Tax Reform in Maine
On Wednesday I participated in the Subcommittee Meeting of the Joint Standing Committee on Taxation. Below are my remarks. In particular, my suggestion for adopting a Business Enterprise Tax garnered some much needed attention. Here are two links that delve more deeply into why Maine should adopt the BET in order to consolidate the way we haphazardly tax businesses.
An article on the BET from the National Tax Journal (PDF)–this article is the more technical of the two.
Joint Standing Committee on Taxation
Subcommittee Meeting – November 9, 2011
Remarks of J. Scott Moody
Vice-President of Policy and Chief Economist
The Maine Heritage Policy Center
Thank you Senator Woodbury and Representatives Knight and Pilon for the opportunity to discuss various tax reform options for Maine. Unfortunately, there are so many problems with Maine’s tax code that it is almost impossible to know where to even begin which points to the root of the problem—there are simply too many types of taxes.
So, first and foremost, Maine needs to start pruning the tax tree. I would suggest starting with the one tax that, in the aggregate, is the most damaging to Maine’s overall economy and that is the retail sales tax. There are several reasons why the sales tax is especially troublesome:
1. The general assumption that broadening the sales tax base is always a good idea is flawed. The genesis of the retail sales tax in the U.S. was in response to the economic damage created by the gross receipts tax (GRT) which was more prevalent a century ago. The tax base of the GRT is the total receipts of a business which maximizes the economically-destructive “tax pyramiding” through the entire production structure of the economy.
To fix this problem, exemptions were purposively created to transform the GRT into a retail sales tax that more resembles a consumption tax. However, due to the problem of “dual-use,” where a good or service can be used for either business or personal reasons, exemptions have proven to be a crude and often ineffective way to create a pure consumption tax. Simply eliminating exemptions, especially on services, will only serve to rebuild the GRT Frankenstein monster piece-by-piece.
2. The sales tax is a tax on investment. Since the retail sales tax can never be fully eliminated on business inputs, which is compounded by the problem of tax pyramiding, so the sales tax acts as a tax on investment. This is especially detrimental to Maine’s construction industry where nearly all of their material costs are subject to the sales tax. This not only raises the cost to the final consumer, but also to the construction companies themselves since their suppliers are also subject to the same tax on their materials. The end result is less money available for future investments which compounds over time.
3. Another negative impact of the sales tax is on display when Mainer’s engage in cross-border shopping in sales tax-free New Hampshire. My recent study, using over 50-years worth of data from the U.S. Census Bureau, found that Maine’s economy could be as much as $2.2 billion higher per year along the border if Maine had the same level of retail sales as New Hampshire. The good news is that the retail sales gap has been closing after the sales tax rate dropped to 5 percent from 6 percent and New Hampshire has dramatically increased their cigarette tax rate.
Additionally, Maine is also the beneficiary of cross-border shopping with Canada. While that relationship is complicated due to currency fluctuations, there is a large tax incentive for Canadians to shop in Maine thanks to their high taxes on consumption—13 percent in New Brunswick including provincial (8 percent) and federal (5 percent). As such, Maine already has an 8 percentage point tax advantage over New Brunswick.
4. The issue of sales tax compliance costs is a serious one. Maine’s economy is dominated by small businesses which have the most difficulty in complying with the tax code. Sales taxes are particularly onerous since the taxability of goods and services can vary greatly—even within a single business establishment.
Also, administratively the state cannot piggyback on a federal sales tax as it does with the income tax. As a result, the state bears the full cost of enforcing the sales tax.
Of these four problems, the one that can be the most quickly addressed is the cross-border shopping issue. Historically, cross-border shopping did not become a major problem until the sales tax rate rose over 4 percent. However, since far more people live on the border today than in 1963 (when the sales tax rate first hit 4 percent), the sales tax rate would likely need to fall to 3 percent to seriously reduce cross-border shopping.
This initial 2 percentage point drop in the sales tax rate to 3 percent should be paid for by spending reductions which would cost approximately $400 million on a static scoring basis. More broadly, however, the total revenue costs would be significantly lower since more retail sales would be occurring in Maine boosting the remaining sales tax, income taxes and excise taxes. This dynamic effect would likely occur relatively quickly since it does not depend on new retail activity, only a shift in where the spending is already occurring.
More comprehensively, the remaining 3 percent sales tax should be phased-out as part of a broader consolidation of businesses taxes—including the corporate income tax, Schedules C (sole-proprietors), D (capital gains), E (partnerships, subchapter S, etc.) and F (farming) of the individual income tax, and the estate tax. These taxes should be folded into a Business Enterprise Tax (BET) which now has a successful track-record in New Hampshire of almost 20 years.
The BET is the best tax tree pruner since it is rationally designed as a type of value-added tax that comprehensively taxes all consumption at the business-level. In doing so, it excludes all investment/saving by business which is critical to boosting the long-term growth rate of Maine’s economy. Finally, as shown in the attachment, the BET can also be filed on a post-card greatly reducing tax compliance costs.