PART
1
Report of the Committee’s Deliberations
I. Goal
of Producing Two Proposals
At its first meeting, the committee heard an overview of the prebate and
rebate programs and of the Ways and Means proposal from 2003 to simplify the
education tax system.
Rebates are available to renters and homestead owners with household
income of $47,000 or less. Prebates are available to homeowners with household
income of less than $85,000 (less than $90,000 beginning in 2007); and
homeowners with household income of $85,000 or more are eligible for prebates on
the first $200,000 of housesite value. A detailed summary of the programs is
attached as Appendix D.
Three major problems with the current education finance system appear to
be:
(1) the inefficiency of collecting $400 million in homestead property tax
and then using a complex system to refund $110 million of that revenue to
approximately 70% of the homestead taxpayers;
(2) the increasing property tax burden resulting from rapid growth in
both real estate values and education spending; and
(3) the lack of a clear connection between the prebate check and the
taxpayer’s property tax bill.
The committee also heard from witnesses and from their own discussion
about many less-sweeping problems with the current system.
In its discussions of how to proceed in future meetings, the committee agreed
to try first to catalogue concerns with the current system and, in addressing
those concerns, to focus on producing two proposals, one proposal for an
entirely different system of taking into account the ability to pay, and one
proposal to address problems in the current income-sensitivity system and to
simplify it.
The committee then identified the information it would need to proceed in
its analysis of the current system and how to improve it. Subcommittees were
appointed to research and report back on the information needed.
II. Overview of Issues
Considered
A. At
its second meeting, the committee heard extensive reports from its subcommittees
on a broad range of issues to be considered. The issues, with highlights from
the committee discussion, follow.
1. Fiscal history of prebate program and school spending since
Act 60.
Mark Perrault
of the Joint Fiscal Office provided a chart of actual and estimated growth in
the cost to the Education Fund of the rebate and prebate programs. The average
annual growth rate over the ten years from 1999 to 2009 is 10.6 percent. That
cost growth is due in large part to education spending and to property values
growing faster than incomes.
First, school
spending is growing (7.2% annual growth rate) twice as fast as non‑property-tax
education revenue (3.7% annual growth rate). Since non-property-tax revenues are
not growing as fast as education spending, the education property tax must make
up the difference. Higher education property tax revenues mean larger property
tax adjustment payouts.
Second, real
estate values (and therefore, property tax bills) are growing faster than
incomes. When incomes grow more slowly than property tax bills, the result is
larger property tax adjustment payouts.
The result of
these two factors is a fast-growing cost for the prebate and rebate programs
and an increasing burden on taxpayers who are not eligible for an income‑based
property tax adjustment.
One way in
which property taxpayers have made some effort to control education spending
has been to vote down school budgets, as evidenced by the fact that in 2005,
twenty-seven school budget votes failed.
A third factor
may contribute to greater costs for the prebate and rebate programs in the future.
Rapidly rising real estate values meant that education property tax revenues
grew in FY06 by 13.1%, even after accounting for the cost of the p/rebate
payments. As the real estate market slows down or even declines in value, education
property tax revenues influenced by that growth may be affected. If education
spending still continues to rise, a larger percentage of Education Fund revenue
would be needed to pay for p/rebates.
2. What
are the causes of school spending increases, and would moving to an income tax
system for school funding encourage spending?
There are many
issues driving costs of education, and other legislative study committees have
examined these factors. Some districts are not seeing as dramatic an increase
in education spending as most other districts, but there is insufficient data
to analyze why.
The committee
was concerned that its proposal to use both a property tax and an income tax could
create a misperception which could increase education spending. That is, if
taxpayers only focus on the low property tax rate and ignore the education
income tax, they might feel encouraged to increase education spending. To
avoid this, it would be important to highlight for taxpayers, when they are
voting on their school budgets, that the education income tax is part of the
total education tax liability.
3. What is the historical basis for the prebate system and what
other options were considered?
Initially, the
House bill which became Act 60 used an income tax to raise education revenue.
When that approach was rejected, a homestead exemption was considered.
