THE RISE AND FALL OF TAX REFORM

THE RISE AND FALL OF TAX REFORM
(from Maine Townsman, April 2002)
by Geoff Herman, Director of State & Federal Relations, MMA

The path to tax reform is riddled with obstacles of extraordinary proportions.

Since MMA’s tax reform effort of 1997, we were already aware of the following:

• You can not accomplish tax reform in robust economic times. (It might dampen the economy.)

• You can not accomplish tax reform in slow economic times. (The economy can’t take it.)

• You can not accomplish tax reform comprehensively. (Too complicated, too much uncertainty.)

• You can not accomplish tax reform incrementally. (Unfairly affects some but not all.)

After the tax reform effort of 2002, we can now add to our knowledge:

• You can not accomplish tax reform in the second legislative session. (It puts too much burden on the next Legislature; election year sensitivity to major change.)

• You can not accomplish tax reform in the first legislative session. (It puts too much pressure on the Legislature in the second legislative session, which will be subject to election year sensitivity to major change.)

• You can not send a tax reform proposal to the voters unless you can answer every question and provide every detail. (Lack of detail, or entrusting some detail to a subsequent Legislature, is unfair to the voters or might mislead them.)

• You can not send a tax reform proposal to the voters if you provide too much detail. (Details are easily amplified, tax increases are removed from the context of other tax decreases, and tax reform is easily opposed on the basis of isolated details.)

In short, you can’t do tax reform.

At the same time, if in a moment of magic the state’s tax code was made to disappear and all memory of Maine’s existing code was erased from the minds of lawmakers, there is no chance on this Earth that the tax code we have now would be re-enacted.

The crazy rate of rise in income tax rates, which kick the highest rates in at below-average household income levels, would never be enacted if we were starting from scratch. The sales tax in this new world order would never be propped on such a narrow base of retail activity. No one would ever vote to make the property tax carry 40% of the overall burden. Huge sectors of property in our busiest communities would never be exempted from the obligation to contribute to the public charge. Lawmakers creating this new code would never be satisfied with a system that yields sharp differential in the property tax rates between adjacent or nearly adjacent municipalities. No one would think it’s a good idea to punish municipalities so severly for encouraging the addition of value to their tax base.

But this is the tax code we are given.

Some of the most ancient Greek philosophers were certain that the planets made a high-pitched screeching sound as they circled the Earth, and they theorized that the only reason this ear-piercing screech was inaudible was because it was so constant and unwavering that people no longer notice it. It is this same phenomenon that applies to Maine’s tax code; its shortcomings are so conspicuous and constant, every effort is put into blunting or exempting its effects and outfoxing its insanities, no one turns their attention to fixing it outright.

Tax reform 2002 began with the vision of a freshman legislator sometime in the fall of 2000 when candidate Barney McGowan was on the stump in the neighborhoods of Pittsfield, Clinton and Detroit. Based on the input from his constituents and his own personal experience as a small businessman, Rep. McGowan became determined to redesign the state’s tax code to provide property tax relief for residents, businesses and farmers, expand the sales tax base to provide a greater level of state support for K-12 education and, if possible, reduce either the sales or income tax rates.

Along with 2000-plus other legislative initiatives, Rep. McGowan put a “concept draft” into the hopper of the newly-elected Legislature, to be considered in the 2001 session. LD 970, An Act to Limit the Use of Property Taxes to Fund Education was a “concept draft” that proposed to draw from some core elements of the taxation and education funding reform that was accomplished in Michigan in the mid-1990s. The bill was a rough blueprint that called for a cap on the property tax mill rate earmarked for public education of 4 mills for primary residences and business properties. According to the concept, all other properties would not be subject to a cap on mill rate associated with education. The revenues lost by establishing this cap would be made up by increasing the sales tax and eliminating selected sales tax exemptions, or an alternative recommendation crafted by the Taxation Committee. The change would be phased in over a 3-year period.

