Tax Reform in Maine
(from Maine Townsman, December 2001)
By Geoffrey Herman, Director of State & Federal Relations, MMA
Maybe . . . just maybe . . . the stars are coming into sufficient alignment so that a package of comprehensive tax reform can claw its way out of the dark land of legislative inertia and into the fringe settlements of political viability. Enough political viability . . . maybe, just maybe . . . so the package could be sent to the voters for either endorsement or rejection.
The tax code, after all, belongs to the voters. They might as well have a shot at choosing the tax policy that suits them best. Maine adopted the sales tax in 1951 to provide some relief to the property tax. In 1969, the income tax was adopted for the same purpose, and the voter’s rebuffed a citizen initiative in 1970 to repeal the income tax. Thirty years later, the municipalities believe the voters are ready to make another adjustment.
Maine’s municipal leaders have long advocated for comprehensive tax reform with two goals in mind:
1) Significantly reduce the state’s reliance on the property tax to fund K-12 education.
2) Widen the base of the sales tax so that economic downturns will not have as dramatically negative an impact on the state revenues necessary to fund vital governmental programs.
Education Funding Reform Committee. The most visible star in this stellar alignment is the Education Funding Reform Committee. As part of the state’s biennial budget bill enacted last spring, the Legislature created this 14 member, all-legislator panel for the specific purpose of developing a comprehensive 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.
From the municipal perspective, this “charge” to the Committee could not have been written any better. These three goals line up perfectly with top municipal priorities, and community leaders believe very strongly that the achievement of these goals would significantly advance the well being of the citizens and economy of this state.
The Committee has until December 31, 2001 to finalize its recommendation. When submitted in January, the Legislature “may adopt or reject the committee’s recommendations or submit the committee’s recommendations to the voters at a public referendum at the time of the general election in November 2002.” In theory, it’s an up-or-down vote for the Legislature, or send it to the voters. The Education Funding Reform Committee has been empowered to develop a proposal that the Legislature is not supposed to water down.
The sidebar article on page 11 is a snapshot of a draft recommendation that will be considered by the Committee when it meets on December 18.
Education Funding: What needs to be reformed? At first glance, the name of this tax reform committee suggests that it has been charged with fixing the education funding distribution formula, but nothing could be further from the truth. In fact, the Committee is expressly prohibited from taking up the issue of how General Purpose Aid to Education (GPA) dollars will be distributed to the 285 school administrative units. Instead, this Committee is specifically charged with looking at the issue of how much overall state revenue should be appropriated to pay for K-12 education and . . . even more difficult a task . . . how to get the Legislature to live up to whatever commitment it makes.
The Legislature’s history of honoring its “intentions” to fund education is not good. The chart on page 9 shows the 30-year history of the Legislature’s “intent” to pay for a certain share of K-12 education. Although the concept goes back to the Sinclair Act of 1957, which paved the way for the formation of the School Administrative Districts (SADs), a specific statement of legislative “intent” to pay a prescribed share of the total did not appear until 1972, when the Legislature expressed its intention to pay for one-third of the average per-pupil operating cost (which was defined at the time to mean all costs except transportation, community services, capital outlay and debt service).
In 1974 that “intention” was increased to a 50% state share of “education program costs”, with a goal of reaching 60% by 1978. In 1975, the 60% goal was scrapped.
In 1976, the 50% goal was restated as “at least 50% of the basic education appropriation.” In 1978, the intention was restated as “at least 50% of the cost of the basic education allocation.” In 1985, the intention was both increased and restated as “at least 55% of the cost of the total allocation…”.
There are three fundamental issues with this series of legislative “intentions”.
First, in the 30-year history of its teasing with respect to this funding obligation, the Legislature has never been as delinquent on its stated “intention” as it is today. To any reasonably-minded layperson not inclined to feats of rhetorical hair-splitting, the Legislature is fully 11 percentage points out of compliance, which represents about $140 million a year that is borne by the property tax rather than state broad-based tax revenues. To put it another way, if the Legislature actually paid 55% of K-12 education, property taxes statewide could be reduced by over 10%.
