We have had a few winter storms come through the area recently with more on the way. Another type of storm appears to be forming in Augusta. This particular tempest touches on the topic of taxes. As promised, Governor LePage is striving to eliminate our Maine state income tax.
This potential policy pursuit offers us an opportunity to explore three postulates of economics, namely that: 1.) decisions are made at the margin, 2.) people respond to incentives, and 3.) we face trade-offs.
First we look at the governor’s own thoughts on the subject. As I understand it, the governor’s public addresses on the subject have centered around the needs to catch up with the rest of New England in job growth, and remain competitive with larger states for the attraction and growth of new enterprises. He feels that eliminating the income tax is essential for this.
Is Maine’s income tax abnormally high? It is rather high as state income taxes go. At a rate of 7.95 percent for the top tax bracket, only seven other states plus the District of Columbia have higher maximum tax rates. These include our neighbors Vermont, New York, and New Jersey at nearly 9 percent. The center of gravity across the U.S. seems to be around five or six percent (Massachusetts has a top rate of 5.25 percent).
Would lowering or eliminating the Maine income tax make us more competitive in attracting businesses to the state? That is a complex question, but it might be a question of putting a cart before the horse.
Is Maine actually lagging in job growth? Do we have a problem we need to address? At the last employment report, the national unemployment rate was 6.7 percent versus Maine’s rate of 5.7 percent. Private sector job growth has been quite good in Maine. It is the public sector in Maine which has held back our recovery, shedding 5,000 workers in recent years rather than expanding public services. With that said, good quality year-round jobs are not overly plentiful in Maine. We could benefit from better employment.
Could we potentially attract more commerce to Maine by eliminating income taxes? That is a definite possibility. Economic decisions are made at the margin and people respond to incentives.
Back in 1991, Connecticut reduced its investment income tax from 13 to 4 percent by introducing an employment income tax of the same 4 percent. This encouraged a number of large hedge funds to relocate from New York City to Connecticut.
However, there are limits to what we can expect. A couple of decades ago the so-called Chunnel (Channel Tunnel) was the buzz around town in London. Some folks felt the Chunnel would equalize real estate values between costly southern England and bargain-basement Normandy.
The problem with this prognostication was apparent to others. Southern England is the very best of the British Isle. Normandy is the worst of France. They can never be equal.
This story comes to mind when I think of a business migration to Maine. Our beloved state is considered by most Americans to possess a harsh and formidable climate. Wimps! However, each of us knows someone who grew up here, and loved this state as none other, and yet left for warmer climes.
What has this to do with income taxes? Maine has rather little chance of attracting businesses from sunny California, but Massachusetts, New Hampshire, and Connecticut are another story.
The families of these states are accustomed to cold winters, and which of these has a better summer than Maine, and can boast of greater beauty? So a reduction in the income tax might actually tip the balance for some businesses to relocate here. This would especially be the case for corporate executives who already summer in Maine.
However, tax rates are not the first issue one investigates prior to relocation of an enterprise. Businesses are made up of families. Families include children. Children require education. Are Maine’s schools up to snuff?
According to the latest U.S. News and Business Report on schools in America, Maine scored number one in the nation as having the highest percent of “gold” and “silver” schools. We have a good story to tell here. If the income tax is eliminated will that story change through reduced state funding to education? That is an important consideration. We face trade-offs.
Families are also concerned with medical care and social services. When our family relocated to Maine in 1997, we were impressed by the services available for our severely disabled son, Michael. It has been disappointing to see how the state funding support for the mentally disabled has dwindled during the past several years.
In the area of health care, we have a challenge in competing with our neighbors in New England, all of whom rank in the top 10 in the U.S. for quality of healthcare, according to the latest statistics compiled by America’s Health Rankings. Maine scored 20th. If the income tax is eliminated, will we climb toward Massachusetts, ranked three, or fall toward Texas and Florida ranked 31 and 32 respectively (neither of which have an income tax)?
We face trade-offs.
Doubtless the most important consideration in eliminating our income tax concerns tax regressivity and fairness. A tax is said to be regressive when lower income families pay a higher share of their income than do wealthy families. A tax is progressive when the opposite is the case. Proportional taxes are those in which all pay the same percent of income.
All states in the U.S. have regressive tax structures. In every state the lower income earners pay a much higher share of their income to support state and local services than the wealthy. In the U.S. as a whole, the lowest 20 percent income earners paid 11.1 percent of their income in state and local taxes versus the top one percent who paid only 5.6 percent, according to the Institute on Taxation & Economic Policy. (www.itepnet.org – For those interested, their paper entitled “Who Pays” is very instructive and contains interesting charts and data.)
At the moment Maine can boast of being among the least regressive states in the country. In 2010, the lowest 20 percent income earners paid 9.6 percent of their income in taxes compared to the top one percent who paid 6.9 percent. More recent changes to our tax structure have moved us in a somewhat more regressive direction.
What will the elimination of the income tax do to our tax structure? This is easy to answer. All of the taxes in Maine are highly regressive, except for the income tax which is progressive. If we eliminate the income tax, we will unambiguously become much more regressive. This is, in effect, a redistribution of income from the poor to the wealthy.
States such as Texas and Florida have no income tax. The bottom quintile of wage earners pay roughly 13 percent of their income in state and local taxes compared to the top one percenters who pay 2.3 percent in Florida and 3.2 percent in Texas. This is the direction Maine will also go if we eliminate the state income tax.
The trade-off for the possibility of more jobs at the margin, is the certainty of higher taxes for the poor and lower taxes for the well-heeled.
In summary, elimination of the state income tax might attract some businesses if we can find a way to maintain education and improve our healthcare system. It will also redistribute tax moneys from the poor and middle class to the wealthy.
There is yet another important element of this debate which we will examine next week.
(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
