Articles By Peter Mills
Maine Tax Policy: Lessons from the Domesday Book
On Saturday night, the 28th of the June, 1969, the state of Maine encountered one of its closest showdowns. With the state itself about to shut down for lack of a budget, the issue was whether to pass an income tax designed by Scott Fox, a Falmouth accountant, promoted by the Republican floor leader, Harry Richardson, and endorsed by the leaders of both the Republican and Democratic parties. Despite such support, the tax encountered stiff resistance from rank and file members on both sides of the aisle, including powerful members of the Appropriations Committee.
In an emotional roll call, the bill passed by one vote in the House when one opponent agreed to vote for passage only after he saw that the 100 other necessary votes were already up on the board. When later sent to the Senate, the bill failed of passage on first roll call. During a recess, one member was convinced to switch and it then passed the Senate by only one vote as well.
Because Governor Curtis supported the bill, he had to fight off a primary challenge in 1970 and came within 800 votes of losing the general election that fall. However, when the income tax by itself was later forced out to referendum by citizen petition in 1971, it was resoundingly approved by 75% of Maine voters.
Maine’s original income tax survived because it was fairly structured, simply designed, easily understood and efficient to administer. Leaders from across the political spectrum were willing to support the tax and to explain its utility. And most importantly, voters had a sense that the money they were sending to Augusta was being put to good use, that they were receiving back something of value for their investment.
I open with this story and highlight its significance because it stands in stark contrast to the present mood of the state and of the nation. To account for this change and trace its history is one purpose of this paper.
1. Why Taxes Matter
" Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule. Both commonly succeed, and both are right."
H. L. Mencken
We can not begin to discuss tax policy without first identifying two themes that may, at first, seem diversionary.
First, taxes are inseparable from appropriations. Revenue and expense are two sides of one ledger. It is only to support public programs that we must talk about taxes at all.
The past four decades have seen dramatic increases in state programs funded by growth in three new revenue sources: the sales tax; the income tax; and federal aid primarily through Medicaid. These pillars of support enabled the state to assume two new and significant roles: first as a dominant provider of social and medical services and second as an equal contributor to K-12 education.
Hard as it is to believe today, for the first two-thirds of the 20th Century, the major function of state government was to build roads and facilitate the expanded use of motor vechicles. Legislators elected in 1960 saw themselves primarily as highway engineers. While the Maine Department of Transportation and the Turnpike Authority continue to manage major sums today, they are now truly dwarfed by two other departments whose budgets outstripped them during the past forty years: the Department of Education and the Department of Human Services.
As a result, the two jobs of major significance to today’s legislator are these: first, to serve as a co-director of one of the world’s largest and most complex health insurers, the American Medicaid system; and second, to raise and distribute taxes as a revenue collector for local schools.
My second preliminary point concerns the political matrices by which public revenue is raised and disbursed. As our federal system has matured, it has become increasingly difficult to resolve questions of hierarchy, that is, to determine at what level of government our tax money should be raised and at what level it should best be spent, whether by local, regional, state or federal entities, or, as is increasingly more common, by some blended arrangement among agencies with each of them attaching conditions to the money as it flows from one tier to another.
To take one example, just setting up a child care center or a Head Start program in a local school involves a process so complex that it cannot be funded and managed without the help of professional grant brokers such as those employed by Community Action Programs. Ever since two income families became the rule, rather than the exception, access to child care has become essential to modern life. School Administrative District 49, the district around Fairfield, provides child care services in each of its four towns. While parents pay a fee for some of the programs based on their ability to pay, the centers are not self-supporting and could not stay open without substantial public supplements. Several streams of federal and state grant programs feed into each facility to support Head Start, Early Head Start and day care. Qualifying parents receive federal vouchers to subsidize day care fees. Pre-kindergarten education programs supplied by the school are partially paid for by general purpose aid from the state because students age four and older are counted under the state’s school funding formula. The whole program is administered and sponsored by the school district which supplies building space, utilities and payroll services. Many of the day care workers are regularly employed by the school district as educational technicians who receive their health insurance and pension plans from the school district and are thus able to moonlight in child care without burdening the program with their fringe benefits.
The recent history of the property tax illustrates further the complexity of current tax hierarchies. As recently as 1951, the last fiscal year before the Maine sales tax, one-sixth of the state’s general fund budget was raised through a statewide property tax collected through the towns, just as had been done since 1820. At the present time, by contrast, the state collects most of its revenue from its own broad-based taxes on sales and income and sends fully 43% of it back to local governments and property taxpayers in the form of school aid, revenue sharing, homestead exemptions, property tax rebates, business equipment tax reimbursements, local road assistance, tree growth refunds and general welfare assistance.
While many people regard such intricacies as tedious, dry, and without consequence, we need to remind ourselves that poor tax policy was the reason England lost control over its American colonies. Just a decade ago in Maine, tax upheavals caused another revolution that began with a shutdown in state government and led to the imposition of legislative term limits, a complete turnover in political leadership and the election of an independent governor as a rebuff to both warring political parties. Even more recently, it was the deficient tax structure of our largest state that produced the Terminator’s takeover of California.
Tax policy is dull stuff but it matters.
2. 1086, 1820, and All That.