Ultimately, the prebate system was devised, based on the more familiar
structure of the rebate system, and was proposed as a way to take “ability to
pay” (an income tax notion) into the calculation for property taxes. In 1997,
it appeared that the prebate system would apply to eighty percent of the
population, and that this large participation would create the political will
to maintain funding for the system. (A problem under the rebate system up to
that time was the underfunding of that program.)
4. What is the administrative cost of the prebate system?
The original
appropriation to the Tax Department for setting up the administration of the prebate
program in 1997 was $500,000.00, for computer programming, forms development,
and new personnel for taxpayer service and enforcement. It is difficult to
break out the cost of administering the prebate and rebate programs from the
general Tax Department budget. A number of related costs have grown over
time. For example, a high percentage of taxpayer appeals in recent years have
been p/rebate‑related. A best estimate of the current administrative
cost of the prebate program is $1 million.
There is a
significant cost to taxpayers, as well. For example, the forms are complex and
time-consuming, and up to ninety percent of off-season questions to tax
preparers are related to p/rebates.
Based on
information from the Vermont Municipal Clerks and Treasurers Association, it is
estimated that there is little or no administrative cost to local governments
at this time for the prebate system. Town officials do, however, spend a
significant amount of time explaining the prebate system to taxpayers.
5. What
do other states’ circuit breaker programs look like?
Other states
have property tax credits, reductions, exemptions, and deferred payment
programs. Fifteen states have circuit breaker programs (rebates), but are more
restrictive in eligibility and benefits. Vermont’s appears to be the most
generous program.
6. What
are current problems in the prebate system that need fixing?
a. The
legislative charge to the committee noted several specific issues in the
prebate and rebate programs to address:
i.
whether prebates and rebates are the best method of taking income into account;
ii. how
the administrative costs of that system compare to another option;
iii.
issues in the definition of “household income”;
iv.
housesite value limitation;
v.
qualifying income thresholds and possible inflation index;
vi. inappropriate
benefit amounts (is there a true need? income manipulation and averaging;
balancing the cost to other taxpayers of paying out these extremely large
benefit checks);
vii.
how best to adjust the property tax bill or otherwise take income into account.
b. The
committee discussed these and a large number of other issues within the
prebate system, and at their third meeting, decided on the order of priority of
these issues. The prioritized list is shown below in Section III.
7. What
are problems in the definition of “household income”?
In this subset
of issues within the prebate program, several more detailed problems
highlighted were:
Gifts and
inheritance are not included.
Reverse
mortgages can create confusion as to whether loan proceeds constitute “income.”
The committee determined, however, that true reverse mortgages are loans, and
proceeds are not included in household income.
Some taxpayers
are able to manipulate their income so that instead of never qualifying, they
can at least qualify every other year, by moving income to an earlier or later
tax year.
“Household
income” doesn’t account for taxpayers who own a large amount of non- or
low-income-producing assets and maintain a low income.
There is a $6,500
exemption for a dependent student-child’s earned income, but no similar
exemption for the income of an adult child who remains dependent; also the $6,500
should probably be updated to nearer $10,000.
8. Estimated
costs and other issues of State collection of property tax.
State-level
collection of the education property tax would result in two parallel systems:
one for State-level collection of the education tax and one for town-level collection
of the municipal tax. This is expensive and cumbersome, as it would require
two sets of tax bills, two checks for taxpayers to write, two levels of
accounting and enforcement. In addition, towns objected to the loss of
delinquency penalty revenue (which is often used to pay tax collectors) from
the education tax, and objected to the loss of the “float,” which is generally
equal to one cent on the tax rate.
9. Rebate
issues for renters and landlords.
Statewide,
twenty-nine percent of housing units are rental units, and according to U.S.
Census data, it appears that eighty-four percent of renter units have household
income qualified for renter rebates. The biggest issue is that there is no
relief program for renters with household income above that level, and that
problem is exacerbated by the current real estate market, which is making
education property taxes rise on the buildings they rent. (That property tax is
typically passed through in the form of higher rents.)
