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MHPC Analysis: Pruning Maine's Tax Tree

by Scott Moody, Chief Economist, The Maine Heritage Policy Center

Maine’s tax system is so complicated and onerous, it can be almost impossible to know where to begin reforming it. The bottom line, however, is that there are simply too many types of taxes in Maine.

First and foremost, Maine needs to start pruning the tax tree. The one tax that is the most damaging to Maine’s overall economy is the retail sales tax. There are several reasons why the sales tax is especially troublesome:

First, the general assumption that broadening the sales tax base is a good idea is flawed. The genesis of the retail sales tax in the U.S. was in response to the economic damage created by the gross receipts tax (GRT) which was more prevalent a century ago. The tax base of the GRT is the total receipts of a business. Taxing gross receipts creates an economically-destructive “tax pyramiding” through the entire production structure of the economy.

To fix this problem, exemptions were created to transform the GRT into a retail sales tax that more resembles a consumption tax. However, due to the problem of “dual-use,” where a good or service can be used for either business or personal reasons, exemptions have proven to be a crude and often ineffective way to create a pure consumption tax. Simply eliminating exemptions, especially on services, will only serve to rebuild the GRT Frankenstein monster piece-by-piece.

Second, the sales tax is a tax on investment. Since the retail sales tax can never be fully eliminated on the products purchased for business use, the sales tax acts as a tax on investments businesses make on infrastructure or raw material. This is especially detrimental to Maine’s construction industry where nearly all of their material costs are subject to the sales tax. This not only raises the cost to the consumer, but also to the construction companies themselves since their suppliers are also subject to the same tax on their materials. The end result is less money available for future investments, which compounds over time.

Another negative impact of the sales tax is when Mainers engage in cross-border shopping in sales tax-free New Hampshire. A recent study found that Maine’s economy could be as much as $2.2 billion higher per year along the border if we had the same level of retail sales as New Hampshire.

Maine is also the beneficiary of cross-border shopping with Canada. While that relationship is complicated due to currency fluctuations, there is a large tax incentive for Canadians to shop in Maine thanks to their high taxes on consumption.

Additionally, the issue of sales tax compliance costs is a serious one. Maine’s economy is dominated by small businesses which have the most difficulty in complying with the tax code. Sales taxes are particularly onerous since the taxability of goods and services can vary greatly—even within a single business establishment.

Also, administratively the state cannot piggyback on a federal sales tax as it does with the income tax. As a result, the state bears the full cost of enforcing the sales tax.

Of the problems mentioned above, the one that can be the most quickly addressed is cross-border shopping. Historically, cross-border shopping did not become a major problem until Maine’s sales tax rose over 4 percent. However, since far more people live on the border today than in 1963 (when the sales tax rate first hit 4 percent), the sales tax rate would likely need to fall to 3 percent to seriously reduce cross-border shopping.

This two percentage point drop in the sales tax rate should be paid for by spending reductions which would cost approximately $400 million. However, the total revenue costs would be significantly lower since more retail sales would be occurring in Maine boosting the remaining sales tax, income taxes and excise taxes. This dynamic effect would likely occur relatively quickly since it does not depend on new retail activity, only a shift in where the spending is already occurring.

More comprehensively, the remaining 3 percent sales tax should be phased-out as part of a broader consolidation of businesses taxes—including the corporate income tax, Schedules C (sole-proprietors), D (capital gains), E (partnerships, subchapter S, etc.) and F (farming) of the individual income tax, and the estate tax. These taxes should be folded into a Business Enterprise Tax (BET) which now has a successful track-record in New Hampshire of almost 20 years.

The BET is the best tax tree pruner since it is rationally designed as a type of value-added tax that comprehensively taxes all consumption at the business level. In doing so, it excludes all investment/saving by business which is critical to boosting the long-term growth rate of Maine’s economy.

By shifting away from the compounding negative effects of a sales tax, and by consolidating business and income taxes into a more targeted Business Enterprise Tax, Maine businesses will finally have a common-sense tax structure to work within.