" The nation ought to have a tax system that
looks like someone designed it on purpose."
In framing the U.S. Constitution, the founders of the American republic understood that the states would continue to support themselves primarily through "direct taxes" on people and property, often known as taxes on "polls and estates." Because the Commerce Clause forbids states from collecting tariffs, either among themselves or against foreign nations, that privilege was left to the federal government which supported itself until the Civil War primarily through tariffs and customs duties.
Meanwhile, states like Maine collected most of their money by directing towns to send in a portion of the property tax to the state. Our county governments continue to collect their revenue in this way today. While the idea of sending property taxes to Augusta seems foreign to us now, the statewide property tax remained in place until 1954 when revenue from a two cent sales tax supplanted it. As a source for school funding reform, the statewide property tax was revived in 1973 as the "Uniform Property Tax" and then repealed at referendum in 1977.
In the year 1086, William the Conqueror sent English public servants out to inventory his nation’s property and to create what became the Domesday Book. It’s purpose was to equalize the king’s property taxes among his subjects after the Norman Conquest. Public employees could well have done very similar work for the state of Maine during our first 130 years of statehood. For in the intervening millenium, the elements of our state tax structure had changed very little from feudal times.
As both the American republic and the states matured during the 19th and 20th Centuries, they became increasingly dependent on excises, taxes that are assessed on various privileges, such as forming corporations, conducting certain businesses, transferring real estate, and the like. Maine’s insurance premium tax, for example, has been in place since 1874. Beginning in 1934, a significant portion of state revenue came from an excise on alcohol and beginning in 1941 from tobacco. In 1951, the year before the sales tax, the three biggest general fund taxes were the taxes on alcohol, on statewide property assessments and on tobacco; all three were of about equal size.
However, the biggest tax of all at mid-century was the gasoline tax within the Highway Fund that was legally and administratively separate from other state finances. Forty and fifty years ago, the Highway Fund regularly accounted for one-third of all state spending.
The extraordinary demands on public infrastructure created by motor vehicles required very little sophistication in tax policy. It was enough to impose user fees and not broad based general taxes. Motor fuel excises, car registration fees, turnpike and bridge tolls and federal subsidies financed highways and their related debt service throughout the century of the automobile.
3. A Matter of Size -- Maine’s Great Growth Spurt.
" Giving money and power to government is like
giving whiskey and car keys to teenage boys."
P. J. O'Rourke
From 1963 to 2002, the highway budget, including federal subsidies, rose from $53.4 million to $422 million, only a little more than the six-fold rate of inflation. During that time, however, the Highway Fund dropped from 32% of the state budget to 8% as education and human services mushroomed. Education (both K-12 and higher education) grew from just $31.6 million to $1.25 billion, six times faster than inflation. The growth in human services was even more dramatic. The account grew from $16.8 million to $2.22 billion at a rate 22 times faster than inflation.
While transportation is funded by user fees, programs in education and social services require general taxes. Expansions in these programs occurred only because the state had new general revenue available from three principal sources: the sales tax, the income tax and federal matching funds.
The sales tax became effective on July 1, 1951, at a rate of 2 cents on the dollar. By 1969, the rate was up to 5 cents where it is today. In original form the sales tax statute contained 13 paragraphs of exemptions. Now there are 90 such paragraphs with numerous sub-parts. In spite of the narrowness of its base and its failure to include most services, the sales tax grew from $30.1 million in 1963 to $857.5 million in 2003, a rate that exceeded inflation by nearly five times.
The Maine income tax, after its passage in 1969 and validation by referendum in 1971, grew so fast that it eclipsed the gas tax in 1974. In another four years it exceeded the size of the entire Highway Fund, including federal subsidies. By 1986, combined revenue from corporate and personal income taxes had surpassed the sales tax. The rate of growth of the personal income tax averaged 22% per year in its first decade, 15% in its second and 6% in its third. Since collections began in 1970, the income tax has grown at 7.6 times the rate of inflation.
As an aside, I might note that the original American income tax was invented in 1861 by a New Hampshire Republican, Salmon P. Chase, who helped found the Republican Party and served as Treasury Secretary under President Lincoln. In 1994, Mr. Chase’s great, great grandson, Christopher St. John, founded the Maine Center for Economic Policy which has had a major impact on tax policy here in Maine.
The third source of new revenue is federal grant money. Invented in 1965, Medicaid is now a $1.4 billion program in Maine, consisting of 1/3 state money and 2/3 federal. Child welfare and protective services are similarly subsidized. 91% of the payroll in our state Department of Labor is federalized. Most major highways and bridges are built with an 80% federal match, as are many sewer plants and other environmental projects.
In 1963, the state received $41.6 million in federal grants. In 2002, it received $1.7 billion, representing a growth rate that was 6.8 times the rate of inflation.
Revenue growth from these three major sources has fueled a sea change in people’s expectations for state services. We now take for granted that the state is expected to supply:
care for most patients in nursing homes, including many from the middle class who have exhausted their own resources;
personal tutoring for any child with an impediment to learning;
free health insurance for families with household incomes below roughly the median level for all families;
child care vouchers to enable both parents in working class households to enter the workforce;
competent protection for abused and neglected children;
round-the-clock support for the mentally ill and disabled now residing in our communities;
respite for victims of domestic violence; and
environmental protection against a wide array of hazards.
