Tax Policy and Economic Development in Maine: 
A Survey of the Issues

Prepared for the
MARGARET CHASE SMITH CENTER FOR PUBLIC POLICY
University of Maine

by Matthew N. Murray, PhD
Professor of Economics and Associate Director
Center for Business and Economic Research
University of Tennessee, Knoxville

August 2002 

Funding for this project was provided by the U.S. Economic Development Administration and the University of Maine. The author would like to thank all of those individuals who have taken time to share their views on tax policy and economic development in Maine. All views remain those of the author. 

Executive Summary

This report focuses on tax policy and economic development in Maine. Separate reports have been prepared as part of a broader project that includes examination of economic development trends and workforce development issues. The purpose of this report is to provide a foundation for discussion and debate of tax policy options generally and, in particular, those relating to economic development in Maine. The work in this report begins with a brief discussion of the linkages between tax policy and economic development. The discussion then turns to the criteria used to structure tax policy (known as the requirements of a good tax system), state and local revenue trends, and specific state and local taxes. Extensive references to the research literature are offered to enable the reader to probe more deeply into specific areas of policy interest. This report is simply the tip of the iceberg. 

Several general conclusions emerge from this report:

1. Tax policy and economic development need to be considered in the broader context of state-provided services and state aid, and the structure of local government finances and service delivery. The fiscal system of Maine is not transparent to most taxpayers; finances are heavily centralized at the state level; state aid (particularly aid to education) limits the flexibility of state government and there is essentially no local government tax autonomy. These problems are interwoven and cannot be easily addressed in isolation.
2. Public policy should be based on well-established goals for the tax system and economic development. Tax policy goals should recognize the accepted tenets of a good tax system, including tax fairness; revenue yield, stability and elasticity; neutrality and economic development; and low costs of administration and compliance. In practice these goals can be in conflict with one another, giving rise to difficult choices for policymakers. Similarly, economic development policies — including economic development incentives — must be based on specific goals and must be amenable to evaluation to gauge effectiveness.
3. The state should sustain a relatively strong degree of overall tax system elasticity to allow for maintenance of a strong rainy day fund and to enable investments that are not possible during periods of weak revenue growth.
4. Efforts to promote tax fairness should rely on the personal income tax, not the sales, corporate income or property taxes. The personal income tax allows policy to focus on the specific circumstances of households, unlike other taxes.
5. Greater revenue balance, such as diversity in revenue sources, is needed at both the state and local levels. The state relies too heavily on the personal income tax, while local governments have no viable alternative to the property tax. 

More specific recommendations include:

1. Maine’s personal income tax rate structure should be compressed, potentially moving to a single flat rate. The current structure includes a rapidly progressive rate structure that can distort economic activity. The rate structure of the personal income tax should mirror that of the corporate income tax.
2. There appears to be some room to increase selective sales taxes, meaning the unique rates levied on specific items such as alcoholic beverages and tobacco. While these items tend to grow slowly with economy-wide growth, they can still be an important complement to the over-all state tax base. Concerns over the regressivity of such levies should be addressed through the income tax.
3. Maine has largely mirrored the nation with its corporate income tax, adopting a double-weighted sales factor for corporate income apportionment and enabling limited liability entities. But the evidence suggests corporate tax burdens in Maine have not fallen to the same extent as the pattern for New England and the nation. Further analysis of this issue is clearly warranted, given the importance of the corporate income tax to economic development. There is no clear understanding today of Maine’s corporate tax burden relative to other states, particularly as it pertains to tax burdens for specific sectors of the economy and for firms of different sizes. Consideration should be given to elimination of the progressive corporate rate structure, moving to a flat rate commensurate with the suggested flat rate on personal income. Consideration should also be given to a business enterprise tax, akin to that in New Hampshire, as a replacement for the corporate income tax. Such a policy would expand the business tax burden to all firms, allow for low rates of taxation and provide a more stable flow of revenue.
4. Efforts should be made to move the sales tax closer to a true consumption tax. To the extent possible, business sales tax burdens should be reduced, as the sales tax borne by business exceeds the burden of the corporate income tax. Consumer services should be added to the base of the sales tax to the extent possible.
5. Grocery food should be added to the sales tax base, enhancing revenue yield and stability, increasing tax exporting opportunities, and simplifying administration and compliance. Relief can be provided at a substantially lower cost through the personal income tax, including refundable credits for low-income households.
6. The state should avoid pressures to reduce the elasticity of the sales tax, especially through tax rate reductions. External forces are at play that are working to lower the performance of the sales tax, including the continued growth in mail order sales, electronic commerce and the service sector.
7. The system of local government finance is broken. The historical benefit-property tax linkage no longer exists. The presence of the Business Equipment Tax Reimbursement (BETR) program, Tax Increment Financing (TIF) districts, circuit breakers and homestead exemptions under the property tax, coupled with no other local tax instruments of note, compromises local government’s ability to provide services and its responsibility to be accountable for the same. Consideration should be given to wiping the slate clean and simply lowering property taxes from their current levels in a revenue-neutral fashion. These issues must be addressed prior to the enabling of additional local taxing authority.
8. Specific options for expanded local taxing authority should be developed. Local options sales taxes and gross receipts taxes are particularly attractive options for consideration. Regional tax base sharing, or state aid, should be used to help equalize tax capacity across municipalities. 

These are some of the more important recommendations that follow from the review of economic development and tax structure in Maine. The full report provides background and a more complete discussion of the issues.

Click here to view the entire report in htm format.

For more information concerning this report or for additional copies, please contact Chris Boynton at mcsc@umit.maine.edu.