Tax Reform Bill is Too Flawed to Become Law
Read the full report | The June 8th referendum on LD 1495—Maine’s recent tax reform bill—will allow Mainers the opportunity to decide on the merits of the tax reform bill. Unfortunately, like many pieces of legislation today at both the federal and state level, the tax reform bill is a very large and complex piece of legislation that has kept a small army of economists, CPAs and lawyers very busy since its enactment nearly one year ago. Many of Maine’s citizens now find themselves confronted with deciphering this tax reform bill for themselves.
In response, this report will shed light on a few of the major flaws in the tax reform bill using a simple “Myth-Fact” presentation. Overall, too many flaws have been discovered in this tax reform bill to allow it to become law. Rather than subject Maine taxpayers—both individuals and businesses—to the pains of learning and adjusting to a radically altered tax code with few real economic benefits; it would be best to simply scrap it and start over.
MYTH: Tax Reform will lower the tax burden on Mainers.
FACT: The tax reform bill is actually a small, net tax increase on Mainers. The idea of “exporting” taxes to tourists is more hope than reality.
All of the tax reductions in LD 1495 come from an extremely strong assumption that businesses will simply pass the cost of the higher sales tax onto tourists or other folks from away. For businesses to pass on the cost, they will have to raise prices. Of course, this begs the question that if they can raise prices to offset the higher sales tax then why didn’t they raise prices before? Put simply, businesses couldn’t raise prices before and they won’t be able to raise prices to offset the higher sales tax. As a result, it will be business owners and their employees who ultimately bear the burden of higher sales taxes—Mainers in other words.
Yet, don’t just take out word for it. Consider this statement from the Brooking Institution’s nationally recognized tax expert Dr. William G. Gale, and Dr. Kim Reuben of the Urban Institute:
“Tax exporting occurs when state and local governments impose tax burdens on non-locals. This cannot be directly because of the interstate commerce clause in the Constitution . . . Viewed from the perspective of effective tax policy, taxes on narrowly defined goods whose benefits are not connected to the payer of the tax, remain both inefficient and inequitable. Broadly speaking, tax exporting is a ‘beggar thy neighbor’ policy; all localities would be better off in the absence of such policies.” [1] [emphasis added]
MYTH: The income tax rate will fall to 6.5 percent from 8.5 percent.
FACT: The advertised 6.5 percent income tax rate is an illusion. The 1.5 percent phase-out of the new household tax credit means most Mainers will pay at an 8 percent rate, not 6.5 percent.
Under LD 1495, the household tax credit takes the place of the current deductions and exemptions. For a family of four, the total household credit is worth $2,200 ($1,200 as a married filing jointly taxpayer and another $250 per person). This means that this household will pay no income taxes until their tax liability exceeds the $2,200 household credit—which occurs around $34,000 of income.
Unfortunately, the household tax credit phase-out reduces the credit by $15 for every additional $1,000 earned (a 1.5 percent rate) over $55,000 (for a married, filing jointly taxpayer). As a result, if the household earns another $1,000 (to $56,000), they will pay an additional $65 in taxes (6.5 percent of $1,000) and lose $15 of their $2,200 household tax credit (now worth $2,185). Combined, this amounts to an increase in their tax liability of $80 equaling an Effective Marginal Tax Rate (EMTR) of 8 percent ($80 divided by $1,000). The 8 percent EMTR nearly wipes out the income tax benefits of LD 1495 for many Mainers .
Additionally, a 0.35 percent tax surcharge exists on income earned over $250,000 which further undermines the so-called 6.5 percent flat tax rate.
MYTH: A lower income tax is worth the price of higher sales tax.
FACT: The sales tax is a small business and jobs killer. Maine needs lower overall taxes, not a gimmicky shift of one tax into another.
A recent report by the Council on State Taxation had this to say about Maine’s current tax structure prior to the tax reform bill to increase sales tax collections:
“Origin based taxes, such as the property tax and sales tax on business input purchases, which are more important in businesses’ location decisions than destination-based taxes, vary significantly as a share of total business tax. Arizona, Maine, Michigan, South Dakota and Washington generate more than 70 percent of business taxes from the sales and property taxes, resulting in significant taxes on business capital located in the state.” [3]
The sales tax is particularly damaging because taxing business input purchases leads to “tax pyramiding” which is paying a tax on a tax. For example, suppose a baker purchases flour to make bread and pays sales taxes on the flour. The baker then prices the bread which includes the added cost of the sales tax. A customer then buys the bread and pays the sales tax again. The end result is that the customer has paid a tax on a tax since the price of the bread included the sales tax paid on the flour.
However, as noted previously, it is doubtful that the baker would in fact be able to pass the higher costs onto the customer. Instead, he may have to reduce staff or cut their pay. For the economy as a whole, this would mean fewer jobs or lower pay as a result of applying the sales tax to business inputs.
