s associate commissioner for tax policy. “There’s a large number of people getting tax cuts, and there’s a small number of people getting a tax increase.”
Overall, more than 12,000 Maine tax filers — most in the top income brackets — will see their taxes rise due to the cap on deductions and conformity with the federal code, according to Maine Revenue Services. Some 175,000 taxpayers will see their taxes fall. The remainder are unlikely to see any change.
$45 million to conform
As the U.S. Congress struck a deal in the opening hours of 2013 to avoid the fiscal cliff — when a range of tax breaks were set to expire, and steep government spending cuts were to take effect — lawmakers made an array of changes to the federal tax code.
The American Taxpayer Relief Act increased the standard deduction amount for married couples filing joint tax returns, extended deductions teachers can claim for paying classroom expenses out of their pockets, made more interest paid on student loans tax-deductible and allowed businesses to continue depreciating the value of certain property for tax purposes.
Maine’s state tax code has traditionally conformed with much — but not all — of the federal code, meaning taxpayers can claim many of the same deductions on their state tax return that they claim on the tax return they submit to the Internal Revenue Service.
But for each deduction taxpayers are allowed to claim, the state forgoes revenue because it’s able to tax less income. That’s revenue the state needs to make up by raising it elsewhere or cutting spending. In 2014, when Maine removes the marriage penalty from its tax code, it’ll cost the state about $20 million annually in revenue, according to Allen. To be sure, that’s $20 million more taxpayers will keep in their pockets.
But all told, conforming Maine’s tax code with the federal code will cost the state $44.9 million in lost revenue over the course of the two-year budget cycle, according to Maine Revenue Services.
“In order to conform, there had to be a pay-for,” Allen said.
$27,500 in deductions
That’s why the LePage administration proposed — and lawmakers agreed — to cap deductions at $27,500 for those taxpayers who itemize deductions on their tax forms. The state previously had no deduction cap. Maine has traditionally adhered to federal rules, which set limits for individual deductions and lower the combined value of deductions for some high-income earners.
According to the IRS, about 31 percent of Maine tax filers in 2011 itemized their deductions, choosing to individually subtract mortgage interest, charitable contributions, business costs and other expenses from their taxable income rather than opting for the $5,800 standard deduction.
The IRS data show 91 percent of Maine taxpayers in the highest income categories — adjusted gross income of $100,000 and more — itemized their deductions. The lower the income, the less likely taxpayers were to itemize their deductions. Just a quarter of those in the $25,000-$50,000 income range, for example, did.
Since higher-income residents are more likely to itemize their deductions, they’re most likely to run into the $27,500 cap on deductions that will be in place when they prepare their state tax returns next year.
“Certainly, upper-income households are getting other benefits” from the 2011 tax cuts, Allen said. “This is going to eat into those benefits a little bit, but, overall, they’re still getting a tax cut.
“It was basically putting a tax increase on 12,000 upper-income households to give a tax cut to 175,000 lower- or middle-income households.”
A cap pioneer
At the federal level, policymakers have proposed caps on tax deductions for years as a way to reduce budget deficits while avoiding the political landmine of singling out particular deductions — the mortgage interest deduction, for example, which is sacrosanct for the real estate industry — and removing them from law.
President Barack Obama’s pending budget proposal for fiscal year 2014 proposes capping deductions as a way to recapture some of the estimated $1 trillion the federal government gives up in revenue through so-called tax expenditures.
Before Obama took office, according to a recent report from the Tax Policy Center, an advisory panel on tax reform appointed by President George W. Bush in 2005 came out with a recommendation to eliminate the deduction taxpayers can claim for paying state and local taxes and proposed reining in deductions for mortgage interest. Those recommendations never became law.
At the state level, deduction caps have been even rarer. Aside from Maine, it appears North Carolina is the only other state to institute an aggregate cap on itemized tax deductions.
North Carolina’s $20,000 cap — passed this week as part of a larger, Republican-backed tax reform package — has non-profit organizations and realtors concerned the cap will discourage charitable contributions and home ownership, respectively. The tax reform legislation also lowers personal and corporate income tax rates to some of the lowest levels in the Southeast.
In Maine, LePage’s move to cap tax deductions is winning plaudits from the left. Joel Johnson, an economist with the left-leaning Maine Center for Economic Policy, said the deduction cap is a “step in the right direction.
“Although it’s a step in the right direction,” he said, “it’s only a small step, and a lot more needs to be done to raise revenues from high-income households to make the tax code more fair and to relieve the burden on low- and middle-income households.”
Matthew Stone is the BDN’s opinion page editor.