Reforming taxes I

Maine’s state and local tax burden is either the highest in the country, or it is at the national average. Its tax system is either commendably progressive or painfully regressive. The tax burden is high because the level of taxation is outrageous, or because income levels here are too low. Year after year, legislators try to solve the riddle of Maine’s tax system but, except for some tinkering, never get anywhere because they don’t really know where to begin. In 1998, however, they did something smart that could pay off now.

In 1998, lawmakers sent $1 million to Maine Revenue Services with instructions to buy software, input data and build models to examine Maine’s tax system at a far more detailed level. One result now is a set of models that rival those of the U.S. Treasury and are matched only by the national leader, Minnesota. A second is on every lawmaker’s desk, or should be. Called the Maine Tax Incidence Study, this work shows legislators the effects of taxes on specific income groups, how corporations are paying taxes – whether, for instance, through higher prices or lower dividends – and separates taxes paid by residents from those paid from out of state, giving a more accurate picture of taxes in Maine. It’s an important improvement in the discussion around taxes.

First, some clarification. Is Maine’s tax burden the highest in the country? No, although it is certainly higher than desirable. Maine state and local tax revenues from residents, as a percent of all sources of their income, was 11.1 percent for 1998, and is estimated at 10.9 percent for 2000. That ranks Maine somewhere between 7th and 10th highest among states. A national group, the Tax Foundation, placed that burden at 13.3 percent last year and called it the worst in the country, but it missed several large tax breaks. Harvard’s John F. Kennedy School, looking at Maine’s retirement system in 1999, asked a related question from a different angle – What is Maine’s public spending relative to personal income? – and found Maine right at the national benchmark.

Are state and local taxes progressive or regressive? Depends on where one looks. Its narrow sales tax and steep rates for income tax tend toward the progressive, though prone to volatility in the case of the sales tax and annual bouts of cursing over the income tax. Municipalities are forced to rely almost solely on a particularly regressive property tax.

And which is it – are incomes too low or taxes too high? Anyone could argue that both are always true. But if Maine’s average per-capita income of $24,000 were replaced by the national average of $29,000, the tax burden would plummet – as, by the way, would the demand for some government services. Taxes need work in Maine, but low income makes the problem feel acute.

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Now, to the Capitol. The intrepid senator from Cornville, Peter Mills, is the latest lawmaker to propose an overhaul of the tax system. He offers a quick summary of Maine’s three major taxes: “The fundamental structure of the property tax has not been changed since it was cobbled together in the Constitutional Convention of 1819. Our marginal rates on the income tax are so high that no one will invest venture capital here. Our sales tax is so riddled with exemptions that it can be described as a cartoon.” (On this last tax, the exemptions have become so pervasive that Maine State Tax Assessor Anthony Neves recently listed legislative meddling as one of three reasons – along with rising purchases of services and sales by catalogue or computer – for Maine’s eroding sales-tax base. This hasn’t stopped lawmakers from proposing another half dozen exemptions this session.)

Sen. Mills would flatten the income tax, reduce the sales tax by a half penny but broaden it, exempt from tax the first $5,000 on auto sales but add a 3 percent tax to motor fuels. He would improve the Business Equipment Tax by linking it to good jobs. He would tax electricity based on fuel type. The point of these changes is to reduce volatility, shift taxes to consumption and minimize the effects on the poor. He could and should have taken the next step to find ways to let municipalities benefit from similar improvements at the local level. Taxing options there are far more constrained than at the state level.

At the end of the last recession, legislators lamented that Maine relied so heavily on just a few sectors to raise sales tax. But five years later, with no pressure to act, the problem is, if anything, worse. One-third of sales taxes comes from just two areas: auto sales and building supplies. Both were down last year. Maine is not in a recession, much less in a crisis. But it has been forcefully reminded this year through a state budget shortfall that its tax system is badly outdated and inadequate.

With the new tax study and models, however, legislators have no excuse for not examining ways to significantly improve Maine’s tax structure. They can start with Sen. Mills’ ambitious proposal.

Tomorrow: Improving local taxes.