Maine Policymakers Agree: Maine’s Income Tax Too High

August 15, 2008

Earlier this week, Maine politicians reacted with surprising unanimity to the Tax Foundation’s new State & Local Tax Burdens report. Governor John Baldacci (D) and Republican and Democratic leaders in the state legislature all acknowledged that Maine’s personal income tax, with a rate that tops out at 8.5%, is too high and needs to be cut.

Gov. John Baldacci said Monday he would propose lowering Maine’s personal income taxes in the January session of the Maine Legislature, but how much depends on the state budget now being developed…

Baldacci said the recent Tax Foundation study that ranked Maine as having the 15th-highest tax burden did note the personal income tax rate in Maine is among the highest in the nation and contributes to the overall tax burden.

“They were right not to include property taxes paid by out-of-staters, but they were also right to point out our high income tax rate,” he said. “I was concerned about that last year and I am concerned about that this year.”

This year, improved data availability enabled us to apportion property taxes to the home states of property owners. This reduced Maine’s calculated burden, as many vacation homes in the state are owned by non-residents, and commercial properties are often owned by corporate shareholders all over the country. Maine’s #15 ranking is a significant decline from rankings issued before we could apportion the property taxes.

Commendably, Maine lawmakers appear to be responding constructively to the report and looking to improve their tax code. Instead of taking the ranking drop to mean that they didn’t have a tax problem, they realize that Maine remains in the top third of burdened states and could particularly benefit by cutting its income tax.

Maine’s 8.5% is the seventh-highest state income tax top rate, exceeded only by California, Iowa, New Jersey, Oregon (which has no sales tax), Rhode Island, and Vermont. Maine compares particularly poorly to its closest competitor states: Massachusetts has a flat, 5.3% income tax, and New Hampshire imposes no tax at all on wage income. And most Maine taxpayers do pay the 8.5% rate, which kicks in at just $18,250 of taxable income for a single filer.

One aspect of the report about the tax changes is troubling:

Baldacci declined to say whether he has a target for reducing the income tax, or whether he will propose reducing the 8.5 percent maximum rate or seek to reduce the taxes Maine residents pay by other adjustments to the tax code. For example, increasing either the standard deduction or the personal exemption levels would reduce the amount of income tax a person pays, even if the person still pays taxes at the 8.5 percent rate.

The best way to improve Maine’s individual income tax would be to cut rates, particularly the top rate. Expanding deductions and exemptions (increasing the amount of income taxpayers get to exclude from taxes) would reduce Mainers’ tax bills, but it would not generate many of the economic benefits that come from cutting tax rates. Particularly, it would leave most workers’ net marginal wage rates—the earnings they receive net of taxes for an extra hour worked—unchanged. By contrast, rate cuts would raise net marginal wage rates, reducing distortions against work.

Furthermore, Maine is already relatively generous on the deduction/exemption side, offering the full standard deduction and nearly the full personal exemption used for federal income tax. Only a handful of states set higher deductions and exemptions, while many states set lower ones. As such, increasing its standard deduction and exemption would just set Maine further out of step with most states.

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