10. Ways
and Means 2003 proposal in H.462 and other ideas.
One of the
features of H.462 (the Ways and Means education finance reform bill from 2003)
and earlier proposals was the inclusion of an education income tax. Many on
the study committee felt that if the goal is to base revenue on the ability to
pay, the income tax is a simpler system than a property tax which must then be
adjusted by prebates and rebates.
B. After
discussion of the foregoing issues, the committee turned to discussion of the
broad outlines of proposals to simplify the current system or to add an
education income tax component to the system.
III. Guiding Principles and
Issue Priority
At its third
meeting, the committee discussed the principles which should guide its study,
and adopted fifteen criteria its proposals should meet. The committee also
determined the priority of the issues it had identified.
A.
Fifteen Principles
Under the
fifteen criteria adopted, any income-based system proposed by the committee should:
·
be more understandable than the current system
·
be more efficient than the current system
·
take into account taxpayer confidentiality
·
comply with the Brigham decision’s holding that “children
who live in property-poor districts and children who live in property-rich
districts should be afforded a substantially equal opportunity to have access
to similar revenues,” and that there be “substantial equality of
educational opportunity throughout Vermont”
·
be less costly for state and local governments to administer than
the current system
·
have lower compliance cost for taxpayers than the current system
·
not need annual legislative action to “fix” problems or adjust
rates
·
provide local school districts with a stable source of revenue
·
be responsive to differences and changes in taxpayers’ ability to
pay
·
have clearly-understood tax consequences on those who make
spending decisions
·
contain clear political accountability for changes in tax levels
·
not be “economically inefficient” or cause undue harm to the
state’s economy
·
take into account not altering the balance of power between state
and local governments or between voters and their government
·
tax similarly-situated taxpayers equally
·
not encourage more school spending
B. Priority List of Issues
The committee also published a list of issues and their priority for the
committee, as follows.
1. Primary
issues.
a. Taxpayers
often don’t understand the connection between the prebate check and the
property tax bill.
b. When
real estate values do not rise as quickly, the cost of prebate system may
outstrip the fund’s ability to pay out the benefits.
c. The
current system is so complex and confusing that most people don’t understand it.
Complexity adds to the cost of forms, cost of administration, number of errors
made by taxpayers and the resulting number of assessments and penalties issued
and cost of enforcement, further resulting in public resentment and frustration.
d. A
successful tax system requires enough simplicity to encourage compliance and
allow transparency.
2. Secondary
issues.
a. Inefficiency
of money going out versus money coming into the system.
·
70% of taxpayers are eligible for the
prebate program
·
47% of the tax paid by claimants on
average is then paid back to the claimants
·
25% of all money paid in education
property tax is then paid back out in adjustment claims
It is more efficient to have a system which
brings in the correct amount of money and does not overcollect taxes in order
to repay 70% of residential property owners.
b. Mortgage
escrow issues should be reviewed.
c. Since
the prebate is based on prior-year value, a change in the assessed value of the
housesite means that the owner is technically not receiving the property tax
adjustment.
d. The
prebate program has added pages to the income tax booklet, which is costly to
the State and adds confusion for taxpayers.
e. Very
large prebate checks are issued each year, some over $20,000.
f. Some
people are “gaming the system,” that is, manipulating their income from year to
year to qualify for prebates/rebates or to receive larger checks.
g. The
rebate system caps a property owner’s tax liability for education and municipal
taxes. This insulation from the tax impact of a vote for education spending
can allow or encourage more spending.
h. The
base (2%) prebate percentage should not be lowered each year when revenues are
high enough to lower the education property tax rates, since prebate claimants
do not contribute to the excess money coming into the Education Fund.
i. The
way we calculate income for eligibility does not include assets, so people with
substantial assets may be eligible. What are the plusses and minuses of an
asset test?
j. Renters
cannot take advantage of the system in the same way as homestead owners, since
they are eligible for rebates only if household income is $47,000 or below.