We expected and received little of this in 1963. The state’s footprint on the Maine economy is 70% bigger than it was forty years ago. In 1963, state spending was 8.3% of Maine’s total personal income. In 2002, it was 13.7%.
Even reactionary observers foresee no likely retreat from such trends. Ours is today a society with great and civilized expectations. In 1963, the sexual abuse of children was commonly ignored. It is now recognized as an open and continuing crisis that consumes a wide range of state resources.
Highway building, once the king of state appropriations, has been superseded by Education and Medicaid. No one is comfortable living in a society where children are not well educated or where people are left to die in crowded charity wards because they cannot afford chemotherapy, coronary by-pass or nursing home care.
4. Staying Alive -- Hyperinflation in Health Care.
" If you think health care is expensive now,
wait until you see what it costs when it's free."
P. J. O'Rourke
There is no end in sight for the continuing escalation of health care costs. It is probably the most persistent and intractable domestic policy issue in America. Not only do high costs reduce access to care, but increased premiums paid by employers retard economic development by draining away capital as we compete against others with lower costs.
Health care inflation impacts state governments in a compound way. In the first instance, the state itself, as a labor-intensive service industry, provides a generous package of health benefits. Maine pays for health coverage for 41,000 employees, retirees and their dependents, over 3% of the population. When health care costs escalate, they affect the state as much as they do any private employer. The future unfunded costs for retirees is staggering. At present, the state has only $64 million in reserves to fund an actuarial liability of $1 billion in future costs for retiree health care.
The state is also a major purchaser of care for needy citizens. Providing health care to others consumes fully one-fifth of the state’s budget. Medicaid pays for 72% of all nursing home residents and one-fifth of all hospital admissions. Medicaid covers over 20% of the state’s population including those who are most profoundly sick. The state is the dominant supplier of care for the mentally ill and the developmentally disabled. When provider costs go up, the state must either increase its payments for such services or accept blame for shifting those costs onto private purchasers who buy from the same providers.
Health care inflation also affects state tax receipts. When employee fringe benefits become more expensive, employers hire fewer workers and salaries are crowded out by the added cost of benefits. Taxable wages are reduced and there are fewer business profits to reinvest.
From 1960 to 2002, annual health care costs grew from 5.1% of America’s gross domestic product to 14.9%. Because health care is such a "superior good" in the sense that it has greater intrinsic value than nearly anything else we buy, health costs in the future will continue to consume an even greater share of our incomes. Given what we spend to relieve heartburn, is there any limit to what we will spend to cure cancer? It is hard to imagine any product or service valued more greatly than one that keeps people alive and well on this planet.
Three economists writing in the July-August 2003 issue of Health Affairs report that real health care spending between 1945 and 1998 grew at rates far greater than GDP, 4.1% per year versus 1.5%. They project that if health care costs continue to grow even at a very conservative rate, say only 1% faster than the rest of GDP, then by 2012, health spending will consume 17.7% of GDP. By the year 2075, health care will consume 38%, or nearly 2/5 of our nation’s total spending.
The authors also assert, rather remarkably, that these future costs should be rendered affordable by the rate of growth in real income. Even while devoting 38% of our economy to health care alone in the latter part of this century, there should be enough money left over to buy everything else that we need or want.
With projected premiums at 2/5 of GDP, it is hard to speculate on what a future insurance system may look like; but it does seem clear that public spending for health care will dominate the picture to a greater degree than today. Even at present, there is clearly no private market answer for people whose family incomes are below 200% of the federal poverty line.
Ten years ago, the Health Insurance Association of America (HIAA) brought us Harry and Louise ads that killed "Hillary care," the Clinton universal health care initiative. However, only two years ago HIAA publicly agreed that people with incomes as high as 300% of poverty lack capacity to participate fully in the health care market without government subsidy. As newfound technologies and longer life spans drive up health care costs, people at ever higher levels of income will require public support.
Health care has become a lot like public education, electricity, the water supply or safety on airlines. It is a semi-public utility whose services people expect to receive when needed regardless of the ability to pay.
5. Why is Education so Costly?
" The only thing more expensive than education is ignorance."
"The schools ain’t what they used to be and never was."
State spending for education has not grown as fast as health care, but it has grown about seven times faster than inflation since 1963. It surpassed the Highway Fund in 1968. Public support for higher education has grown roughly in proportion to state aid for K-12.
Spending by towns on education has grown by less than 3 times the rate of inflation even though the property tax base, the value of all taxable property in the state, has grown slightly faster.
The state’s contribution to foundation funding for K-12 was only 24% in 1963 and is now up to 44%, having peaked out at 51% in 1989. However, the state has assumed an ever increasing burden of paying for all of the pension costs for retired teachers and 40% of their health insurance costs, neither of which is included in foundation school funding. When these are added to the total, the state’s level of support for K-12 education is nearly equal to the local share.
