1997 Tax Reform
(from Maine Townsman, March 1997)
By Geoffrey F. Herman, MMA Director of State & Federal Relations

As a state we rely too heavily on the property tax to fund local and state government. To be more precise, we rely too heavily on the residential property taxpayer.

Of the three principal sources of state and local tax revenue - the income, sales, and property taxes - the property tax provides the most revenue by far. In state fiscal year 1997, $2.64 billion of revenue will be raised by these three taxes, and fully 45% of that total ($1.2 billion) will be raised by the property tax.

No tax should be relied on so heavily, especially the property tax. Unlike the income tax, the property tax is a flat rate tax, and in that respect lacks progressivity. Unlike the sales tax, the property tax is not applied to a discretionary purchase, and therefore imposes itself as an unavoidable obligation on the taxpayer.

If there is some doubt about the pressure on the property tax, witness a mill rate around 2.5% of assessed value in many Maine cities and "service center" communities. Witness the statewide drive to cap property taxes at 1%, yet to be successful, but now entering its third year in the trying. Witness the drive to stop unfunded state mandates enacted in 1992. Witness bitter local battles in recent years over school budgets.

Realignment

The mix of the tax burden among the various state and local taxes is not just slightly askew. It is structurally out of alignment. The proportions are significant. It is almost as though the inventor of the system intentionally designed the property tax to be the scapegoat tax, the tax that must rise so that the other two can remain flat or fall, the wetland of all taxes that passively absorbs the financial difficulties of the state.

To bring meaningful relief - to make the property tax 35% of the tax mix, for example, rather than 45% - $250 million a year would have to be moved off the property tax side of the ledger and picked up by the more progressive, less controlling state tax revenues. Minor adjustments to the system will not bring relief to the property tax. Even fixing all the "shift and shafts" enacted over the years that have further burdened the property tax will not fix the problem. $250 million a year is a lot of money. A structural imbalance exists within the system such that a year or two of appropriate state-level support for municipal programs may be a temporary palliative, but it’s not a cure.

The Approach

Meaningful, tangible property tax relief is the driving force behind An Act to Comprehensively Realign the Tax Structure of the State, a legislative proposal that has evolved from a 1996 initiative of MMA’s Executive Committee.

First, two citizen polls were conducted that verified the significant ground swell of concern about the property tax, and the extraordinary interest of the citizenry in being involved in the tax restructuring decisions (see related article).

MMA then hosted over 30 candidates’ forums across the state before last November’s election to discuss the issue of the property tax burden with as many candidates for state office that were interested in participating.

A special 20-municipal-member Ad Hoc Tax Policy Committee was appointed by MMA President Mike Roy and charged with developing a legislative proposal for the Association’s Legislative Policy Committee to consider - a proposal to kick off the statewide discussion.

Legislators from all corners - Republicans, Democrats and Independents - were asked to have enough faith in the process and enough commitment to solving the problem to put their names to this effort as the bill’s sponsors. Despite the fact that the measure, like any substantial tax reform proposal, would attract its share of controversy, a well rounded group of legislators agreed.

The Speaker of the House of Representatives, Elizabeth H. Mitchell (Vassalboro) signed on as the bill’s lead sponsor. The Speaker’s signature, as with all the other sponsors’, is a gesture of support for considering meaningful tax reform in 1997.

Finally, on February 13th, MMA’s Legislative Policy Committee endorsed a plan hammered out over the course of several months by the Ad Hoc subcommittee.

The Plan

Like a three-legged milking stool, the plan rests on three essential, integrated elements. Each piece supports, supplements, or relies upon the others to make the whole - to support the platform of property tax relief. Critics of the plan tend to focus on a single element, ignoring the proposal’s other two components, and giving short shrift to the goal.

Homestead Exemption

The lead element in the proposal is the implementation of a $20,000 homestead exemption. A homestead exemption is an automatic subtraction of a certain value from the assessed value of every Maine homeowner’s principal residential property. In this proposal, the homestead exemption is $20,000 of "equalized value" or "just value", meaning that the value of the exemption is $20,000 so long as the municipality is assessing property at 100% of market value. At a 100% assessing ratio, a homeowner can calculate the value of the homestead exemption benefit by multiplying $20,000 times the municipal mill rate.