3. May
be issues but not of major concern.
a. There
are costs of administration for the tax and education departments.
b. Some
people who should take advantage of prebates don’t understand that they are
still eligible even if, for example, a brother, child or parent is on the deed.
c. Even
though a co-owner may be eligible for a prebate, the amount is reduced for the
co-owner.
d. The
definition of “household income” is inconsistent, because a dependent parent’s
income of $6,500 is not counted, but there is no $6,500 exclusion for income of
an adult dependent child.
e. Rebates
and prebates use income from different years in determining the adjustment
amount.
f. An
honest mistake by the taxpayer or Tax Department can result in the taxpayer
having to pay a large tax bill up front, then waiting for the p/rebate check.
g. If a
town goes through a reappraisal, the prebate check is based on previous year’s
value plus CLA, while the tax bill is based on new assessed value, resulting in
taxpayers possibly paying more than they should.
h. Many
people are now paying for accountants to do prebate forms, which costs them
money.
i. Owners
of residential property who are not eligible for income sensitivity are paying
a significant percentage of their income on property taxes. The property tax
adjustment system is no longer just for low-income Vermonters, so what is the
rationale for an income cutoff?
j. The
rebate system is more likely to help those in large towns versus those in more
rural areas.
k. Timing
issues regarding ownership of property can create problems.
l. With
two separate programs for prebate and rebate, some people are confused and only
apply for one program, and thus receive less assistance than they are entitled
to.
IV. Initial Broad Proposals Considered
Also at its third meeting, the committee discussed the pros and cons of a
number of broad proposals, in light of the committee’s guiding principles and
list of priorities. The broad proposals reviewed follow.
A. Plans to Modify the Current Prebate/Rebate System
1. Eliminate the prebates, expand eligibility for rebate, and use
saved money to lower residential tax rates.
2. Have Tax Department notify towns of each person’s property tax
adjustment amount, and town then bills taxpayer for net amount.
3. Eliminate prebate, keep rebate, and give everyone a homestead
reduction.
4. Eliminate prebate and have rebate based on current prebate
formula.
5. Eliminate
prebate, every homestead owner receives tax bill reduced by a flat amount; property
tax bill will show the reduction amount.
Town bills
state for lost education and municipal revenue; rebate the following spring for
anyone with household income below $85,000 ($90,000 in FY 08).
Rebate uses
same formula as current prebate system; spending above base payment will be the
taxpayer’s education tax responsibility.
Rebate no longer capped, nor a combination of education and municipal tax;
eliminates the slope for over $85,000, because homeowners would be receiving a
direct tax bill reduction; eliminate $15,000 exemption option in current
prebate system.
6. Any yet-to-be-identified ideas.
B. Plans to incorporate an income tax element as a direct measure
of ability to pay.
1. Replace system with an education income tax.
2. Plan discussed at last meeting:
Reduce base homestead tax rate to $0.30 (for example) and increase that
base rate by triple (for example) the percentage of education spending over the
base per-pupil amount.
Eliminate the prebate system.
Create an education income tax.
Maybe keep the rebate program; and maybe create an adjustment for
education income tax paid by renters.
V. Analysis of the Proposals
At its fourth meeting, the committee analyzed the major proposals in
detail, identifying the pros and cons of each, as follows:
A. Proposals to Modify the Current System
1. Proposal 1 Eliminate the prebates, expand eligibility
for rebate, and use saved money to lower residential tax rates.
Pro:
If you raise
the eligibility level to $60,000 household income, the number of people
affected appears to be relatively low.
Simpler, less
costly program.
Lowers property tax rate.
Con:
Exacerbates the
eligibility cliff.
Does not
address the problems with the definition of “household income.”
Removes cost
containment feature of the prebate program. (But also creates more cost
containment for those who were eligible for the prebate but would now not be
eligible for the rebate.)
Doesn’t account
for higher tax burden in high‑value towns.
Leaves in place the heavy reliance on property taxes.
2. Proposal 2 Have Tax Department notify towns of each
person’s property tax adjustment amount, and town then bills taxpayer for net
amount.