Second, some legislators argue that the state is honoring or nearly honoring its financial commitment when the premium payments to the Maine State Retirement System that the Legislature makes on the school teachers’ behalf are factored in, along with recent appropriations the Legislature has made toward the School Renovation and Revolving Loan Fund. The problem with this reinvention of history is that these other costs to which the state is exposed were never considered to be part of the mix. The 55% goal refers to a defined allocation, which has never included Teachers’ Retirement or the Renovation Revolving Loan Fund.
Third, the Department of Education takes quite a different spin. DOE argues that the state is honoring its 55% funding intention because the term “total allocation” includes only the state and local share of the foundation allocation plus the state and local share of the debt service allocation, and that sum doesn’t count the one quarter of a billion dollars of property tax revenue raised each year under the “local option” category. It seems that if you can define “total allocation” cleverly enough, you can make Rhode Island look bigger than Texas.
Representative Bernard McGowan. The sponsor of the legislation that ultimately culminated in the creation of the Education Funding Reform Committee is Representative Barney McGowan of Pittsfield.
Everywhere he looks across the terrain of state tax policy, Rep. McGowan sees bandaids. The Homestead Exemption . . . a bandaid. The Circuit Breaker program . . . a bandaid. The Business Equipment Tax Reimbursement program (BETR) . . . a bandaid. Tax Increment Financing program (TIF) . . . a bandaid. Exemptions, whether property, sales or income tax exemptions . . . more bandaids.
Rep. McGowan is passionate in his belief that Maine’s citizens and businesses should not have to be dependent on the government for property tax relief. The state’s over reliance on the property tax to fund education has created a culture of dependency on state government (through the Homestead, Circuit Breaker and BETR programs) and local government (through the TIF program), all for the purpose of relieving an excessive burden that shouldn’t exist in the first place. If the property tax weren’t being tapped so hard to pay for K-12 education, it could be focused on providing the municipal services (roads, fire and police protection, solid waste, water and sewer infrastructure, etc.) necessary to support and protect the very property that is supporting the tax.
Instead of addressing the underlying cause, Rep. McGowan believes we have created specialized, “bandaid” property tax relief programs that both levels of government must monitor, administer, adjust, maintain, fight for and quibble about. And paying for them robs the state of the capacity to properly pay for education. It’s a self-perpetuating trap.
Rep. McGowan wants to break that cycle, and he thinks Maine could take a lesson from the state of Michigan on how to do just that. In 1993-1994, the Michigan legislature and ultimately the Michigan voters forced that state to pay an 80% share of the costs of K-12 education by establishing firm caps on the property tax rate for educational purposes. The educational property tax rate caps adopted in Michigan were 3 mills (at full value) for Michigan residents and 12 mills (at full value) for all other property owners. Prior to this change, the average property taxpayer in Michigan was being assessed 17 mills (at full value) for education. In order to make up for the lost property tax revenue that supported K-12 education before the mill rate caps went into effect, the Michigan voters authorized an increase in the sales tax rate from 4% to 6%.
As a member of Maine’s Education Funding Reform Committee, Rep. McGowan has vigorously advocated for a reform package for Maine that is modeled after the Michigan plan but is not identical to it. Rep. McGowan’s plan would establish a maximum mill rate for the local education budget of 4 mills for all primary residential, commercial industrial and completely undeveloped properties and a maximum educational mill rate for all other property of 12 mills. Since the average property tax rate for educational purposes is currently over 11 mills, the average property taxpayer in Maine would see a 7 mill reduction to the local property tax rate under the McGowan plan. The state would be required to make up for the lost property tax revenue by expanding the sales tax base . . . modernizing it to better reflect all the retail transactions that are taking place in today’s economy.
Senator Peter Mills. Just as Rep. McGowan’s Michigan-style legislation precipitated the formation of the Education Funding Reform Committee, so did a couple of bills that Senator Peter Mills (Somerset Cty.) introduced during the first legislative session.
Specifically, Sen. Mill’s legislation would have put out to the voters proposed changes to the Maine Constitution to modernize the section dealing with school funding. Unbelievably, no state financial responsibility for public education is required under current constitutional law. The current constitutional provision requires the Legislature to do nothing more than compel all the municipalities to pay for K-12 education.