Additionally, businesses will have to contend with higher sales tax compliance costs. A previous study found that Maine businesses will spent 9.34 cents in sales tax compliance costs for every dollar in sales taxes collected.[4] The reason for such a high compliance cost is because Maine’s economy is dominated by small businesses who are the least capable of dealing with such costs.
MYTH: LD 1495’s limitation of the “household credit” to Maine residents passes constitutional muster.
FACT: This limitation violates the United States Constitution on several counts. If challenged in court, it would be struck down in whole or in part. Here’s why:
Commerce Clause
The Commerce Clause of the United States Constitution gives Congress the exclusive power to regulate commerce among the states. At the same time, states are prohibited from enacting laws that impose undue burdens on interstate commerce. The United States Supreme Court has labeled State laws that burden interstate commerce by giving local, in-state entities an explicit advantage “virtually per se invalid.” LD 1495 impermissibly burdens interstate commerce by limiting the household credit to Maine residents and thereby creating a tax penalty for out-of-state employees who earn a living in Maine. Because the benefit of the credit is limited to Maine residents, a court would strike down the law as unconstitutional.
Privileges and Immunities Clause
Also found in the United States Constitution, the Privileges and Immunities Clause generally prohibits a state from denying to non-residents the same benefits it provides to its similarly-situated residents. This provision precludes a state from imposing higher tax rates or taxes on non-residents than it imposes on residents. For example, in the 1970s, New Hampshire imposed an income tax on out-of-staters who commuted to work in New Hampshire. By contrast, New Hampshire imposed no income tax on its own residents. A Maine resident working in New Hampshire challenged the tax and the United States Supreme Court ruled that it denied non-residents the “substantial equality” required by the Privileges and Immunities Clause. The effect of New Hampshire’s “commuter tax” on non-residents is very similar to the effect of Maine’s household credit and it is therefore likely that a court would give LD 1495 short shrift as well.
Equal Protection Clause
This clause of the United States Constitution prohibits a state from denying a class of people “the equal protection of the law.” Although courts give states much leeway in creating tax classifications, courts pay less heed when individual rights are infringed. For example, in 1982, the Supreme Court used equal protection analysis to review an Alaska statute that paid tax rebates to residents based on their length of residency. The Court invalidated the residency requirement, recognizing that the right to travel, “when applied to residency requirements, protects new residents of a state from being disadvantaged because of their recent migration or from otherwise being treated differently from longer term residents.” Maine’s new law similarly disadvantages taxpayers who move or return to Maine by preventing them from using the household credit during the first tax year of their residency. A court would strike down the law as an infringement on the fundamental right to travel.
MYTH: It is permissible to amend LD 1495 while suspended prior to the People’s Veto vote on June 8th.
FACT: On April 8, 2010, Governor Baldacci signed into law LD 1830, which – if the People’s Veto is unsuccessful – will extend the implementation dates contained in LD 1495 for one year, thereby offsetting the delay imposed by the People’s Veto. The only problem with LD 1830 is that any modification of a “suspended” bill was strictly forbidden by the Maine Supreme Judicial Court in a 1933 opinion. In the 1933 opinion, the justices stated that :
“After the referendum has been invoked and until the voters have acted thereunder, the subject-matter of the referred bill is withdrawn from further consideration of the Legislature. It can neither amend nor repeal the act during that period.”
By enacting LD 1830, the Legislature has openly – and knowingly – violated the Maine Constitution.
MYTH: We should ignore the Constitution because tax reform is good policy.
FACT: Whether one thinks that LD 1495 and LD 1830 are good policy is constitutionally irrelevant. It is fundamentally disrespectful of democratic institutions to enact a scheme that violates both the Maine and Federal Constitutions. It should and must be changed to conform to both. We are – or should be – a nation of laws, not men.
Notes and Sources:
[1] Gale, William G. and Reuben, Kim, “Taken for a Ride: Economic Effects of Car Rental Excise Taxes,” report prepared for Enterprise Rent-A-Car.
[2] For more information on calculating the effective marginal tax rate see: J. Scott Moody, “LD 1495: Frankenstein Tax Reform,” The Maine Heritage Policy Center, The Maine View, Vol. 7, Issue No. 2, July 7, 2009. http://www.mainepolicy.org/resources/media/179_1998560130.pdf
[3] Cline, Robert; Phillips, Andrew; Neubig, Thomas and Thayne, Julia, “Total State and Local Business Taxes: State-by-state estimates for fiscal year 2009,” Council on State Taxation, March 2010.
[4] J. Scott Moody, “The Sales Tax Compliance Burden,” The Maine Heritage Policy Center, Maine Issue Brief, No. 13, May 18, 2007. http://www.mainepolicy.org/resources/media/152_539966669.pdf
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