New Tax Study Shows Limited Progress

New Tax Study Shows Limited Progress

May 3, 2011 Posted by J. Scott Moody - No Comments

Yesterday, Mainebiz ran a story on a new study showing Maine’s tax competitiveness as the best in the nation published jointly by Ernst & Young and the Council on State Taxation called the “Competitiveness of State and Local Business Taxes on New Investment.” To be sure the specifics of this study are good news for Maine’s economy; unfortunately, the limited scope of the study does not foretell a turnaround in Maine’s overall business climate or the economy.

First, the good elements from the study:

  • Maine uses a single sales factor corporate income apportionment formula.  While Maine’s corporate tax rate is higher than average (8.93% in Maine compared to 6.7% nation-wide), Maine’s favorable income apportionment regime more than offsets the rate differential for the hypothetical investments included in the competitiveness index.
  • Maine has an average property tax rate.  Maine’s real property tax rate (in Portland) is 1.69% compared to a national average of 1.97%.  Personal property tax rates in Maine are slightly above average at 1.77% compared to ta national average of 1.65%, but new equipment is exempt from the property tax and any local property tax paid on qualified equipment is refunded through the Business Equipment Tax Reimbursement Program.
  • Maine has no franchise tax.
  • Maine’s combined state and local sales tax rate is one of the lowest in the nation (5% compared to a national average of 6.2%).

Now for the limitations/caveats:

First, and most importantly, the overall scope of the study is limited to C-corporations.  As such, the study does not take into account the effects of the individual income tax on other types of businesses such as S-corporations, LLCs and sole-proprietorships.  Since Maine’s business community is more reliant on smaller businesses, the importance of C-corps is smaller relative to other forms of businesses.

In fact, according to data from the Internal Revenue Service (IRS), C-corps, in 2008, only represented 25 percent of C- and S-corp returns in Maine.  The IRS also projects that by 2016 that C-corps will fall to 20 percent of all corporate tax returns.  As a result, S-corps not only represent the bulk of corporate returns in Maine but also a growing share as well.

Maine Business Tax Returns by Type

Secondly, the sales tax portion of the study gives Maine a boost in their rankings for two reasons:

  • Secondly, the study rightfully discusses the negative economic consequences of the sales tax on business-to-business transactions, a.k.a., tax pyramiding.  Ironically, the “narrowness” of Maine’s sales tax helped in this case because 3 of the 5 representative firms used in the study are service oriented.  And, if the so-called tax reform package had become law it would have likely hurt Maine’s ranking in this study because it would have extended the sales tax to more services (a negative in this study) while lowering the individual income tax rate (not measured in this study).  So policymakers should be wary of calls to extend the sales tax to more goods and services.

Finally, a few other points:

  • The study rightfully gives praise to the corporate single sales apportionment factor.  This means that a corporation only pays taxes on the sales generated within the state–this minimizes the impact of taxation on the location decisions of the business itself.  However, Maine’s combined reporting requirements erodes the value of the apportionment factor by effectively taxing out-of-state income.  Unfortunately, the study does not factor in combined reporting requirements which would hurt Maine’s ranking.
  • The study does not factor in tax compliance costs.  This is a particularly important angle at the state-level where some states don’t have all of the same taxes.  For example, New Hampshire does not have an income or sales tax which dramatically lowers tax compliance costs vis-a-vis Maine and other states that do have one or both.  My research has found that Maine’s sales tax is particularly burdensome to small businesses in terms of tax compliance costs.

Given these limitations/caveats, this study by itself is not enough evidence for Maine policymakers to pat themselves on the back and do nothing.  There is still much more work to be done, especially for the vast majority of businesses that file through the individual income tax code.  A first step would be to fully conform the income tax code to the federal code allowing businesses to take advantage of Section 179 expensing and bonus depreciation (conformity would also lower tax compliance costs).