Sen. Mill’s other bill would have proposed to the voters another constitutional change to allow the establishment of different rates of assessed value that would apply to certain classes of property. Under current law the taxes on all real and personal property in Maine must be assessed and apportioned according to the property’s “just” (or “market” or “cash”) value. Sen. Mill’s bill would have opened the door to differential rates of taxation so that business equipment and machinery, for example, might be assessed at 50% of its just value, making the state’s personal property tax reimbursement program (BETR) less necessary. Neither of Sen. Mill’s proposals was enacted during the legislative session last spring; instead, the concepts were folded into the Education Funding Reform Committee process, along with Sen. Mills himself.
Sen. Mill’s sees the Education Funding Reform Committee as an opportunity to achieve the three “charges” given to the legislative panel, and then even more. Like Rep. McGowan, he would like to see the tax reform package effectively strip away the bandaids and address the underlying problem of overreliance on the property tax through fundamental restructuring. Along with delivering substantial property tax relief, Senator Mills would like to build a permanent structure on which to establish the state’s system of taxing industrial property.
Sen. Mills has been working closely with Rep. McGowan on the development of his proposal. The amalgamated Mills-McGowan proposal is emerging as the draft recommendation that the full Education Funding Reform Committee will consider at its next and probably last substantive meeting on December 18th.
The Petition of the Maine Taxpayer Action Network. The property tax burden is not an abstract problem. The elected and appointed municipal officials face it every day. They see it in the face of the people who can’t afford to pay their taxes. They see it in the dislocation caused by sharply increasing property values in prime locations. They see it in the disproportionate property tax rates that exist among municipalities in close proximity. They see it in the shifting demographic patterns characterized by a retreat away from, rather than toward, the supportive infrastructure that has already been built. In light of the high property tax burden on their citizens, municipal officials are faced every day with the incapacity to install the infrastructure necessary to support development.
But the demand for property tax relief goes well beyond the frustration of the municipal officials who must administer the tax. On October 12th, the Maine Taxpayer Action Network (MTAN) submitted to the Secretary of State a citizen-initiated petition calling for the Legislature to consider adopting a universal property tax cap of 10 mills and limiting increases in the assessed valuation of property to no more than 2% per year. The MTAN proposal is based on the property tax cap established in California in 1978 when the voters adopted “Proposition 13”. According to MTAN spokesperson Carol Palesky, the submitted petition has 10,000 signatures more than the 42,101 necessary to ensure the measure is submitted to the Legislature this upcoming session. The Secretary of State’s Office still has to review all the petition documents and certify that the requisite number of valid signatures has been obtained, and that process may not be completed until after Christmas. If the MTAN petition is finally certified, the Legislature is authorized to either enact the MTAN proposal (which is guaranteed not to happen) or send it out to the voters on the statewide ballot on November 5, 2002.
The Legislature is also authorized to send out to the voters an alternative to the MTAN proposal, a so-called “competing measure”. Conveniently, this alternative proposal could be the recommendation developed by the Education Funding Reform Committee.
The Recession and the Sales Tax. It’s the same old story, different decade. The national and state economies have slowed and state revenues are drying up fast. As a result of the latest re-projection of state revenue, the Legislature is facing a $250 million revenue shortfall, $109 million of which has to be balanced within the next six months, with the remaining $140 million balanced within the next year and a half. The projected structural deficit for the FY 04-05 biennium has now climbed to over $600 million.
It’s deja-vu, ten years later. The negative state revenue impacts from the 1990 recession triggered extremely bitter legislative sessions, played a hand in shutting down state government for a time in 1991, and kicked-off an extended period of state revenue shortfalls and “structural deficits” that lingered malignantly throughout the decade. Over that time period, the state average property tax rate in Maine jumped almost 40%, from 12 to 17 mills, sparked in large part by a spike in local spending for education in order to supplement deficient state appropriations.
A major factor contributing to the volatility or “elasticity” of state revenues is the narrowness of the sales tax base. First, the actual base of retail sales that can be taxed in Maine is riddled with exemptions. Second, most retail services are entirely excluded from a sales tax application. Third, more and more consumers are turning to Internet and electronic marketplaces, where the sales tax collection obligation on the retailer turns into a “use tax” obligation on the consumer, which is essentially unenforceable.
As a measure of the problem, in the latest downward projection of state tax revenue, the sales tax is leading the retreat. Of the newly-discovered $250 million state budget deficit, $105 million is caused by a slumping sales tax. In comparison, the individual income tax (which generates much more annual revenue to the state treasury than the sales tax) is projected to under-perform to the tune of $84 million over the next 18 months. The corporate income tax, which typically produces about one-tenth of the individual income tax revenue, is expected to shed $36 million off original projections.
