A RESPONSE TO RICHARD WOODBURY’S WORKING PAPER ONINCOME TAX REFORM IN MAINE - How it Works and Who Benefits?By: Albert A. DiMillo, Jr. retired Corporate Tax Director, CPA and life-long DemocratMr. Woodbury’s working paper on income tax reform in Maine has some usefulinformation, but it contains factual mistakes and leaves out many facts that one wouldneed to fully understand Maine’s so called “Tax Reform” and “How It Works and WhoBenefits?” The result is the paper is at best incomplete and misleading.On page 1 of the paper; the author repeats the false and misleading statement that “thereform is calibrated to retain broadly similar progressivity in tax burden across theincome distribution, while lowering the income tax assessments on 96% of residenttaxpayers.”The 96% comes from a new Maine Revenue Services (MRS) report of the impact of thenew tax law (LD 1495) on the income tax for the year 2010. However, what is notincluded in these numbers is the MRS estimate that at least 50% of low income taxpayerswho currently don’t pay any income tax will only have an income tax decrease, if theyfile an income tax return to receive a $50 - $70 tax refund. MRS estimates that at least50% of these taxpayers will not file for the refunds, because of the small amount of therefund and the cost to file the return. (In calculating the revenue impact of the new lawMRS estimated that $5.7 million of these small refunds would never be collected and thatthis revenue was utilized to help make the law revenue neutral). When one includes aconservative estimate of 125,000 low income non filers, the percentage of Mainers withan actual income tax cut goes down from 96% to 77.6%. The other fact missing from theauthor’s analysis is that the MRS report for the year 2013 shows that the number of Mainer’s with an income tax decrease goes down another 3% to about 74.6%, becausethe new law does not index the income tax for inflation until 2014, as compared to the oldlaw that had inflation adjustments every year. Finally, what the author does not tell youis that 100% of Mainers will see a sales tax increase, that eliminates the vast majority of the income tax decrease in year 2010 and by 2013 the average taxpayer will have a smallnet tax increase.With regard to the progressivity, the income tax cuts for the most wealthy Mainers is over 18%, which is more than twice the percentage income tax cut for all other Mainers,which averages less than 9%. In addition, when one adds in the regressive sales taxchanges, the net tax changes reduce the combined income and sales tax progressivitysignificantly. The MRS report for year 2013, estimates that a group of 4,638 taxpayerswith income over $350,810 will get a net income and sales tax cut of $34.8 million. Theother 99.3% of Mainers will have a net income and sales tax increase of $3.5 million. Noreasonable analysis of this fact could conclude that this result improves the progressivityof Maine’s sales and income tax systems.On page 3, the author describes the new law’s “Structural Reform” which replaces personal exemptions and standard or itemized deductions with a limited and phased out

household credit. The word “Reform” is used by the author and proponents of the newlaw in such a way that many might assume the “Reform” makes the system better. Infact, of the 42 states with an income tax, 32 states allow personal exemptions, standarddeductions and itemized deductions like old Maine law before LD 1495, 8 states allowedno itemized deductions and 2 states allow limited itemized deductions. Under LD 1495,Maine would allow a limited tax credit that will partially replace itemized deductions for taxpayers. Accordingly, Maine will move to an income tax structure like no other state.The new credit system is much more complicated than the old system and the author doesnot give any arguments why this new credit structure is better than the old system.On pages 4 – 10, the author illustrates detail calculations of the income tax under the oldlaw and the new law for various income levels and prepares numerous graphs that arerelatively uninformative, because they only look at the income tax changes and do no addin the sales tax increases for the various income levels. In addition, the author’scalculations are correct only for the year 2010 and do not attempt to calculate the impactto taxpayers in years 2011-2013, which will be different due to lack of inflationadjustments until 2014 under the new law. It is unclear whether the author did notunderstand the substantial impact of the lack of inflations adjustments in the new law, or if he just intentionally left this information out as most proponents of LD 1495 have doneto date on this issue.On pages 4-5, the author prepares detail calculations of the income taxes due under theold law and the new law for a family of four with $90,000 of income and $20,000 of itemized state deductions. He calculates the income tax under the new law as $3,475 and$3,647 under the old law or an apparent savings of $172. Of course what he fails to tellyou is that the MRS model estimates this taxpayer’s increase in sales