Just as the Michigan plan was hammered out by a special committee of 14 legislators, evenly divided between Republicans and Democrats, the Legislature ultimately converted Rep. McGowan’s bill into the creation of the “Education Funding Reform Committee”, also equally divided between the two major parties, which was charged with meeting between the first and second sessions of the 120th Legislature and developing a tax reform recommendation that would achieve three goals:

• Provide more state money for education and consequently ensure equal educational opportunities for all students of the State;

• Provide property tax relief for home owners, farmers and businesses to encourage new businesses to locate to the State and new businesses to expand and entice more people to live in the State; and

• Balance the primary methods of raising taxes between the property tax, sales tax and personal income tax.

Cautiously, with no inordinate enthusiasm displayed by most of the Committee members, the Education Funding Reform Committee developed its own blueprint of reform. On January 2, 2002, the EFRC recommendation was finalized with the following essential elements.

1) The entire tax reform package would be sent out to the voters for review and approval by a majority vote of Maine’s electorate.

2) The state’s Constitution would be amended to delete the obligation for equal apportionment and allow variable property tax rates for financing K-12 education to be applied to separate categories of property.

3) Beginning with the assessment of April 1, 2004, there would be established maximum property tax mill rates for education funding. No municipality would have to raise more revenue for K-12 education than the amount generated by the maximum rate of 6 mills applied to virtually all property except “secondary residential property” (second homes, vacation property), which would be subject to a maximum property tax rate for education of the state average, which is 12 mills.

4) The state’s education subsidy formula would be redesigned in the context of the Essential Programs and Services model so that the total state-local allocation is sufficient to provide an adequate education in all school administrative units, and maintained to sustain that sufficiency over time.

5) The legislative body of a school district or municipality would not be permitted to exceed the 12-mill property tax cap that applies to secondary residential property. The local legislative body would be permitted to exceed the 6-mill property tax cap for education, but in all cases the over-cap appropriations would be assessed only against the primary residential property owners.

6) As a result of the maximum property tax rates for education purposes, the Homestead Exemption would be repealed and the appropriation for the circuit breaker tax relief program could be reduced to adjust for the diminished need. All revenues “saved” by the state because of the repeal or scaling back of these programs would be redirected to contribute to the state share of K-12 education.

7) As part of the approval of the tax reform package by the voters, the Taxation Committee would be charged with developing a recommended expansion of the sales tax, either by base or by rate or in combination, to the extent necessary to adequately finance the state share of the K-12 allocation. This work would be accomplished during the first session of the 121st Legislature. In addition, the Taxation Committee would be charged with designing an educational Rainy Day Fund for the purpose of ensuring that an appropriate level of educational funding revenues are retained and protected during positive economic periods to hedge against the volatility of sales tax revenue production.

8) A re-design of the system of assessing all personal property in Maine, converting the current system to an excise tax system whereby a uniform mill rate statewide would be applied against the original purchase price of the personal property.

When the EFRC recommendation was finalized, it appeared the stars were well aligned for the Legislature’s serious consideration of tax reform. As a whole, the Education Funding Reform Committee may have lacked Rep. McGowan’s unbridled enthusiasm, but it produced a comprehensive product that squarely achieved the goals given to the Committee it its legislative charge.

At the same time, a citizens initiative calling for a straight 10 mill property tax cap, sponsored by the Maine Taxpayers Action Network, appeared to have enough signatures to get on the statewide ballot in November.

At the same time, a $250 million state revenue shortfall had carved a hole in the state budget, a symptom of the volatility of state tax revenues…a volatility that could be reduced with an expansion of the sales tax base which was an essential element of the tax reform recommendation.

At the time it was not unreasonable to think that comprehensive tax reform might finally have a chance.

The recommendation of the Education Funding Reform Committee was converted into LD 2086 and LD 2087. LD 2086 contained the guts of the tax reform plan. LD 2087 was the constitutional amendment that would be necessary to allow separate property tax mill rates for education funding. Constitutional amendments require a two-thirds vote of support in both the House and Senate in order to be sent out to the voters, so the tax reform effort had a very high political bar to jump over.