Pro:
Taxpayers would
not have to pay the taxes in and then receive money back; they would still have
to fill out the prebate forms, however.
It is easier for taxpayers to talk to town officials (no travel time to Montpelier,
smaller office to deal with).
Con:
Breach of confidentiality: town officials learn that taxpayer is
income-eligible for a property tax adjustment, and may be able to calculate the
taxpayer’s household income.
3. Proposal 3 Eliminate prebate, keep rebate, and give
everyone a homestead tax reduction.
Pro:
Cheaper to
administer, simpler.
Is more progressive than the proposal to eliminate the prebate and lower
the homestead tax rate.
Con:
May adversely
affect most of those in the prebate system now.
Doesn’t account
for higher tax burden in high-value towns.
Exacerbates the
eligibility cliff.
May cause cash
flow problems.
Removes any cost containment features that the prebate system provides.
4. Proposal 4 Eliminate prebate and
have rebate based on current prebate formula.
Pro:
Cheaper to administer, simpler.
Con:
May adversely
affect most of those in the p/rebate system now.
Doesn’t account
for higher tax burden in high‑value towns.
Exacerbates the
eligibility cliff.
May cause cash
flow problems.
Removes any cost containment features that the prebate system provides,
except for taxpayers with household income below $47,000.
5. Proposal 5 Eliminate prebate, and instead, every
homestead owner receives tax bill reduction of a determined dollar amount.
Property tax bill will state the tax reduction amount; town bills state
for lost education and municipal revenue.
Rebate following spring for anyone with household income below $85,000 ($90,000
in FY 08); rebate uses same formula as current prebate system.
Spending above base payment will be the taxpayer’s education tax
responsibility.
Rebate no longer capped, nor a combination of education and municipal tax.
Eliminates the slope for over $85,000 because homeowners would be
receiving a direct tax bill reduction.
Eliminate $15,000 exemption option in current prebate system.
Pro:
Con:
Too many
changes and too complicated; people are just getting used to current system.
Is no simpler
than current system, and the committee’s two goals are simplification and cost
reduction.
The reduction
in property tax is less specifically related to the taxpayer’s income or
property tax burden.
Does not address extreme prebate check payments.
B. General Discussion of Issues in the Proposals to Modify the
Current System
1. Transition costs of combining prebate and rebate programs.
The committee talked generally about the savings of combining the prebate
and rebate systems in some way, and whether there would be a one-time
transition cost for those who were covered by the discontinued system. In
answer to that question, it appears there might be no such cost, because both
the prebate and rebate amounts related to a single property tax year are paid
within a single fiscal year. A combination of the programs would simply mean
paying the benefits all at the same time within the fiscal year.
2. How to measure income for calculating prebates.
The committee also discussed whether household income eligibility should
be changed to some other measure of income, such as the income tax concepts of
taxable income, gross income, or adjusted gross income. The committee heard
testimony on what items are included and excluded in each of these concepts, and
testimony on what information would be needed to show the effects of a change.
The committee decided that it would not be possible to obtain sufficient data
to analyze fully how changing the measure of income might change those who were
eligible for the benefits. The committee also agreed that the program was
complex enough without adding confusion by changing a long-used income measure,
and decided to keep the household income measure.
3. Large prebate checks.
All members of the committee were concerned about the fact that a few
claimants receive excessively large checks. The committee discussed various
solutions to the problem.
The committee discussed the possibility of using an annual $6,000 cap on
adjustment payments. The amount of $6,000 was chosen for discussion purposes because
it was a level which only a few people exceeded, and would bar the most
excessive prebate check payments (only 460 claimants received checks in excess
of that amount in FY06, but these checks ranged from $6,000 to over $20,000).
The committee also discussed whether a payment cap might be used as a threshold
limit, which would trigger either an asset test or an investment income test.
That is, if the claimant’s assets or investment income were below a certain
level, then the cap could be exceeded. An alternative proposal was to allow a
payment to exceed the cap if the claimant could show “true need” in some way.