For communities with a mill rate of 15, for example, the homeowner will enjoy a $300 reduction in the property tax bite per year. If the local mill rate is 25, the annual property tax relief will be $500.

A related article in this issue by Jo Josephson describes the homestead exemption concept in more detail. The bottom line is that there is nothing mysterious about the homestead exemption from a tax policy point of view. At a value of $20,000, the homestead exemption delivers extremely powerful property tax relief to the state’s residents. The homestead exemption complements the state’s circuit breaker program, which would remain available for Maine’s renters and to relieve the more acute property tax problems affecting Maine’s low income citizens.

Sales Tax Base Expansion

There is no free lunch, however. Subtracting a substantial amount of value from the municipal assessment lists before applying the mill rate and collecting the property tax results in a loss of revenue to municipalities, revenue needed to fund the schools, plow the roads, provide police, fire and rescue protection, deal with the solid waste, and all the other bread-and-butter services delivered by municipal government. The plan is dependent, therefore, on the state reimbursing the municipalities dollar-for-dollar for the revenues lost to the homestead exemption. The reimbursement price tag is $115 million per year. The state’s obligation to reimburse municipalities for the revenue lost to the homestead exemption is the link between the first leg of the plan, which is property tax relief, and the second, which is the expansion of the sales tax base.

This is a point in the plan where other interested parties prick up their ears.

Maine’s sales tax base is very sensitive to changes in the economy. According to any number of reports from Maine’s Tax Bureau and academic institutions, the sector of the economy to which Maine’s 6% sales tax is applied is too restricted. It is too narrow. The sales tax enacted in 1953 is very much the sales tax of today, although Maine’s economy, like the economy of the nation, no longer resembles the economy of a half a century ago. Maine’s own Economic Growth Council in 1996 described Maine’s sales tax as "retail-oriented" and "highly sensitive and narrowly based". In a 1996 study of all the states' tax codes conducted by the Corporation for Enterprise Development, Maine’s tax system received a ranking of 36th among the 50 states for "stability", and it is clearly the sales tax that is dragging Maine down in that regard.

The problem with a narrow tax base is its volatility. 20% of the roughly $730 million collected annually by the sales tax comes from the sale of automobiles. Add in building supplies and big-ticket items like appliances, and nearly 50% of the sales tax base is represented. It is easy to see how a downturn in the economy, when consumers put off expensive purchases, would cause sales tax revenues to plummet, just as they did so dramatically in 1991. The tax experts use the word "elasticity" to describe a volatile tax. The problem with a highly "elastic" tax is its unpredictability, its instability. During good times, an elastic tax provides more revenues as it stretches with the economy; during downturns, the tax becomes flat and there may even be a drop in the revenues it generates.

There is something for everyone to dislike about the instability of a major tax source. For people who are particularly reliant on governmental services - school children, the elderly, people with low income, to name a few - a sharp drop in governmental revenue means a cut in vitally needed services. For people who are concerned about government gobbling up all the tax revenues that come its way, volatility is something to worry about as well. During boom times, a narrow sales tax base like Maine’s will generate excessive revenues, and it takes a watchdog Legislature to make sure that unsustainable governmental growth does not occur as a result, as many people claim happened in Maine during the boom years of the late 1980’s.

With all this in mind, the tax restructuring proposal seeks to expand the sales tax base by applying the tax to a broad range of services. Currently, the sales tax is principally applied to things - widgets - retail items that are sold over the counter. Unlike many other states, Maine does not apply the tax to services, even though the economy in Maine and elsewhere has moved dramatically from a manufacturing-based to a service-based economy.

According to a summary provided by Maine’s Bureau of Taxation, every other state that has a sales tax applies it to some degree to amusements or "admissions". Maine is extremely limited in that regard, applying it only to extended cable TV and video tapes. Twenty-three states tax labor repair services, but not Maine. Twenty states tax interstate telephone services, but not Maine. Twenty-one states tax laundry and dry cleaning services, but not Maine. Twenty states tax health club services, but not Maine. And the list goes on.

