January 14, 2013

LePage's proposed budget includes income tax increase

Two-year suspension of inflation indexing could spell $8.6 million increase in income tax collections

By Steve Mistler smistler@pressherald.com
Staff Writer

Gov. Paul LePage's two-year budget makes no mention of a tax increase, but it will raise the tax bill of the average Mainer by $49 over the next two years.

The proposal relies on subtle but lucrative changes to the state's income tax indexing. How it would work is complicated, but the result is a projected increase of more than $8.6 million in state income tax collections over the next two fiscal years beginning July 1 and an estimated $1.5 million in the subsequent years.

If the Legislature approves the plan, average Mainers who pay income taxes will see a combined two-year increase of $49 in their tax bills, according to Michael Allen, LePage's associate commissioner of tax policy. The annual effect on taxpayers beginning in fiscal year 2016, when the biggest indexing change goes into effect, is unclear, but critics of the change argue that it disproportionately hits low- and middle-income earners.

The proposal is included in a two-year, $6.2 billion budget plan that includes several controversial measures designed to protect a $400 million income tax cut package passed by the Legislature in 2011. Among the most contentious provisions is a two-year suspension of state aid to municipalities -- a proposal Democrats and the Maine Municipal Association have described as a massive tax shift that will lead to either cuts in community services or increased property taxes.

The income indexing change has drawn less attention so far, but it too is beginning to generate opposition.

"There is no other way to see this than a tax increase on middle and low-income Maine families," said Speaker Mark Eves, D-North Berwick, in a statement. "Coupled with the cost shift from eliminating funds for our cities and towns, it only does more harm to Maine's struggling economy, our people and small businesses."

The budget provision calls for a two-year suspension in the state's indexing of the individual income tax rate. Indexing is used to link tax or benefit rates to inflation. For income taxes, it's used to offset wages that climb into higher tax brackets without any corresponding increase in purchasing power.

After the two-year suspension, the state's current consumer price indexing could be replaced with "chained consumer price indexing." The new metric essentially leaves people in a higher tax bracket for a longer period of time than the old one, thus allowing the state to collect more in income taxes.

Chained CPI has been around for years, but it has been popularized recently during congressional lawmakers' negotiations in the fiscal cliff deal. It's expected to remain a hot topic in the upcoming battle about the nation's debt ceiling.

Debt reduction hawks champion chained CPI as a way of reducing the national deficit. Congressional lawmakers have discussed using the index to reduce Social Security costs and in federal tax brackets. It's been heralded as a deficit reduction tool by the conservative Heritage Foundation, the Simpson-Bowles deficit commission and the Committee for a Responsible Federal Budget.

Allen, with the state's tax policy division, said the national talks about the indexing prompted the LePage administration to include it in its budget. Allen said he did not know whether other states had adopted the indexing.

Former state economist Charles Colgan, now with the Maine Center for Business and Economic Research, said he was not sure whether Maine ever had considered adopting chained CPI previously for income taxes.

Allen and Colgan agree that chained CPI may be a more accurate measurement of inflation and the cost of living.

However, critics argue that using chained CPI hits low- and middle-income earners harder by leaving them in higher tax brackets longer. Meanwhile, top earners aren't affected as much because they're already in the highest tax bracket.

"It does have distributional consequences," Colgan said.

Allen said Monday that Maine Revenue Services had not yet done a full analysis of the indexing change to calculate its effect on the state's income tax brackets. Nonetheless, the indexing change probably will reduce the tax cut that some Mainers would receive in the reduction package passed two years ago.

The tax cut package passed in 2011 reduced the number of tax brackets from four to three and eliminated income taxes for about 70,000 Mainers. Allen said some of those people could end up paying taxes if the indexing plan is adopted, although it would be a small amount.

The effect on middle-income earners would be greater.

According to Maine Revenue Services data, 40 percent of Maine taxpayers earn less than $27,312, while another 40 percent earn more than $47,255. That middle-income group will see an average tax cut of $119 this year, according to a recent analysis by the Portland Press Herald.

However, some of those people could see a reduced tax cut benefit because of the proposed indexing. Earners at the lower end of the middle bracket could end up receiving a lesser benefit than if the current indexing metric remained in place.

Meanwhile, critics argue that the proposed change wouldn't affect most of the state's top earners because they're already in the top income bracket.

Allen said the anticipated revenue derived from chained CPI was modest but immediate.

"The chained CPI is probably raising $1 million or $1.5 million in the first year," he said. "It's the cumulative effect down the road where it would generate really meaningful savings. Even at the federal level, it certainly has an impact right up front."

Chained CPI has many supporters at the federal level. Allen echoed their argument that the indexing is probably a more accurate reflection of inflation and cost of living.

However, opposition is mounting, with critics calling it a regressive tax scheme that allows politicians to increase tax revenue without the exposure of raising rates.

That narrative will become part of the debt negotiations at the federal level. In Maine, the indexing could become part of a larger budget debate about the tax-cut package.

Steve Mistler -- 791-6345
smistler@pressherald.com

 

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