Student enrollments in K-12 peaked at 244,791 in 1971 and have since declined to 204,000. By 2012, enrollments are projected to decline still further to 186,000. It is pertinent to ask why costs for K-12 education have increased so much faster than the rate of inflation since 1963. One reason was the impetus to build new regional high schools under the Sinclair Act, a far-reaching 1957 statute that offered financial incentives for the creation of consolidated school districts. It produced a school building boom from 1950 through 1980. Another reason for growth in costs was a concerted effort to increase teacher salaries during the 1980’s, but salaries have since slid back to levels that are disconcertingly low. A recent survey from Education Week places Maine at 47th in the nation.
A third reason for increased costs is the trend to decrease class sizes and to enhance opportunities for children with special needs. According to recent surveys by Education Week, Maine has the seventh lowest pupil-teacher ratios in the United States for elementary schools (13.1 students per teacher in 2002 versus 16.0 for the nation). During the past ten years, student enrollments have dropped by 6% while the number of teachers has gone up by 10%.
The need for more teachers is partly explained by increased enrollments in special education which have gone up by 26.5% in the past ten years. 18.1% of all public school students are enrolled in special education. The national average is 13.3%. This partly explains why Maine is 12th in per pupil costs ($8232 versus $7376 nationally) even though teacher salaries are low. Maine is number 1 in the percentage of education costs spent on instruction rather than administration (67.3% versus a national average of 61.7%).
6. Envisioning Volatility.
" The ‘bungee cord’ effect: "spiralling increases in funding followed by sharp and potentially severe cutbacks."
Josephine LaPlante & Robert Devlin from
"Dollars & Sense" 1993
Our present revenue system with its reliance on sales and income taxes encountered a big test in the recession of 1991, and it failed. Although the recession was by no means severe in historical terms, its effects on the state budget were devastating and the political fallout severe. Sawin Millett, who was state budget officer at the time, recalls that revenues began dropping in November of 1990 and then continued to plummet in a sustained free fall from month to month with no predictable limit to the down side.
The abrupt downturn traumatized our state to the core and permanently altered its politics. Combined with the contemporaneous crisis in Workers Compensation, it even closed down government for three weeks. It brought the downfall of the Martin-Pray legislative era, the enactment of term limits, significant alterations to public pension rights, a number of tax increases and the election of a popular but politically independent governor with only a limited power base and effectiveness. Oversight of state government has since been left to transient legislators who have little institutional memory, who must struggle much harder than their predecessors to survive the door-to-door electoral process, and whose energies are focused mainly on the next campaign that starts 16 months after the preceding one ends.
Josephine LaPlante and Robert Devlin, after studying the budget crisis of 1991, laid the blame on hyper-elasticity in the state’s tax code. Her use of the "bungee cord" metaphor made it possible for every legislator to envision what volatility means. LaPlante and Devlin pointed out that one-third of our sales tax revenue comes from the sale of automobiles and building supplies. When the economy is depressed, few people buy cars or construct a home; when the economy picks up again, these purchases rebound. Because the state does not tax staples like food, home heating fuel and basic electricity, most revenue derives from the sale of big-ticket items that are deferred when incomes are down. Thus, the sales tax responds in a highly exaggerated way to changes in the economy. The tax lacks an adequate base to carry it through hard times.
LaPlante and Devlin further explained that the state’s income tax is similarly volatile because of its large standard deduction and high personal exemption levels, its graduated bracket system and its dependence on taxes paid by two-income families. In 2001, the state encountered another recession, and we learned that the income tax is volatile for yet another reason: capital gains. The state taxes long term capital gains as ordinary income, much of it subject to the 8.5% top marginal rate. Stock market gains fueled huge surpluses for most states during the last half of the 1990’s; but when the markets turned down in 2001, state income taxes for 2002 fell dramatically.
During the winter of 2001-02, our economic forecasters had predicted a large drop in revenue from capital gains precisely because of the recession and stock market drops that were already in progress; but when tax returns came in during the spring of 2002, capital gains had dropped much further than expected. The resulting loss in revenue caused major state budget crises, not only in Maine but in nearly every other state with an income tax that piggy-backs the federal system.
While most legislators understand volatility through a vision of the bungee cord metaphor, many assert on faith that volatility can be cured or greatly relieved by altering the structure of our present taxes. They suggest, for instance, that merely by broadening the base of the sales tax our revenues can be stabilized. I have a different view. It seems obvious to me that volatility is intrinsic to taxes based on sales or income since the revenue is derived from sources that are so intertwined with the instabilities in our market economy. Trying to stop volatility is like trying to dampen tides in the Bay of Fundy.
William the Conqueror knew how to avoid volatility; he taxed wealth and property. So did the state of Maine from 1820 to 1954. The big three taxes in 1951 (aside from the dominant and protected gas tax) were the taxes on tobacco, property and alcohol. Alcohol and tobacco taxes are notoriously regressive, that is, they are paid disproportionately by poor people; but they are also highly dependable. People continue to buy tobacco and alcohol in a recession. The property tax is also very stable, which is perhaps its major attribute. Californians voted to slash their property taxes in 1978 under Proposition 13 and place their faith in the income tax instead. In 1999, they were awash with silicon capital gains but in 2001, they were hammered by recession.