On February 19th, LD 2086 and LD 2087 were given their public hearing before the Taxation Committee. Several legislators, many municipal officials, the school board and school superintendents associations and MMA all urged the Taxation Committee to keep the momentum moving on comprehensive tax reform. Property tax cap advocates, the business lobby and the state’s teachers union opposed the tax reform initiative, for different reasons.

Immediately after the public hearing, the Taxation Committee created a subcommittee of seven of its 13 members to further refine the legislation, and for the next month the subcommittee met on almost a daily basis in an effort to simplify the reform package, integrate the taxation proposal with the system that distributes education subsidy, and work with the experts from Maine Revenue Services as well as the Department of Education to determine the actual fiscal impacts and perform a distributional analysis that modeled the impacts of the tax reform package on Maine’s residents of various income categories, non-residents and businesses.

The proposed changes to personal property taxation were jettisoned from the proposal because the issues were too complicated to work out in the time available. The Rainy Day Fund for education was built directly into the plan going to the voters rather than merely assigned to the next Legislature as a “to-do” item. The gradual integration of the tax changes and the Essential Programs and Services education funding model was written into the plan. Clarifications were adopted to make sure that school renovation funding would not be subject to the 6 mill cap and would not be targeted only against the primary residential property owners. After a review of the tax modeling work done by Maine Revenue Services, the homestead exemption, which under the original plan would be repealed, was preserved, and the “circuit breaker” property tax relief program was actually expanded.

Finally, in mid-March, the special subcommittee reported back to the Taxation Committee with the amended tax reform package and it received a strong 12-1 “ought to pass as amended” vote.

As the reform package came into clearer focus, however, the concerns about certain elements began to mount:

• What services, exactly, would become subject to the sales tax?

• What if the Essential Programs and Services school funding model doesn’t support our current level of per-pupil spending?

• What if the Legislature refuses to expand the state’s sales tax even if expressly directed to do so by the voters?

• What stops the Legislature from coming back after all of this is implemented and jacking-up the 6 mill cap to an 8 mill cap or a 10 mill cap?

• What stops the Legislature from subsequently jacking up the mill rate for just business property?

• How do we know that the revenue generated from the expansion of the sales tax will not be diverted to state spending priorities other than education?

• What protections do we have that the Rainy Day Fund won’t be raided by the Legislature for other purposes?

• What protections do we have that this plan will be revenue neutral?

Also in the interim, the Secretary of State and subsequently the Superior Court ruled that the 10 mill property tax cap petition failed to get enough signatures because one of the petition circulators was not who he claimed to be. The signatures were genuine, the circulator was not.

And the hole in the state budget became smaller and ultimately manageable after a rebound in the economy caused a positive reprojection of state revenue.

As MMA began polling legislators for their position on tax reform, there seemed to be a three-way split. About 33% were supportive of the reform effort, or at least open to sending the developed package out to the voters. Another 33% were opposed, and the final one-third said they were somewhere in the middle, leaning one way or the other but as-yet undecided.

The Maine press was quite clearly on the side of reform, urging the Legislature to move the recommendation along to the voters in many editorials. MMA commissioned a public opinion poll that affirmed very strong interest in tax reform. By a margin of 70% to 6%, the 500 randomly selected voters in Maine answered said that the state needs a major overhaul of the entire tax system. Fully 80% of the respondents said that the state needs more courageous leadership from the Governor and the Legislature when it comes to making taxes fairer for all the people of Maine.

It all came to a head in the evening of April 4th While the Senate was effectively killing the tax reform effort by voting to “indefinitely postpone” the constitutional amendment that would be necessary to make it all happen (LD 2087), the House engaged in a full blown debate on comprehensive tax reform. The article starting on the next page summarizes that debate.