tax in 2010 will be$163 and that because state income tax is deductible in calculating this taxpayer’s Federalincome tax while sales tax is not, their Federal income tax will increase by $26 (15%federal tax rate x $172 state income tax decrease). In total, this taxpayer’s total taxesactually increase by $17 in 2010 (-$172+$163+$26). That’s the good news, by 2013,assuming zero inflation in 2010, and 2.5% inflation in years 2011-2013, the income taxsavings under the new law will decrease from the $172 to just $39 and the sales taxincrease will increase to $175. The total net tax increase for this taxpayer in 2013 willgrow from $17 in 2010 to $142 net tax increase in 2013.The author correctly states on page 10 that the income tax under the new law is higher than under the old law for taxpayers with a large amount of itemized deductions. He thengoes on to state that “Whether the tax increase for high income itemizers was a deliberateobjective, a calibration error in the new formula, or a cost-reducing necessity to achieverevenue neutrality in the reform package as a whole is unclear from the legislativehistory. There are reasons to believe that the redistribution was deliberate: that the largetax advantages extended to high itemizes under the current tax code is something that policymakers do not want to continue under a structurally reformed system.”In a meeting I had with Representative Piotti and Michael Allen (from MRS) in March of 2009, I asked Mr. Allen why did the proposed new law limit the benefit of itemized

deductions. He responded that it was done not for a tax policy reason other than thenumbers just did not work. It was mathematically impossible to cut the top tax rate to6.5%, allow full benefit of itemized deductions and keep the law revenue neutral.The author also tries to justify the limiting of itemized deductions, by giving the exampleof two taxpayers with the same income, but one has significantly greater mortgageinterest because of their personal choice to buy an expensive home. Of course, the author fails to understand that thousands of Mainers will see substantial income tax increases because the new law limits or eliminates the tax benefit from large medical and charitablecontribution deductions. Thousands of Mainers have very large medical deductions for dependents either in nursing facilities or with other major health problems. I have personally spoken with several taxpayers who will see their Maine income tax increase by at least $2,500 in 2010, solely because of the limiting of the tax benefit for medicalexpenses. If one of the “structural reforms” was to have Maine taxpayers with largemedical expenses fund windfall tax cuts for the rich, then this “tax reform” accomplishesthat goal.With regard to charitable contributions, thousands of higher income Mainers, who makesubstantial charitable contributions, will see very large Maine income tax increases under the new law. The most extreme example of this however, is with the top 912 taxpayers inMaine that are estimated to have yearly income over $1.0 million. The expanded MRSreport of the impact of the new law on Mainers in year 2010, estimates that 751 taxpayerswith income in excess of $1.0 million will have a income tax cut of $17.0 million or $22,665 each under the new law, while the other 161 taxpayers with income over this$1.0 million, will have a tax increase of $3.4 million or $20,893 each. The main reasonthese 161 taxpayers will have a tax increase is because they will not receive any tax benefit from their substantial charitable contributions. For example a married taxpayer with $1.0 million of income and itemized deductions of $40,000, will have an income taxreduction of $12,157 under the new law. If this same taxpayer with $1.0 million of income had an additional $250,000 itemized deduction for charitable contributions, their tax under the new law would increase by $9,093 rather than decrease by $12,157. If the“structural reform” and tax policy is to reward millionaires, who give back little or nothing to the community and to penalized those millionaires that are generous, then thenew “tax reform” law is structured correctly.On pages 12-14, the author talks about the winners and losers under the new tax law. AsI stated before, this analysis is misleading and incomplete because it does not combine both the sales tax increase with the income tax changes and also does not quantify theimpact of the loss of the inflation adjustments for years 2011-2013. The MRS report of the impact of the new law on taxpayers in year 2013, estimates that all Maine taxpayerswill have an average net income and sales tax cut of $45 each or a 1.4% tax reduction.The detail breakdown of this group, however, reveals that Taxpayers with income under $35,970 will on average have a net tax cut of $39 each, that taxpayers with income from$35,970 to $350,810 will have a net tax increase of $22 each and that taxpayers withincome over $350,810 will on average have a $3,680 tax reduction or a 6.8% cut. Clearlythe only real winners under this so called “tax reform” are those earning over $350,810.