According to a 1992 study conducted by the Federation of Tax Administrators, of 155 services taxed under the sales tax laws of the nation, Maine applies the sales tax to just 27 services. Of all the states in the country, only 14 tax fewer services than Maine.

The services to be covered by the sales tax in the tax restructuring proposal are listed on page 10 of this issue. The list is intended as a starting point for discussion. In developing the list, the guiding principles were that the expansion have some breadth, and that the services chosen would be those that people or businesses purchase with discretionary dollars. According to our calculations, the revenues raised by expanding the sales tax in this manner would pay for the $115 million annual reimbursement needed to offset the homestead exemption.

The proposal includes a requirement that every year a report is presented to the Legislature that identifies: (1) the amount of revenues brought in because of the expanded base; and (2) the amount of reimbursement provided to the municipalities. Any revenues that are collected in excess of the reimbursement amount must be deposited in a special tax relief fund under the control of the Legislature. The plan is entirely "revenue neutral".

Services Charges

Providing a $20,000 homestead exemption and paying for it with revenues obtained by responsibly expanding the sales tax base gives property tax relief to every Maine homeowner. The property tax relief, in other words, is spread out evenly. The property tax problem, however, is not so evenly spread. The property tax problem is particularly acute in what have come to be called the "service center" communities, Maine’s cities and towns that act as regional centers where commerce, government, academic institutions, and social services agencies all congregate. There is a dramatic correlation between those communities and the highest property tax mill rates in the state.

Providing a homestead exemption does nothing to reduce the mill rate. A homestead exemption delivers property tax relief by reducing the assessed value of residential property, but the same mill rate will apply. To drop the mill rate, something else has to be done.

It should also be remembered that to draw down the burden on the property tax, upwards of $250 million per year must be provided for property tax relief. The sales tax expansion offsetting the homestead exemption gets us only half the way there.

The tax reform proposal fills out the rest of the relief package and addresses the high tax burden in our service centers by proposing the broad application of a "service charge" to the owners of those buildings that are currently exempt from property taxation, but are nonetheless protected and provided other services by the municipality.

Like the expansion of the sales tax base, this plank in the platform is not without its controversy. It is driven by the observation that just as the sales tax base is too narrow, so is the property tax base. Buildings owned by the state, the colleges and universities, the hospitals and the various medical buildings that exist under a hospital’s umbrella, the non-profit nursing homes and housing complexes - all of these facilities and many more like them contribute without question to the culture and dynamics of a community, but not without cost.

In round figures, there is $10 billion of property value in this state that is exempt from taxation.

Approximately 33% of that value is federal property, against which a service charge could not be charged.

Approximately 23% of that value is municipal or quasi-municipal property, against which a service charge would make no sense.

Approximately 4% of that value represents open land that is exempt from taxation. State parks, land in the possession of exempt land trusts, the unimproved property owned by exempt summer camps - the tax reform proposal would not apply a service charge to this undeveloped property, as it demands very little in the way of municipal services.

Approximately 6% of all exempt value represents the value of essential church property, such as houses of religious worship and a portion of the value of parsonages. The tax reform proposal exempts this property from a service charge as well.

Under the proposal, however, the exempt property that remains would be subject to a service charge. State, academic, hospital, and other exempt properties would pay a service charge that would be calculated by applying a special mill rate to the assessed value of the property. The mill rate would be the municipal mill rate, less any part of that mill rate attributable to education, welfare, and the cost of any services which the exempt property may already pay through user fees.

The thinking is that if everyone has their oar in the water, even if some are not asked to row quite as hard, the load will be lighter for the whole community.

In round numbers, removing education and welfare from the aggregate municipal mill rate will reduce that rate by slightly more than 50%. The average effective tax rate in Maine is about 16 mills. If a mill rate of 8 (50% of the average) is applied to the $3.4 billion of exempt value statewide that remains after the federal, church, municipal and open land exemptions are taken out, over $27.3 million per year would be available to the municipalities where the exempt property is located. The service charge would not be implemented all at once, however. In recognition of the change in policy, the tax restructuring proposal would phase in the full implementation of the service charge over a three-year period.

