LD 1, the landmark legislation increasing school funding and providing property tax relief, was adopted last January amid much fanfare. While the impact on school funding and on individual property taxpayers has received the most attention, the legislation has also had a significant effect on municipalities. To date, the most significant impacts of LD 1 on cities and towns appear to be the municipal spending limitation provisions and the expanded homestead exemption. These two components of LD 1 have had a noticeable effect on the way municipal budgets are prepared and the way they are perceived by the public.
LD 1 was the Governor's and Legislature's response to the citizens initiative (Question 1A), developed and supported by the Maine Municipal Association and approved by the voters in June 2004. The initiative was to become state law in mid-January of 2005, but the enactment of LD 1 amended and replaced it.
Although it incorporates key features of the initiated law - chiefly a guarantee of 55 percent state funding of General Purpose Aid to education including 100 percent state funding of special education costs, LD 1 differs in significant ways from the legislation approved by referendum. The increased state school aid is phased in over four years, rather than all at once. LD 1 also provides a boost in funding for the state circuit breaker program that reimburses taxpayers whose property taxes exceed 4 percent of their adjusted gross income. And, it increases the homestead exemption to $13,000, but the state reimburses municipalities only half of the property tax revenues lost due to the exemption.
The spending limitations contained in LD 1 provide a cap for state General Fund expenditures, and for each of the three local governmental units - municipal, school and county - dependent on the property tax levy. The spending limitation system for municipalities and counties uses the same components in the growth factor calculation (total personal income (TPI) and property growth). The spending limitation system for schools is contained in the Essential Programs & Services (EPS) funding model.
The legislative body that approves municipal, county or school budgets, through a special voting procedure, can override the spending limitation. Maine Municipal Association and the Maine State Chamber of Commerce will be releasing a report soon that analyzes how the different levels of government - state, municipal, county and schools - complied with the LD 1 spending limits in its first year.
LD 1 and its spending limitation procedures went into effect last July for municipalities on a fiscal year (July-June) budget. Those spending limits will be used for the first time in 2006 by towns and cities on a calendar year budget.
While LD 1 is a complex piece of legislation whose effects – intended and unintended – will become clear only over time, municipal managers and finance directors have already made at least tentative judgments about the spending limits, homestead provisions, and overall budget impact. And in at least a few communities, LD 1 has already altered the way budgets are prepared and voted on.
MUNICIPAL SPENDING CAP
The municipal limit on spending is structured differently from the state's spending limit. The state General Fund cap is based on a 10-year rolling average of real total personal income (TPI) growth plus any population increase. The municipal limit applies only to the property tax commitment used to fund the municipal part of the budget. The growth factor, applied to this "core municipal commitment", combines TPI growth with any increase in "new" property value over the previous year. This property growth factor calculation requires municipal assessors to separate new construction, improvements and split lots from the existing property tax base. Inflationary increases in value resulting from revaluations or factoring are not considered as "new" value.
Preliminary figures (from the Chamber and MMA analysis) indicate that at least two-thirds of the fiscal year municipalities stayed within the growth limitation for the first year, a significant achievement given that the legislation was taking effect during budget preparation and, in some cases, after budgets had already been approved.
In general, the larger municipalities with perhaps more predictable budgets and greater professional expertise took the LD 1 limits in stride, while in smaller communities the effects were far more variable.
LD 1 'No Big Deal'
Jim Cohen, Portland's mayor, said the city council had a relatively minor role in meeting the spending limits. "Portland has been living within the framework outlined by LD 1 for a least a decade," he said, as part of the council's goal of keeping the property tax rate stable. "We thought we would be under the limit, and we were," he said.
Despite the challenges of running the state's largest school system, which include students from poor families and many who speak languages other than English, Portland also tracked the EPS limits quite closely, exceeding the target by less than 1 percent, according to the Department of Education's preliminary figures.
"We're the largest school system in the state, and that helps us be more efficient," Cohen said.
The city council did have a lengthy discussion of how to respond to the increased state (education) revenues Portland received in the first year of LD 1 implementation - about $700,000 more than the previous year. The council had previously pledged to use any such revenue to reduce property taxes. Ultimately, the council decided to use the money, as Cohen put it, to "mitigate" the effect of the unreimbursed portion of the increased homestead exemption.
First Year Confusion
Life was considerably more complicated in Lamoine, which holds a March town meeting but uses a fiscal year beginning in July. It thus became one of the first test cases for LD 1, and the process, thanks to the early meeting, was confusing for even the most attentive taxpayers, according to Stu Marckoon, the town's administrative assistant.