Ultimately, a narrow majority of the committee endorsed the $6000 cap. A
minority recommended that the standing tax committees also review the various
solutions discussed, including (a) a cap on the combined prebate and rebate
adjustment, but at a possibly higher amount; (b) exceptions to the p/rebate
cap, including an exception for a showing of true need; (c) a limit on the
value of the income-sensitized housesite, regardless of household income level;
and (d) no eligibility if investment income exceeds a certain level.
4. Adjusting the 2% household income base
for prebates.
Each year, if excess Education Fund revenue is available, the legislature
is authorized to reduce the homestead and nonresidential education tax rates
and also to reduce the two percent of household income base for the prebate
calculation. The committee discussed whether the two percent should also be reduced,
since those who receive the prebates are not contributing to the excess revenue
generated. A majority endorsed not reducing the two percent base. A minority
felt that the standing committees should look further at how to address this
issue.
5. Loss of taxpayer confidentiality if town is notified of
taxpayer’s p/rebate amount.
Notification to the town of the taxpayer’s prebate or rebate amount would
alert town officials to the fact that the taxpayer met the income eligibility
limit, and might even provide enough information for town officials to estimate
the taxpayer’s amount of household income. In determining how to deal with
this loss of tax confidentiality, the committee discussed using the approach
that a person who claims a p/rebate would thereby waive confidentiality. This
same approach was discussed during the Act 60 debates, and rejected because it
was felt that no one should have to give up personal financial confidentiality
in order to obtain the correct property tax liability or to obtain property tax
help for lower-income taxpayers.
The committee discussed options for protecting the information once it is
given to the town, such as making the property tax records non-public or making
local officials subject to the Tax Department confidentiality laws and penalties.
The committee noted that it would take a fair amount of time for a town
official to try to calculate a person’s income from the adjustment amount, and
that town officials would have no desire to try to figure out incomes and would
never have the time to do it in any case. As a result, the committee decided
not to subject local officials to the confidentiality laws and penalties.
The committee also noted that town officials might not want even to be
perceived as having access to this information.
Another possibility was to make the property tax records nonpublic documents.
But this, it was felt, would only create bigger problems, because the public
needs property tax information at real estate closings and at delinquent tax
sales; and it might require that delinquent tax warrants also be made
confidential (which might not even be possible).
When the committee ultimately chose a solution to this problem (see next
paragraph), it decided that the options just discussed for protecting the
information were unnecessary.
The committee ultimately resolved the entire confidentiality question,
and the problem of taxpayers not understanding the connection between p/rebate
checks and property tax bills, by proposing the following:
The Tax Department would notify the town of a certain amount by which to
reduce the taxpayer’s property tax bill. The amount would be the taxpayer’s
(a) prebate amount, if any; plus
(b) rebate amount, if any; plus
(c) any portion of the income tax refund which the taxpayer chooses to
have
(d) any additional amount the taxpayer chose to have withheld during the
year for property tax purposes.
Under this proposal, the Tax Department will not send out prebate and
rebate checks to the taxpayer, but will instead pay the adjustment to the town
and notify the town to reduce the property tax bill by this amount. The
proposal also allows the taxpayer to choose to send some or all of the income
tax refund, and to choose to have additional withholding throughout the year,
to avoid having to come up with a large lump sum to pay property taxes. The
taxpayer might not even be eligible for a prebate or rebate, but have chosen to
use withholding as a simpler method of property tax payment.
Since the property tax bill would show the reduction, and require payment
only of the reduced amount, taxpayers would see clearly the connection between
the p/rebate and the property tax bill. The committee felt that this approach
would resolve a perennial problem under the Act 60 system, viz., how to issue a
property tax bill for the adjusted tax amount without introducing more
complexity into the system and without violating taxpayer confidentiality.
This approach solves the confidentiality problem, because town officials
would have no idea which components (prebate, rebate, refund, withholding) make
up the amount the Tax Department reports to the town for that taxpayer.
It was noted that if no one uses refunds or withholding for property taxes,
then town officials would know that anyone with an adjustment amount was
income-eligible for p/rebates. To prevent this problem, the new law could keep
confidential any Tax Department information on how many people are using
refunds or withholding to pay property tax.