The tax restructuring proposal also requires that all service charge revenue be used to reduce the municipal commitment, just as is the case with State-Municipal Revenue Sharing. The result is lower property tax mill rates. And the effect will be felt most dramatically in the communities where the exempt property is concentrated, which is the state’s service centers.

The Other Pieces

With these three integrated elements, the proposal is made whole, but there are some other pieces worth mentioning.

A four-point set of standards to obtain eligibility for property tax exemption as a "benevolent and charitable" organization is provided. The standards come from the state of Pennsylvania and are a good deal sharper and crisper than the standard that has evolved in Maine case law. A substantial amount of purely charitable work has to be demonstrated. The provision of the services has to relieve government of its burden. The recipients of the services have to be legitimate subjects of charity. It is a common sense definition of the level of "charity" necessary to secure a forgiveness of a property tax obligation.

The proposal contains a directive that a report be presented to the Legislature every year detailing the amount of revenues raised by the sales tax expansion and the amount of revenues distributed to the municipalities. Accountability is one goal of this proposal.

The proposal requires that any revenues collected by the sales tax expansion that exceed the revenues distributed to the municipalities to cover the cost of the homestead exemption be placed in a special tax relief fund. Revenue neutrality is another goal of this proposal.

In response to the polling results that suggested a powerful interest on the part of the respondents to be connected to the tax reform effort, the proposal contains a referendum provision. After being shaped in the Legislature, it would be passed out to the voters for ratification in November.

Conclusion

It’s a bold proposal. Providing a $300 - $500 annual reduction in the property tax burden for all Maine homeowners is a dramatic proposal, indeed. It would accomplish this end, and at the same time improve the stability and progressivity of Maine’s overall tax structure. It’s rational. It’s revenue neutral. It’s accountable. In the final analysis, An Act to Comprehensively Realign the Tax Structure of the State would responsibly deliver real property tax relief.

Over the next couple of months, however, as the Legislature undertakes its review of this and other tax reform measures, it will be easy to lose sight of that goal. As might be expected, the proposal has its critics. To those critics, we come back with two questions.

The first question is whether the state’s heavy reliance on the property tax is a problem that needs to be fixed?

The second question is how to fix it? If this proposal is flawed, what is the better alternative? Facile answers, like "fully funding Tree Growth" or "increasing school funding at annual Consumer Price Index levels", or "by simply reducing the cost of government", are easy answers that just won’t do. This is a structural problem and it requires a structural solution.

TAX REFORM: WHAT'S AT STAKE? (sidebar)

By Chris Lockwood, MMA Executive Director

Although tax policy is the focus of this proposal, the basic issue at stake is whether important public policy issues in this state (e.g., forestry, transportation, tax structure) will be shaped through the legislative process, or whether Maine, like so many other states, will continue down the path of rigid citizen initiated referenda taking these decisions out of the hands of elected officials.

In 1995 and 1996, Maine came dangerously close to a complete upheaval of basic municipal services (fire, police, roads, snowplowing, education, etc.). This upheaval would have resulted if a citizen-initiated California Proposition 13 syle property tax cap referendum had been enacted. Fortunately, the measure’s proponents failed to gather sufficient signatures, but citizen unrest about residential property taxes remains strong.

In addition to our over-reliance on the property tax, Maine’s tax structure has other problems. Presentations to the Governor’s tax policy subcommittee and the Legislature’s Taxation Committee have reinforced the conclusions of the nearly dozen tax studies conducted during the past ten years. Absent meaningful changes, Maine’s state and local tax structure is extremely vulnerable to economic cycle swings and taxpayer revolt.

It was within this context that the Maine Municipal Association’s (MMA) Executive Committee launched an effort last summer to address tax policy issues in a constructive fashion, rather than waiting for a crisis. MMA believes that changes are needed, but we also are committed to seeking change through the legislative process. Our efforts to date have been to generate a commitment from the Governor and Legislative to identify comprehensive tax reform as a top priority for action in 1997. As a part of that effort, we have worked to formulate a draft proposal as a beginning point of discussion. The key point we ask is that interested parties focus on the goal to address Maine’s tax structure issues constructively through the legislative process, rather than through a rigid citizen-initiated referendum measure.