"We get an early start, and the budget was already done before we heard about what LD 1 would do," he said. Lamoine, like a few other small towns, has traditionally funded most municipal functions through vehicle excise taxes and fees, reserving most of its property tax commitment to support schools. In 2004, there was no municipal commitment at all, since significant surplus was available, something that would ordinarily have mattered little.
But since fiscal 2004-05 became the base budget year, Lamoine's "growth factor" for a new budget was meaningless since the previous year's municipal commitment was zero.
This only became clear after the March town meeting had already approved a budget that this time required a municipal commitment of $58,000, just over 10 percent of the total budget of $535,000. After taking advice, the selectmen decided to hold a special town meeting in April to consider overriding the spending limitation - and the voters turned down the warrant question.
"There was a lot of talk around town that approving the override would raise people's taxes," Marckoon said. "That was true, but it was only a quarter of a mill, and something we had done before" - but not at the benchmark 2004 town meeting. He admits the town was "not well prepared to present the override question," since the legislation was still so new and selectmen were struggling to decide how to proceed.
Selectmen then presented a budget that eliminated the need for any municipal commitment, and voters approved it in another special town meeting in June. There were significant cuts to make up the $58,000 gap. Selectmen, who were paid $800-$1,000 a year, saw their pay cut to $100. Social service agencies that traditionally received $600 got $1 instead. The volunteer fire department was reduced by $1,000, and there were significant cuts in the administrative account and the parks and recreation line. The budget also assumed a further increase in revenues such as code enforcement fees.
Of all the cuts, the one that roused the most reaction was an $8,000 reduction in payments to the Ellsworth Ambulance Service that guaranteed response to calls from Lamoine. "People were really concerned about having that service," Marckoon said. So another special meeting was convened for that specific item, and the money was restored "in about two and half minutes," with the funding coming from surplus.
Lamoine is now preparing its 2006-07 budget that, among other items, keeps selectmen's pay at $100. It will probably require a municipal commitment of $50,000-$60,000 and that, because the baseline commitment remains at zero, will require an override vote to be adopted. Marckoon doesn't know how that vote will go, but he did say the selectmen will make an effort to explain what's at stake. "We'll probably send out a brochure beforehand so people understand the law and how it affects the town budget," he said.
If Lamoine does override, it will then have a municipal commitment base (above zero) that can increase in future years; last year the town would have had a growth factor of 3.68 percent.
Affects Town Meeting Debate
In Mount Vernon, the spending limit played a significant part in debate at town meeting, but without the drastic effect seen in Lamoine. Selectman Bruce Inch considers the spending limit a weak fiscal control, in that the same voters can override it by the same majority needed to pass a warrant article. Yet he said, it did have an effect on this year's annual town meeting discussion and voting all the same.
Selectmen and the budget committee had agreed on a budget that stayed within the LD 1 limit, which in Mount Vernon permitted a 4.49 percent increase. Traditionally, voters add money to warrant articles from the floor, but this time they had the growth limit to consider.
"Even though they could make any spending decision they liked, there was a sense that they should respect the limit, because it's the law," Inch said. Ultimately, the town meeting increased spending about $9,000 above the growth limit, but Inch said that had more to do with a calculation error concerning the necessary commitment than an intention to spend beyond the limit.
Voting Format Changed
In Dover-Foxcroft, voters decided - after voting to exceed the spending limit at last year's town meeting - to change the format for approving the budget to a referendum ballot, rather than the traditional open floor vote. But Town Manager Jack Clukey says he doesn't believe the two events are necessarily related.
"There was some discussion about the referendum issue in the previous year, though we didn't receive a petition," he said. He had heard from townspeople that there was support for such a move before LD 1 was enacted, and that "the interest seemed to be that in other towns, it had achieved the intended purpose of increasing voter participation."
At the town meeting that approved the spending limit override, discussion was lengthy, but was not focused on the limit itself. Instead, voters were more interested in the new capital projects the town proposed undertaking that caused spending to increase that year. In the end, both a library expansion and public works garage renovation were approved, along with the override.
The first year bumps that some towns experienced may even out with time. The caps contained in the legislation are cumulative, rather than just year-to-year. That means if a town spends just 2 percent more than the previous year when its growth factor is 4 percent, it will have that additional "space" the following year if expenses are higher. It could spend, say, 6 percent more the following year without exceeding the spending limitation target.
The Legislature's decision to increase the homestead exemption, but not fund the increase, caused hard feeling in some municipalities. No one was more adamant in his disagreement with that decision than Caribou City Manager Steve Buck, who attended several session of the Legislature's Taxation Committee to make his case that the homestead plan was unwise.