The standing committees would need to look at how and when the Tax
Department would pay adjustment amounts to the towns. Some of the issues
involved would be how to net payments to the towns and how to allocate payments
between education and municipal property taxes.
C. Preliminary Ideas to Replace the Current System with a New
Income-Based System or to Incorporate an Income Tax Element
1. Proposal 1 Replace system with an education income
tax.
2. Proposal 2 Reduce base homestead tax rate (to a rate
of $.30, for example) and increase that base rate by triple (for example) the
percentage of education spending over the base per-pupil amount. Eliminate the
prebate system.
Create an education income tax (at a rate of approximately 1.0% or 1.5%,
for example) of taxable income.
Maybe keep the rebate program; and maybe create an adjustment for
education income tax paid by renters.
D. Committee
Discussion of Issues Related to an Education Income Tax
1. Income
tax rates and burden. The committee noted that the simplicity of an income tax
(as opposed to trying to adjust the property tax for the taxpayer’s income
level) has to be balanced against any problems which might arise from creating
a higher marginal income tax rate. High marginal rates can affect decisions of
higher-income taxpayers to migrate into the State or to leave the State. Tax
preparers and others have anecdotal evidence of this happening now with the
relatively high Vermont property and income tax rates, although some
in-migration occurs because of our quality of life, in spite of our tax rates, and
other causes may encourage out-migration, such as warmer weather.
2. Limit
on amount of income subject to education income tax. The education income tax
provision in H.462 (the Ways and Means proposal of 2003) had a limit of
$150,000 on the amount of taxable income subject to the tax. There are several
rationales for limiting the amount of income subject to an education income
tax. First, a limit would maintain the tax burden at a level similar to the
property tax burden, and not redistribute it. Second, limiting the amount of
income subject to education income tax would be similar to the Federal limit on
income subject to Social Security tax (applies only to a limit of about $90,000
of income). Third, an income tax limit would mirror the “natural” property tax
limit which occurs at higher income levels. That “natural” property tax limit
occurs because, with rare exceptions, the value of a house, expressed as a
percentage of income, levels off and then declines as incomes reach extremely
high levels.
3. Application of the tax to a specific group. The committee
also discussed whether an education income tax would be imposed only on Vermont
residents or also on nonresidents who have Vermont income. Since the proposal
reduced the property tax rate only on homesteads, it was felt that the income
tax might be imposed only on those same people. The tax might be on those who
have their principal residence in Vermont; and a credit or other provision
would need to be made for renters, who would continue to pay the nonresidential
property tax rate indirectly through their rent.
VI. The
Administration’s Position on Income Tax
A. Presentation by Secretary of Administration Charles Smith.
At its fifth meeting, Secretary of Administration Charles Smith presented
the Administration’s position opposing an education income tax. An attempt to
summarize this testimony is presented here, but for complete accuracy and more
detail, the reader should consult the transcript of the Secretary’s remarks,
available at the Legislative Council Office.
In brief, the Administration opposes shifting the education tax liability
from the property tax to the income tax. Taxpayers feel stretched on all three
of the major tax bases: property, income, and consumption taxes, and to the
extent that this committee is responding to public stress from the education
property tax, the Administration feels that a shift to the income tax would not
really alleviate that stress. Moreover, the Administration does not support
moving to an education income tax because it would lack sustainability, would not
aid in cost control, and would lack fairness, all of which would have a
negative impact on business development in the State.
Sustainability is questionable because of Vermont’s rate of growth in
education spending. Education spending has been growing at more than double the
growth rate for the rest of the economy, and no tax can rise fast enough to
keep pace. The property tax, at least, does have a natural discipline built
in, insofar as local school districts vote on their school budgets and see a
real connection between their vote and their property tax burden. That
connection provides a dampening effect on property tax rates. But that
dampening effect is not present in an income tax. That is why an education
income tax is less sustainable than an education property tax.