One can certainly reduce volatility in sales and income taxes by making them more regressive, for example by taxing food or by eliminating personal exemptions from the income tax. But even if poor people were willing to be taxed in this way, these taxes will still be highly sensitive to small swings in the economy. We cannot rely on either the sales or income tax to provide consistent support within the frame of a fiscal year. This is unfortunate because the need for most governmental services, such as those provided by school teachers, firemen and prison guards, is persistent. In a serious recession, the demands for many safety net services, such as welfare and Medicaid, actually go up substantially. They are counter-cyclical to the economy and to the taxes that support them.
7. Reaching Our Limits
" People who support unnecessary laws remind me of those who call the fire department to get cats out of trees.
Did you ever see a cat skeleton up a tree?
Cats come down when they get hungry."
Rep. Eddie Dexter of Kingfield
"Progress might have been all right once,
but it’s gone on too long now."
Current tensions over tax issues are not fully explained by volatility alone. We seem really to be confronting limits on what present systems will support, not only in Maine but in most other states. It may not be what we are able to do so much as what we are willing to do. People are simply in no mood to continue raising state and local taxes.
Our present Democratic governor captured the mood in his budget speech to the legislature on February 5, 2003, when he compared our plight to "an economic and financial ice storm--unavoidable and unrelenting. . . . I believe that raising taxes at this time is the wrong way to go. It sends the wrong message to our citizens and businesses, who, quite frankly, can’t afford more taxes. . . . Now is the time for fiscal restraint and discipline."
Contrast his speech with one given by Governor Ken Curtis in 1969. He spoke of Maine as a "Sleeping Giant," then awakening. The preceding year had a set a record for industrial expansion. 4000 new jobs had been created by 58 new firms in Maine; 97 others had expanded. Tourism had grown more than 15% in one year. New paper mills were going up. General Fund revenue had grown by more than 11% even without raising taxes. The state was able to supply a 40% increase in aid for education in 1968 and more was clearly coming.
Curtis confidently laid out a menu of new taxes to enhance programs like Medicaid, the most significant product of Lyndon Johnson’s Great Society. He suggested raising the sales tax, increasing the excise on cigarettes, adopting a new tax on soft drinks, removing the automobile trade-in credit, and creating an income tax on individuals and corporations. He listed half a dozen ways in which new taxes might be combined to enhance revenue. If Governor Baldacci had given such a speech to launch his governorship in 2003, he would have been shouted down. If one reads both speeches without knowing the authors, one would conclude that they are not both from the same political party. However, they are from the same party; they are simply governors in different times.
During the long runup in state revenues from 1950 to 1990, people seemed more tolerant of taxation. The availability of new taxes, often leveraged with federal matching money, made possible astonishing changes in the role of state government, primarily in education and social services; but people’s willingness to be taxed now seems exhausted. There is also the competitive factor. States are constantly comparing themselves with each other in their efforts to attract business. The phrase "race to the bottom" needs no explication. Grover Norquist and a host of conservative commentators have set the tone by asserting that all taxes are bad. Government in all forms must be shrunk. To slay the beast, cut off what feeds it.
It is not the purpose of this chapter to add yet another voice to the interminable debate over the proper size of state government. As a Republican I have my own views on a host of things that the government does badly; but my present concern is the lack of stability in state & local revenue. Instability breeds chaos and chaos leads people to adopt radical and thoughtless remedies to complex problems, remedies that are truly pernicious to our society.
Clearly, the states have no new sources of revenue on the horizon and the two major sources they have developed over the past 40 years -- sales and income taxes -- have proven unstable and unpredictable. They are also limited by competitive pressures among the states. In this climate, what policies should we pursue?
8. Do not Flee from Taxing Wealth
The Domesday Book "was perhaps the most remarkable administrative accomplishment of the Middle Ages."
William the Conqueror knew a thing or two about raising revenue. In 1086, he taxed his subjects according to their wealth and did appraisals to tax them fairly. In his day, wealth was tangible and therefore easier to assess.
Because most of our wealth today is intangible, because it exists in the form of patents, copyrights, credits at banks and shares of stock, and because such intangible wealth flows so freely from one jurisdiction to another, people argue that it is no longer fair to tax real estate for anything except the raw cost of the government services that real estate requires -- for example, the plowing of roads that lead up to it. It is argued that if we cannot tax all wealth fairly, then we should tax none of it except for the associated service fees.
People who make this argument ignore the fact that taxation is foremost a question of power: the state can tax only that which it controls. A prime example of a tax that failed for lack of power to collect it is the use tax that was passed by most states to complement the sales tax. Passed in Maine in 1951, its purpose is to create symmetry by imposing a substitute for the sales tax when articles are purchased out-of-state and brought into Maine. States have little ability to enforce a use tax on most items, however; to this day the use tax is seldom paid except on those products - like motor vehicles and boats - where the state asserts its power to collect through mandatory registration of the object taxed.
The fact that Maine cannot effectively collect a use tax on clothing bought in North Conway should not be used as an argument to abandon nearly a billion dollars worth of revenue produced each year by the sales taxes that we do collect in places like Freeport and the Maine Mall. By the same token, we should not give up taxing real estate just because we lack power to tax other forms of wealth.
Continuing to tax real estate is also justified because the value of real property is largely created by the state. Land would be worth little without access to a public road or to a fire department. Think about owning real estate in a jurisdiction without police protection. How much would one pay to buy a dude ranch in Afghanistan outside of Kabul? Its price would have to be discounted by what it costs to hire a standing army to protect it. The collective presence of a well-ordered state adds value that far exceeds the direct cost of services provided.