"I was told that southern Maine communities were experiencing a significant shift in (property) tax burden from businesses onto homeowners, and that a bigger homestead would compensate for that," Buck said. "But that's not true of northern Maine municipalities. We haven't seen that shift and we don't have that problem."
Instead, he said, the locally funded homestead, with an additional exemption of $6,500, raised the city's tax rate by $1.30 and increased taxes for non-residential properties by 5.8 percent. Nor, in his view, did the expanded homestead help all that many of its intended beneficiaries.
He calculated that a home would have to be valued below $80,000 to gain any benefit from the homestead because, for more expensive properties, the benefit of a $13,000 exemption would be outweighed by the higher tax rate. Even though 79 percent of Caribou homesteads, some 2,160 in all, are below $80,000 in value, many benefit only slightly from the change. If a $100 reduction in a tax bill is counted as "significant" relief, then only 18 percent of homeowners saw their taxes drop by that amount, Buck said.
Though Caribou is one of only a few cities to operate on a calendar year, and hence has not yet prepared a budget under LD 1 guidelines, Buck doesn't think there will be much difficulty with the growth factor, which for Caribou was 4.48 last year. "We're very conservative with our dollars. You won't see a lot of municipal spending that hasn't been scrutinized," he said.
Adding to tax rate concerns last year was a quirk in school funding that lowered Caribou's state subsidy in the first year of the EPS system and raised the tax rate by 70 cents. Buck says the city will receive more in future years, when the state pays 100 percent of its share rather than the 84 percent received this time. "We don't have any complaint about that," he said. "We understand and support the EPS system."
Despite his own concern about the homestead expansion, which he believes should have been a local option, rather than mandatory, Buck admits that the local reaction from businesses was muted, despite the overall $2 increase from the homestead exemption and schools. The city sent out a lengthy explanation of the changes, and, in the days that followed, received only five calls in response. "They all wanted to know why the homestead wasn't $13,000," Buck said. (Because Caribou assesses at 92 percent of full value, the actual reduction was $11,960.) "If we'd thought to explain that, we might not have gotten any calls at all."
One could say that the new state homestead provision was modeled on Portland's short-lived local homestead ordinance, which offered a similar amount of relief before being struck down by the Maine Supreme Judicial Court.
Jim Cohen, however, was one of four dissenters on the Portland council in the 5-4 vote setting up the program. "I had two concerns - one, whether it was legal, and the second, whether it was well timed," he said. Now that the city is implementing a revaluation that does shift the tax burden from commercial to residential, the timing is better, he said, and the Legislature removed the legal concern about authorization the court had found earlier. "Personally, I think the circuit breaker is a better program because it's targeted to need, but we can live with the homestead the way it is now," he said.
WORK IN PROGRESS
For towns just now beginning budget preparation under LD 1, Brunswick Finance Director John Eldridge recommends an early start. Even though Brunswick has had one year's experience with the caps - coming in just below both the municipal and school targets - he still considers the legislation a work in progress, and subject to interpretation in several respects.
"Frankly, we thought some aspects of the law weren't clear. We took MMA's analysis and for the most part followed that." Even now, he said, questions remain about how to calculate the growth factor, or at least the portion that pertains to growth in property value. Assessing personal property used in business is one example, he said. Depreciation is standard in assessing, but how should it apply here, he asked. "Are we supposed to deduct depreciation from allowable growth?"
Eldridge has another concern about including debt service payments in the total allowable spending. While it may not affect local decisions on whether, and how much, to borrow, the bond rating houses may view it differently. "The assumption they've always made it that spending capacity is unlimited. Even if the limit can be overridden, they may view this as a spending limit," he said If so, this could increase the perceived risk, and hence the interest rate for the bond. "I guess we won't know the answer to that one until we take out a new bond issue," he said.
There is an unintended effect of LD 1 that Eldridge said marks a change in how municipalities are likely to prepare budgets in the future. The separate limits for county, municipal and school spending may make sense in some respects, but they could discourage the cooperation that previously took place in municipalities that run their own school systems.
"Before, the focus was the tax rate and keeping it in check," Eldridge said. When the school department was facing steeper spending demands, the municipal budget was one place to look for possible savings, he said - and vice versa in other years. Now, with the separate limits on each portion of the budget, he thinks that such cooperation may be replaced by a more go-it-alone approach. "I don't think that's something they thought a lot about, but it could be one of the results," he said.