Maine’s Tax Reform Efforts

June 10, 2009

The Maine legislature passed a major tax reform bill (PDF) last week and is awaiting Gov. Baldacci’s decision.

The bill would get rid of the graduated income tax rate structure, so that instead of four different rates and brackets, there would be just one flat rate of 6.5%. As reported by the Tax Foundation’s 2009 State Business Climate Index, here are Maine’s current rates and brackets:

2% > $0

4.5% > $4,850

7% > $9,700

8.5% > $19,450

Clearly, most taxpayers are in the 7% or 8.5% brackets, so their top tax rate would be lower if L.D. 1088 is signed into law, as much as 24% lower. To protect the few low-earning taxpayers who pay a top rate of 2% or 4.5%, the bill includes a large new, refundable tax credit.

To keep the overall bill revenue-neutral, at least by the state’s own estimates, the sales tax would be applied to many services that are currently exempt. Naturally, to the business owners, employees and customers in those sectors, the burden of the sales tax expansion might outweigh the pleasant news on the income tax front. However, most of those services are sold directly to the final consumer, so their taxation is in line with the principles of sound tax policy—specifically, broad bases and low rates.

There is however cause for some concern on at least three counts:

  • Maine is attempting to shift some of the tax burden off of their citizens and onto out-of-state residents. The list of newly taxed services include numerous items specifically designed to disproportionately tax “out-of-staters” such as rentals, entertainment and recreation services. Not that Mainers never spend their money on such things. This tax-your-neighbor strategy is likely to draw retaliation from neighboring states and distort economic decision making.
  • New Hampshire is a famously low-tax state, with no tax on general sales. By extending its sales tax to previously untaxed services, Maine would improve the fairness and efficiency of its own sales tax, but it would also lengthen the list of services where a better deal can be had in New Hampshire.
  • Additionally, the statutory 6.5% rate does not represent the full effect of all the new tax provisions. Many Maine families would lose part of the new credit, and so their “effective marginal tax rate” would be 8%, still better than the status quo but not as big an improvement as it seems.

All this taken together leads one to raise a cautious hand in support of the efforts of the Maine legislature to broaden the tax base while lowering the rates.

Related Articles

A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.