Maine’s Tax Reform Efforts

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.