TAXABLE SERVICES UNDER TAX REFORM ACT OF 1997 (sidebar)

17-B. Additional taxable services. In addition to the taxable services listed in subsection 17-A, "taxable services" also means:

Amusement and recreational services. "Amusement and recreational services" include all services provided in this state to the general public or through private clubs that involve exchanging a right of access to any amusement, recreational, exhibition, cultural, or athletic activities for any user fee, price of admission, gate fee, or equivalent form of remuneration.

Personal services. "Personal services" are services provided in this state to the general public by a person of specialized skill, talent, or experience. Personal services characteristically provide attendant care to the recipient of the service, or care, maintenance or repair services to the recipient’s real or personal property. Personal services include, without limitation, such services as:

• Personal attendant services, including without limitation barbering, beautician, manicure, tattooing, body piercing, massage, reflexology, tanning, and exercise or fitness services;

• Laundering and dry cleaning services;

• Painting, papering, and interior decoration services;

• Jewelry, camera, watch, and gun cleaning and repair services;

• Pet grooming and kennel services;

• Musical instrument tuning and repair services;

• Swimming pool installation, repair, cleaning, and maintenance services;

• Radio, television, and sound system repair services;

• Furniture, rug, and upholstery cleaning and repair services;

• Locksmith services;

• Personal property and self storage services, including storage and mooring services for non-commercial watercraft;

• Services related to the washing, cleaning, polishing, lubrication, painting or detailing of motor vehicles;

• Disinfection and pest extermination or control services;

• Landscaping, lawn care, grounds maintenance, and tree removal services;

• Photography and photographic studio services;

• Printing, imprinting, painting, or lettering tangible personal property for persons who furnish such personal property for that service;

• Any fabrication, printing, or production of tangible personal property by special order when such property is not intended for resale;

• Repair services for non-commercial watercraft;

• Dance instruction and dance studio services;

• Dating, escort, and personal introduction services;

• Flower or balloon delivery services and services similarly provided as a demonstration of personal appreciation;

• Limousine services;

• Taxidermy services;

• Flight instruction services; and

• Antique or art auctioning or dealership services.

"Personal services" do not include construction services.

Business services. "Business services" are any services provided in this state to business consumers except those services that constitute an integral or inseparable component of any activity of the business consumer involving the manufacturing, fabrication, processing, or manipulation of tangible personal property such that the business service is targeted to the unique needs of the business consumer and non-transferable across a range of business activities. Business services include, without limitation, such services as:

• Motor vehicle parking, other than metered space, in a lot or garage having 30 or more spaces;

• The service of leasing or renting tangible personal property;

• Employment agency services of any kind, except when such services are provided to an employer whose place of business is located in another state;

• Credit collection or credit reporting services;

• Secretarial, stenographic, or editing services;

• Building maintenance, janitorial, or cleaning services, including window cleaning services;

• Office moving and installation services;

• Document and record preservation and storage services;

• Telephone answering services;

• Private investigation, patrol, building alarm and security, and armored car services;

• Management consulting, advertising, information, and public relations services;

• Tax preparation services;

• Financial accounting, financial management, and investment counseling services;

• Office and business machine repair services;

• Sign construction and installation services;

• Food catering and institutional food preparation and delivery services; and

• Photocopying and document preparation and delivery services.

"Business services" do not include construction services.

Licensed professional services. "Licensed professional services" are services provided in this state to the general public by persons holding a certificate, license, registration, or other formal permission to perform, provide or practice the service in this state, and such permission is characteristically granted only when the practitioner has obtained advanced education or specialized training. Professional services include, without limitation:

• Lobbying services;

• Architectural and design consulting services;

• Legal services;

• Surveying and professional engineering services, including geological and hydrogeological consulting services, and consulting services related to the science of soil analysis and subsurface engineering;

• Arbitration services;

• Appraisal services; and

• Accounting, financial investment, and financial management services.

"Professional services" do not include those services provided by health care practitioners.