A state can only tax what it controls. The people of this state have to tax something to support themselves; and what else is Maine known for if not for its highly desirable real estate? It has been our most important attribute since English fishermen opened a store at Damariscove in the summer of 1608. We don’t have Alaska’s oil, Connecticut’s insurance companies, New York’s stock exchanges, Wyoming’s coal, or California’s silicon capitalists; but we do have some of the finest real estate on earth and lots of it. It is perhaps the biggest reason people move here.
9. Repairing the Property Tax
" The smart dollar goes where it is treated best."
Anthony Neves, Head of Maine Revenue Service
It is my long-standing, heretical thesis that Maine’s property taxes, in the aggregate, are not so much too high as they are dreadfully uneven in their burden. The current average municipal tax rate of 18 mills is the same as it was 30 years ago when the state first began systematically tracking all realty sales. From my review of town reports going back to the Civil War, I would say that property taxes were about the same 140 years ago in real dollars, but one would have to know more about early assessment practices to make that judgment reliably.
While it is true that revenue from the property tax has increased substantially in recent years, this is not because true value tax rates have changed. It is because property values themselves have risen so much faster than inflation. The total value of all taxable real estate in Maine rose from $7 billion in 1975 to $85 billion in 2001, a rate of growth that was more than three times
inflation. York County alone grows every year by an amount that equals the total value of all of Piscataquis County real estate. Hyper-inflation in real estate has aggravated unevenness in the property tax from one town to another.
This unevenness can be relieved by improving three tools that are already in generally accepted use: general purpose aid under the school funding formula; circuit breaker homestead relief; and municipal revenue sharing. All three are feedback systems that use state revenue to relieve inequities; and all three can be made to work better.
To improve school funding we need to adopt a system that defines essential programs and services. This will empower local citizens to know for the first time from an objective source what it should reasonably cost to provide an adequate education for K-12 students and to achieve statewide standards known as the "Learning Results." This will provide a more suitable denominator for the school funding formula. While some municipal groups complain that the state has failed to pay its intended 55% of foundation costs, it is only fair for the state to require that those total costs be reasonably defined and measured under a uniform standard.
We also need to expand our so-called "circuit breaker" homestead relief program by which the state refunds property taxes to people with limited capacity to pay. The state should provide better relief to people with middle incomes and burdensome tax bills: fishermen on Chebeague Island; retired people on lake front property; and the aged, the disabled and all others whose taxes are rising faster than their limited earnings. This program is by far the cheapest and fairest way to rectify property tax inequities. The money goes only to Maine residents; it goes to renters as well as homeowners; and the amount of relief is proportional to need.
Finally, our municipal revenue sharing system should be converted to what we call "revenue sharing II," which targets state money to service center towns where tax rates are highest, often five to ten mills above the state’s eighteen mill average. The most appropriate source for such money is to cut distributions to those communities whose taxes are well below the state average, those fortunate towns and cities that simply do not have a property tax problem. There are many in this state.
With these three refinements, there is no legitimate reason to abandon or limit the property tax which is a stable source of locally controlled revenue for towns and cities. Furthermore, 20% of our residential property taxes are paid by out of state owners, probably the highest ratio in the nation.
10. Much Greater Reserves
" I don’t want the cheese. I just want out of the trap."
Preserving the property tax as the base for our local revenue system is an important stabilizing measure; but the ultimate weapon against volatility is an adequate reserve. It is a myth that volatility can be cured through tax reform alone; spreading the base of the sales tax or reducing our dependence on capital gains may help, but only by a little. We might also consciously adopt more regressive taxes, for example by decreasing the income tax standard deduction or by imposing a sales tax on food; but these are unpopular proposals that would not solve the underlying problem. Volatility will persist because deep swings are fundamental to our new economy and support systems.
The best remedy is to plan for volatility through adequate reserves. States that succeed in managing volatility are happier places in which to live and enjoy more stable politics. Wyoming, the state with the smallest population, carries reserves of over $3 billion, largely derived from taxes on coal and mineral wealth. Alaska is comparably favored with reserves derived from oil.
Maine, with a population that is twice as large as either of these wealthier states, entered the last recession with reserves of about $140 million, roughly 6% of one year’s General Fund revenue. When the recession hit, the reserve was gone overnight.
It is commonly believed that politicians in a relatively poor state like Maine lack the willpower to set aside adequate reserves to weather recessions; but we have succeeded in doing so in other contexts. In the mid-1990’s our unemployment compensation fund had been in crisis for two decades. Reserves had fallen far below safety levels. Benefits were higher than we could afford. The supporting tax system was dysfunctional, and the burdens of the tax were unfairly distributed among employers.
Over several sessions of the legislature, a remarkably gifted bureaucrat in the Department of Labor, Gail Thayer, kept peppering the Labor Committee with suggestions for reform, together with graphs, printouts and numerous financial projections. After working on the problem for two years, the Labor Committee finally adopted a plan that reformed the system from top to bottom. Organized labor agreed not to oppose the loss of certain benefits; the Chamber of Commerce agreed not to oppose a tax increase; and the burden of the tax was thoroughly redistributed among employers.