Five years ago, after the sharply negative effects of the 1990 session began to fade, MMA launched a campaign for comprehensive tax reform in an effort to prepare the state for the next economic downturn. Although the municipalities believe it is clearly in state government’s interest to reduce the highly elastic nature of its tax code, the municipal interest in helping the state achieve that goal is not entirely altruistic. Municipal government is highly dependent on a predictable and stable state treasury. Municipal and state revenues and expenditures are inextricably linked, and the volatility of the sales tax code ultimately migrates into the property tax . . . just witness the spike in property tax mill rate during the recessionary and post-recessionary period throughout the 1990s.
At every other stage of the economic cycle, MMA has been told that the time is not right. When times were bad, we were told to wait for better times. When times were good, it didn’t look like the code needed changing. When the proposal was a comprehensive approach, it was deemed too comprehensive and affected too many special interests. When the proposal took an incremental approach, it was criticized for not being comprehensive enough and picking on only a few.
Maybe now the time is right for tax reform, as we begin the recession cycle yet again, and pause to remember just how much damage our reliance on a boom-or-bust revenue cycle can cause.
THE REFORM PROPOSAL ON THE TABLE (sidebar)
The next and probably last substantive meeting of the Education Funding Reform Committee is scheduled for December 18, when this edition of the Maine Townsman is at the printers. That meeting on the 18th will likely be the make-it-or-break-it opportunity for tax reform in Maine, at least until the voters go into the voting booths on November 5, 2002 and collectively answer the question posed by the petition of the Maine Taxpayers Action Network, “Do you want to limit property taxes to 1% of the assessed value of the property?”.
The recommendation that is being developed for the full Education Funding Reform Committee to consider is a blend of the contributions of Representative McGowan and Senator Mills. The goals of this comprehensive recommendation would be to reduce the state’s reliance on the property tax to fund K-12 education, reduce the volatility of Maine’s tax code, establish a uniform and predictable structure to the taxation of business equipment and machinery in the state, and bring the three major sources of governmental revenue in Maine into a more equitable alignment.
The essential elements of the proposal are as follows:
1) 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 four separate categories of property – commercial-industrial, primary residential, secondary residential, and undeveloped tracts.
2) Beginning with the assessment of April 1, 2004, there would be established maximum property tax mill rates for education funding. Municipalities that do not need to raise the amount of educational revenue generated by the maximum mill rates would not have to apply those maximum rates, but no municipality would have to raise more revenue for K-12 education than the amount generated by the maximum mill rates. 6 mills would be the maximum education mill rate applied to all primary residential property, all commercial and industrial property, and all parcels over some minimum acreage (e.g., 5 or 10 acres) that are entirely undeveloped but not enrolled in a current use program. 12 mills would be the maximum mill rate applied to all other property (i.e., secondary residential property).
3) 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.
4) 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.
5) 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.
6) 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. The Taxation Committee would also be charged with considering the conversion of the sales tax to a gross receipts tax. This work would be accomplished during the first session of the 121st Legislature and could either be enacted directly by the Legislature or sent to the voters in November 2003. In addition, the Taxation Committee would be charged with designing an educational budget stabilization fund for the purpose of ensuring that an appropriate level of educational funding revenues are retained and protected during positive economic periods to ameliorate the volatility of sales tax revenue production.
7) The state constitution would also be amended to phase-in the repeal of the ad valorem personal property tax. Specifically, all personal property (over a per-unit threshold value) first owned or installed in the state after April 1, 2003 would no longer be subject to the ad valorem personal property tax. Instead, all post-03 personalty would subject to an excise tax. The fixed base of this excise tax would be the book value of the personalty when first installed, and the depreciating excise tax mill rate schedule would be developed by the Legislature. The calculation of the depreciating mill rate schedule would be designed to balance:
• The state’s interest in establishing a uniform, stable and competitive industrial tax obligation compared to other states;
• The state’s interest in removing disincentives to replace or modernize business machinery and equipment; and
• The municipal interest in obtaining revenues from the personal property tax base reasonably necessary to provide support services and a fair-share contribution for local public education.