Tax Reform Plan is Not Revenue-Neutral

Tax Reform Plan is Not Revenue-Neutral

June 5, 2007 Posted by J. Scott Moody - No Comments

Oh sure, the tax reform plan winding its way through the Taxation Committee is designed to be “revenue-neutral” from the perspective of the state government. However, the plan does not consider how it will interact with the federal tax code. The Taxation Committee plan will lower the income tax, but raise the sales tax to compensate. The downside is that the income tax is deductible for purposes of the federal income tax, the sales tax is not (technically there is a sales tax deduction but only the higher of income or sales taxes can be deducted, helpful for states like Texas with no income tax, but a high sales tax, but not much help for Mainers. Oh, and even that goes away after 2007 unless extended by Congress).
The end result is that many Mainers will lose a significant portion of their federal tax deductibility for their state income tax. Since most Mainers who itemize are in the higher income ranges, the effective federal income tax rate is significant–about 20 percent. The Taxation Committee’s most recent estimate of the income tax reduction is $218,807,000. Multiply that by the effective federal income tax rate of 20 percent, and Mainers could face up to $43,761,400 in increased federal income taxes because of reduced state income tax deductibility. So much for “revenue-neutrality.”
In addition, the Taxation Committee plan calls for a property tax reduction of $98,084,000 via increases in the homestead exemption and circuit breaker. This too will be offset by an increase in the sales tax. Like income taxes, property taxes are also deductible against your federal income tax. However, this is more complicated since there is no guarantee that this will actually reduce overall property tax collections. For instance, towns could “capture” the state property tax relief by raising property taxes higher than they would have otherwise. But, assuming no “capture” by towns, this property tax relief could cost Mainers up to an additional $19,616,800 in higher federal income taxes.
Overall, the Taxation Committee’s tax reform plan could actually cost Mainers up to $63,378,200 in higher federal income taxes. This is in addition to the higher sales tax compliance costs of up to $14,936,000 that I discuss in this Issue Brief.