Within a short while, reserves rose from $80 million to over $400 million. With such reserves in place, taxes on employers have been reduced to historically low levels. Maine now has the benefit of a well-funded system to protect workers and to buffer the state’s economy against recession and layoff. This was one of the most remarkable and unheralded achievements of the King administration.
The state has achieved a similar degree of resolve to protect pensions for state employees and teachers. In recent decades the state has accumulated $5 billion in retirement reserves and the Legislature continues to contribute $244 million annually, about 10% of the general fund budget, toward fully reserving the state’s pension obligations. These payments are now being made under the compulsion of a constitutional amendment created by the Legislature and endorsed by the public.
If we can create reserves of $400 million to protect the unemployed and $5 billion to protect retiree pensions, it makes no sense to say that the best we could do for the entire General Fund at the peak of the 1999 boom was to save $140 million in a Rainy Day account. Such a small amount might as well have been a Christmas Club.
11. Curbing the Borrowing Binge
" A promise made is a debt unpaid, and the trail has its own stern code."
Robert W. Service from "Cremation of Sam McGee"
The Legislature also avoids responsibility by borrowing money through bonds. State borrowing has become a perpetual gimmick to unburden legislators from having to raise money they do not have. Issuing bonds transfers the revenue decision onto the shoulders of successive legislators, not yet elected. With the advent of term limits, legislators have the lifespan of a fruit fly; no wonder we like to borrow money to postpone the issue of raising taxes!
One can understand why Maine borrowed to support the Civil War and the First World War, why Maine borrowed to complete highway systems between 1910 and 1965, to build regional high schools under the Sinclair Act in the 1960’s and to construct sewer treatment plants in the 1970’s; but why borrow now? We seem to do so as a convenient but sloppy habit carried over from earlier times.
In the spring of 2000, when Maine had surplus funds on hand at the height of the recent stock boom, we were unable to close the state budget without agreeing to borrow $33 million to build a state mental hospital in Augusta to replace one that had been in service for 150 years. The state had no sinking funds or capital reserves from which to contribute money to the cause. Yet, when I attend town meeting in Cornville each March, the town report lists several reserve funds to which the town appropriates money each year, in anticipation of replacing equipment or refurbishing buildings that will require future capital. The state also has such reserve systems on paper but does not permit department heads to use them. When revenues drop off, the Legislature drains all the money from such accounts as it did during the recessions of 1991 and 2002.
The Legislature has fallen into the habit of putting out a bond referendum each year to fund the entire capital program for highways and bridges. As these bonds have accumulated from prior legislatures, lawmakers debate interminably over whether to raise the gas tax to pay for what our predecessors spent. In the meantime, we send out bonds of our own for future legislators to fund. If we want the public to validate our capital programs, then the legislature should put such issues on the ballot in a bill that includes the taxes that must be raised to pay for the proposed improvements.
Instead of passing the buck to our political successors, we should, by including the tax increase in the question itself, invite voters themselves to choose whether to pay more for gas or to drive on bad roads and spend their money instead on new tires and tie rods. There is no right or wrong answer to this perennial issue; it is an economic decision that the public should participate in making. Of course, sand and gravel lobbyists do not want the legislature to put these tough questions out to public vote, for fear that projects will be rejected when voters must balance them directly against the tax revenue required.
It is good politics for leaders to include voters in decision making whenever feasible and to frame rational choices for voters to make. The referendum process is as underused by the Legislature as it is overused by special interest groups with an axe to grind.
12. Our Town, Regionalism and Avuncular Federalism
" As Americans we sometimes suffer from too much pluribus
and not enough unum."
At present, there is widespread disaffection with our tax systems at all levels of government. Congress is responding by cutting taxes of all kinds, the good ones along with the bad; and these cuts are being made without any regard for their effect on the states whose own tax systems are keyed to the federal. Most states are finding it difficult to conform to the estate tax reductions and few have conformed to the rapid depreciation provisions that Congress passed retroactively in response to the tragedy of September 11, 2001.
The popularity of the estate tax repeal has been especially confusing to people like Warren Buffett and Bill Gates who, although highly affected by the tax, also believe that preserving the tax is sound policy. As James Carville, the "Raging Cajun," recently complained, "If we Democrats can’t even tax a few dead Republicans, we may as well give up and call ourselves the ‘Pro Choice Party’ ‘cause dat’s de only dam issue we got left." The estate tax is under attack because it was left unattended for so long by Congress. As the rate of tax remained high and exemption levels failed to increase with inflation, small business owners began to perceive the tax as confiscatory.
What is true of Congress’s treatment of the states is also true of the state’s treatment of municipalities. During the 1990s the Legislature was constantly reminded by the Maine Municipal Association (MMA) of the need for reforms in the complex revenue systems shared by state and local governments. Because those of us who espoused incremental reforms were not able to carry the day, the MMA by-passed the Legislature in order to present property tax payers directly with a radical and inappropriate referendum proposal.
If we in the Legislature contend that reform and consolidation at the municipal level is crucial to our future, we need to ask why there have been no new school districts created since 1969. If we complain that there are too many fire houses within five miles of Augusta, we need to ask what the state has done to encourage merger and inter-local participation. To avoid political cataclysms, we must create incentives for progress, even if only in small doses, and be ready to reward victory at each stage.
