The debate within the Blue Ribbon Tax Commission

by Rob Roper

Part I – The Findings

The Blue Ribbon Tax Commission Report

Perhaps the greatest value the eighteen months of work our Blue Ribbon Tax Commission produced is a clearer understanding of   what we really have for a tax system in Vermont. As the commissioners pointed out, there are many misperceptions regarding Vermont’s tax structure, as well as some startling discoveries. However, much of this depends upon your perspective. There was considerable (though civil) disagreement between the majority and the minority opinions, and the the debate between the two sides is worth examining.

In its final report, the Commission put forward six findings:

(1) The Vast Majority of Vermonters Pay Taxes. This seems to contradict the impression many have that a large percentage of Vermonters don’t. While it is true that a very small number of high income people supply the lion’s share (nearly 60%) of all income tax revenue, the Commission considered the total taxes Vermonters pay from all sources: income, sales, property taxes and fees. While the income tax was most progressive, the sales tax was most regressive.

However, the minority report explains, “This approach, while illuminating in some respects, ignores three facts that make the income tax distinct from other taxes.” These are, that the income tax is the one most generally used to judge economic competitiveness, that individuals and business leaders stress the importance of income tax rates. These perceptions of job creators should not be ignored, and, finally, that the income tax is a compulsory tax whereas with the sales and property taxes consumers can alter their behaviors to some degree to escape or lessen their tax burden.

(2) Vermont’s Choice of Income Tax Base Promotes High Marginal Rates and Lower Effective Rates. Here the Commission was largely unanimous in its conclusions. Vermont’s marginal tax rate of 9.5% (TY 2008) on incomes over $200,300 is among the highest in the nation, but the effective rate is much lower. The report cites the example, “tax filers with $1 million plus income paid an effective tax rate of 5.17 percent, 45% below the top marginal rate…”

The minority did point out that there are other factors driving up Vermont’s marginal income tax rates, including state spending levels, the progressive tax structure and tax exemptions.

(3) Changing Consuming Buying Patterns are eroding Vermont’s Sales Tax Base and Should be the Focus of Policymakers. The shift from consumers purchasing goods, which are taxed, to services, which are not, is creating a challenge for tax collectors. Additionally, and perhaps more importantly, the shift to on-line purchases on which sales taxes are not collected are creating both a revenue problem for the state and a competitive disadvantage for our local merchants.

While the committee unanimously recognized and agreed this is a problem, the minority report worries that the finding will deflect attention, “from the serious consequences of Vermont’s decision to levy a sales tax while New Hampshire and other states do not.”

(4) Tax Expenditures Form a Shadow Budget that Requires Scrutiny. The report states, “Ideally, the tax structure would contain general rules that apply to everyone. The tax structure contains these general rules, but they are moth eaten by exemptions known as tax expenditures. Tax expenditures are exceptions to the general rules of the tax structure including, ‘permanent exclusions from income, deductions, deferrals of tax liabilities, credits against tax or special rates.” These tax exemptions “cost” Vermont roughly $1 billion per year, and they do not suffer much scrutiny.

One example the majority opinion cites is, “the tax expenditure exempting residential fuels from taxation is estimated to reduce potential tax revenue by $44.1 million.” The report also notes that Vermont spends $15 million helping low income Vermonters pay for heating fuel through LIHEAP. Therefore, if the objective of excluding heating fuel from taxation is to help poor people better afford the stuff, would it not be better to tax the fuel, which would apply to people of all incomes, and provide a means tested fuel rebate for low income people.

The minority report had a big problem with this logic. “Tax expenditures purport to measure ‘foregone revenue.’ This assumes that the government has a right to every dollar. By this reason, all income not collected on the income tax could be foregone revenue just waiting appropriation…. Accordingly, I would object to referring to this spending of forgone revenues and prefer to label these policy choices as tax exemptions.”

(5) There is insufficient Data to Claim that Vermonters Are Migrating Due to High Taxes – Current Statistics Show an In-Migration of Income. Again, there was significant disagreement within the Commission over this point. According to the data gathered from the IRS, tax filers moving into Vermont earn about 18% more on average than those leaving, although the available information doesn’t tell us anything about who these people really are.

The majority concludes that the legislature shouldn’t spend much time worrying about the anecdotal evidence that the wealthy are leaving Vermont, and even if the anecdotal evidence is correct, “it is questionable and dangerous to design a tax code for fewer than 200 people.

The minority disagreed. The available data raises more questions than it answers, and, “Overall, Vermonters should not be satisfied if anyone is leaving Vermont due to high taxes…. Policy makers can and should use the tax system to attract more high income tax filers to Vermont, particularly through demonstrating competitiveness in our income tax, estate tax, corporate income tax, and programs to foster economic development.”

And,

(6) The Complexity of Vermont’s Education Funding System Obscures Basic, if Difficult, Tax Structure Issues. On this final point, the Commission stated frankly that it would not make specific recommendations. Its finding included the fact that 70% of Vermonters pay their education taxes based on income. “The current tax system shields the wealthy from the full force of an income tax. The current system protects many Vermonters from the full force of the property tax. The middle class tend to be caught in between.”

Part of the solution, argues the minority is to sensitize education consumers to the cost of their decisions. “Taxpayers make different choices when they are sensitized to the costs. Income sensitivity, and the confusion it engenders, leads education consumers to make choices that they would not make if they were properly sensitized to the tax. This sensitization would ultimately slow the unsustainable rise of Vermont’s property taxes.”

Click here to read the full Final Report

This article is the first in a series.

Look for “Part 2: Recommendations” later this week.