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What’s unfair, volatile? A state tax structure that just won’t change

Dick Woodbury
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Dick Woodbury
Posted Dec. 20, 2013, at 12:40 p.m.
Last modified Dec. 20, 2013, at 1:21 p.m.

Maine’s tax structure hasn’t received a major overhaul since Gov. Kenneth Curtis reformed it more than 40 years ago. And nearly anyone you ask today says tax reform is sorely needed now. The problem is that we can’t seem to agree on what that tax reform should look like.

In a recent article in Maine Policy Review, extracted here, I analyze how alternative approaches to reform might be evaluated and structured to achieve different goals, such as progressivity, growth, revenue stability and exportability.

This last goal, exportability, is an issue I emphasize in the study. It has particular relevance for Maine, because of the many nonresidents who spend time in the state. Since some taxes are imposed on residents only, while others are collected from both nonresidents and residents, there are opportunities through tax reform to change that distribution.

Property tax relief for residents

The burden of property taxes on Maine residents is the most uneven of our major taxes. Roughly half of Maine residents pay less than 4 percent of their income in property taxes. But about 28 percent pay more than 6 percent of their income; 11 percent pay more than 10 percent of their income; and 3 percent pay more than 20 percent of their income.

Though property taxes are collected and spent locally, there are several things that the state can do to relieve property taxes.

Circuit breakers: Property tax refund programs are the most narrowly targeted approach to property tax relief, because refunds are distributed exclusively to resident homeowners who have the highest individual tax burdens. In Maine, maximum property tax refunds peaked at $2,000 in 2005 but were reduced to just $300 this year. Larger refund programs can go a long way toward equalizing the out-of-pocket burden of property taxes across resident homeowners.

Homestead exemptions: Maine law currently exempts from property taxes the first $10,000 in the value of primary homes. In a typical Maine community, that translates to a property tax reduction of between $150 and $200. Raising the homestead exemption benefits nearly all resident homeowners (relative to nonresident and commercial taxpayers). It also provides proportionally greater relief to lower-valued homes and to residents in communities with higher property tax rates.

State aid: Transfers from state revenues to municipalities and school districts reduce property taxes indirectly by requiring fewer funds to be raised locally. They are a broader form of property tax relief, because they reduce tax rates across the board (for residents, nonresidents and businesses). In dollar terms, across-the-board state aid reduces property taxes on a $1 million home by 10 times the reduction on a $100,000 home.

Under the current school funding formula, however, there is an important distinction between communities that are “minimum receivers” (where vacation homes are concentrated) and those that are not. The formula explicitly targets its funding to communities without a large property tax base from which to raise funds locally.

Choosing among these approaches to property tax relief depends on which taxpayers one aims to relieve, and by how much. There is an implicit trade-off between depth and breadth. For the same cost, one can provide a lot of property tax relief to a narrowly targeted taxpayer group, or a small amount of relief broadly distributed, or anything in-between.

A fair, competitive income tax

Maine’s new income tax formula, following tax cuts passed in 2011, has rates of 6.5 percent and 7.95 percent. In 2013, no income tax is paid by single households with income below $15,200, married couples with income below $28,400, or 4-person families with income below $36,200. The highest 7.95 percent marginal rate is paid by single households with income above $30,900, married couples with income above $59,800 or 4-person families with income above $67,600.

Three issues have dominated discussions of income tax reform. The first is the top tax rate, which is the ninth highest among the 50 states. This may discourage some individuals and businesses from locating in Maine. The magnitude of this effect, however, is a subject of considerable controversy.

The second issue is the progressivity of the income tax. By applying different income tax rates, or by phasing out income tax deductions and credits, one can achieve nearly any distributional objective. Many of the reform proposals considered in recent years have achieved progressivity with a low flat-rate tax structure, but with resident-targeted tax credits that phase out at higher income levels.

A third issue is the cost of Maine’s many tax exemptions, deductions, credits and reimbursements that have been incorporated in the system over time. In order to provide these specialized tax benefits to certain taxpayers, Maine’s tax rates need to be higher on all other taxpayers.

A broader, more stable sales tax

Maine imposes a 5 percent general sales tax (temporarily increased to 5.5 percent), a 7 percent tax on prepared meals and lodging (temporarily increased to 8 percent), a 10 percent tax on rental cars, and a 0.44 percent tax on real estate transfers. Maine also imposes an excise tax on cigarettes at $2.00 per pack, beer and hard cider at $0.35 per gallon, wine at $0.60 per gallon, and sparkling wine and low-alcohol spirits at $1.24 per gallon.

Sales and excise tax reform is usually advanced as part of an umbrella of reforms that aim to rebalance Maine’s tax system — raising those consumption taxes in order to lower income and property taxes. This rebalancing can be achieved by increasing sales and excise tax rates, or by applying sales taxes to additional products and services that are currently tax-exempt.

As the composition of consumer purchases has evolved over time to include more services, advocates of reform contend that the sales tax base should also expand. They also emphasize the volatility of revenues that results from a narrower tax base. According to a 2007 survey by the Federation of Tax Administrators, Maine appears to have a sales tax base that is narrower than that of most states, taxing 25 of the categories in the survey, compared with 55 at the median (among states with a sales tax), and up to 160 at the extreme.

Examples of sales that are currently exempt from taxes in Maine are recreational services such as golf, skiing, movies, amusement parks or concerts; repair services such as for cars, lawn mowers or appliances; personal property services such as dry cleaning, rug cleaning, car washing, picture framing or storage; or personal care services such as hair cutting, beauty salons and massage.

‘Exporting’ the tax burden

As noted, we have a large nonresident presence in Maine. About 15 million tourists visit Maine annually. We have the highest percentage of second homes of any state in the country. And we have sizable numbers of nonresident retirees in Maine, some of whom spend as much as five or six months per year in the state.

Nonresidents who spend time in Maine are generally exempt from state income taxes, often reside in high-valuation regions with low property tax rates and devote a large portion of their spending in Maine to purchases that are exempt from sales taxes.

By taxing consumption more universally and more heavily, the state can allocate the tax burden in rough proportion to the amount of time people spend in Maine, rather than whether they are defined as residents or nonresidents. The revenues from consumption taxes, which are imposed on both residents and nonresidents, can then be directed to income tax and property tax relief that benefits Maine residents almost exclusively.

Each of the comprehensive tax reform proposals of the last decade has clearly emphasized the goal of exporting more of Maine’s taxes to nonresidents.

Few would argue that the failure of comprehensive tax reform over the last decade is an indication that Maine’s tax system is perfectly structured as it is now. But crafting a tax reform package that we can agree makes sense remains an elusive goal.

Sen. Richard Woodbury, a Yarmouth independent, has served five terms in the Legislature. The complete version of this article first appeared in Maine Policy Review, published by the University of Maine’s Margaret Chase Smith Policy Center, and can be found at digitalcommons.library.umaine.edu/mpr.

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