Taxes of any kind do not long survive except by consent of those who pay them. The American revolution taught King George the Third that this is true for monarchies as well as for democracies. I believe that William the Conqueror conducted his extensive Domesday inventory in 1086 precisely because it was such good politics for him to do so, even though his intrusions were resented. Listing all property in the kingdom was a way of assuring his subjects that they would be taxed evenly. As we know from recently published psychological experiments, a perception of fairness even among monkeys and little children is an instinctual motivator of paramount importance in gaining consent to desired behavior.
Voters are more sophisticated than they are given credit for. Collectively, they know whether they are receiving fair value for the money they invest in the machinery of government; but the choices presented to them are too often limited and inappropriate. Those whom they entrust as political leaders assume a very special burden. I believe that burden includes not only a duty to frame appropriate choices for public decision, but also to propose changes to our laws in timely ways that are responsive to the constant fluidity of our social, economic and political lives.
February 1, 2004
Bibliography of Sources for
State Financial Information
Compendium of State Fiscal Information from the Office of Fiscal and Program Review (287-1635) summarizes the recent history of all major sources of operating revenue and expenditures plus debt obligations and per capita comparisons with other states.
The first volumes of the Governor’s Budgets submitted in January of 2001 and 2003 contain helpful pie graphs and analytical material on budget issues.
Any recent Maine General Obligation Bond, available from the State Treasurer (287-2771), contains a large quantity of fiscal information about the state, much of it in narrative and graphic form addressed to potential investors.
Reports of the Maine State Revenue Forecasting Committee, available from the State Planning Office (287-3261), outline four-year projections for revenues and the economic assumptions upon which they are based.
Summary of Major State Funding Disbursed to Municipalities and Counties from the Office of Fiscal and Program Review (287-1635) summarizes the recent history of all sources of state support flowing to Maine’s municipalities.
Municipal Valuation Return Statistical Summary, published by the Property Tax Division of Maine Revenue Services (287-2011), contains a complete profile of the property tax for every town plus aggregate figures by county and state.
Commissioner’s Recommended Funding Level, published each December by the Department of Education (624-6790), contains a complete outline and recent history of the K-12 school funding formula which accounts for 30% of the General Fund budget.
Medicaid in Maine, an annual report from the Bureau of Medical Services of DHS (287-2674), the state’s largest health insurer, outlines recent trends in Medicaid spending broken down into components. The state’s share of Medicaid accounts for 1/6 of the General Fund budget and is leveraged with a two-to-one match from the federal government.
Maine State Retirement System Annual Report outlines the recent history of all state, teacher and local pension systems administered by MSRS (287-3461) including investment returns on $7B of assets. State and teacher pensions cost about 10% of the General Fund. The state’s unfunded liability is $1.9 billion, nearly an entire year’s General Fund tax revenue.
Maine Tax Incidence Studies printed in December of 2000 and 2002 by the Research Division of Maine Revenue Services (287-6965) explains where state and local tax revenues come from and who pays them. It includes comparative data from other states. Economist Mike Allen is the Bureau’s chief analyst.
A Golden Opportunity II published by the Maine State Planning Office (287-3261) in December 1999 outlines how Maine can enhance the retirement industry. A valuable part of the document is Appendix C, a report entitled "Taxes and Retirement in the State of Maine" prepared for the Libra Foundation by the Kennedy School. This study contains an insightful general profile of Maine’s state and local tax structure and addresses how Maine’s wealthy retirees interface with high taxes and cold winters.
The Maine Policy Review published three times a year by the Margaret Chase Smith Center for Public Policy at UMO contains a wealthy analytical history of policy issues relevant to our work as Maine legislators. Past articles are available in the Law Library and can be downloaded from www.umaine.edu/mcsc/mpr.htm .
Maine Center for Economic Policy (622-7381) and the Maine Municipal Association (623-8428) are constantly publishing fresh and valuable analytical work of use to Maine legislators. Of recent note is Frank O’Hara’s Maine Revenue Primer published by MECEP in April of 2003, a lucid explication of Maine’s revenue sources.
Dollars and Sense by Josephine LaPlante and Robert Devlin published by the Muskie Institute in 1993 is an encyclopedic analysis of how Maine raised and spent revenue during the decade of the 1980’s and what went wrong in 1991. The authors’ recommendations are still relevant and largely unfulfilled.
The Condition of K-12 Public Education in Maine published each year by the Maine Education Policy Research Institute (780-5044) contains a wealth of information on public education and school funding as well as census and income data to put education issues into perspective.
Health Affairs, published six times a year with supplements on the web, is the nation’s pre-eminent clearinghouse for policy studies on health care. Recent articles on cost trends include:
"Increased Spending on Health Care: How Much Can the United States Afford?" by Chernew, Hirth and Cutler in Vol 22, #4 (July/August 2003)
"Health Spending Projections for 2002-2012" by Heffler, Smith, Keehan, Clemens, Won & Zezza in the Web Exclusive Series (published February 7, 2003).
"Is Technological Change in Medicine Worth It?" by Cutler and McCLellan in Vol 20, #5 (September/October 2001).