But sustainability is a problem to a greater or lesser extent with any
tax we use to support education, because Vermont has an increasing problem with
education cost containment. With education spending growing at about seven
percent a year, while the rest of the state economy is growing at half that
pace or less, cost containment is of paramount importance. Replacing the
property tax with an education income tax would lessen the natural cost control
discipline inherent in a property tax – and that natural discipline is the
connection between the local vote and the property tax rate. Moving to an
education income tax would just be one more legislative move away from that
connection; it would remove the ability of taxpayers to affect tax rates based
on what the taxpayers feel they can afford. So, while moving to an income tax
might initially give some feeling of tax relief, that relief would just allow education
costs to continue their unrealistic rise.
Fairness is lacking in an income tax approach because it would shift a
larger portion of the cost of education to a smaller segment of the population;
and that small segment of the population is already paying a very large share
of the State tax burden. While progressivity in a tax system can be a
desirable feature, there may be a point at which too much progressivity can
have negative consequences in terms of tax fairness and negative consequence
for a state’s economy. Vermont is third highest in the nation in income tax
progressivity; and with income sensitivity taken into account, Vermont may be
number one in the nation in progressivity. In approximate numbers, fifty
percent of Vermonters pay five percent of Vermont’s income tax, while seven
percent of Vermonters pay half of all Vermont income tax. And if income
sensitivity is taken into account, seven percent of Vermonters pay almost
seventy percent of our income tax revenues. If an education income tax is
added to that, the tax burden will be tipped even more heavily toward a very
small segment of the taxpayer population.
All of these negative features of moving from the property tax to an
education income tax would have an adverse affect on business development in
the state, as Vermont would increasingly seen as indifferent to wealth creation,
which is a necessary component to business and job development.
B. Committee Questions and Comments for Secretary Smith.
One committee member remarked that with property values rising faster
than incomes are rising in Vermont, the property tax is increasingly
inequitable; whereas an income tax is inherently equitable since it is based
specifically on the taxpayer’s income level.
The Secretary responded that a major concern, though, is lack of a cost
control feature in an income tax, and that although school budget votes may be
painful, it is part of the democratic process of working out how to deal with
increasing costs. Local voters are making the tough decisions, and if we keep
relieving the impetus (property tax rate pressure) for those decisions, we
delay cost control.
Another committee member asked whether fairness and business issues are
the main reasons the Governor objects to an income tax.
The Secretary responded that all the issues mentioned are important, but
that fiscal sustainability and cost control are important, especially when
expenditures are growing at three times the revenue growth rate.
A third member of the committee asked whether the Administration would
still oppose an income tax if it included a cost control proposal, and noted
that the committee’s proposal was not really to move away from a property tax
to an income tax, but was instead to move away from an income-based property
tax (a confusing and complex way to take income into account in the tax base),
and move to a simpler and more direct way to take income into account, viz., an
education income tax. The member noted that the income sensitivity program may
lack sustainability, as well, and the committee is trying to address that in
this proposal.
Another member asked whether the Governor would be more inclined to
consider an income tax proposal if the committee could create a system in which
a larger proportion of taxpayers paid the income tax revenues.
The Secretary responded that the Administration would certainly be
willing to look at the committee’s proposals, but that it is clearly concerned
with any move away from a property tax base to an income tax.
A subcommittee also drafted a written response to the Administration’s
objections (See Appendix F), in which the fairness issue is addressed as
follows:
Annual reappraisal of
Vermonters’ home properties (which essentially occurs when Property Valuation
and Review sets new Common Levels of Appraisals in every town each year)
exacerbates the disconnect between property value and the ability of the owner
to pay when values rise as fast as they have in the past few years. Even
assuming that a Vermonter originally buys a property that roughly reflects his
economic status, this connection evaporates as the Grand List value rises with
the decreasing CLA percentages as comparable properties bring higher prices
when purchased by more affluent individuals. Property tax does not necessarily
reflect an individual’s ability to pay, and income tax generally reflects more
clearly an individual’s ability to pay.
VII.
Committee’s Further Discussion of its Two Proposals
The committee then continued its discussion of the details and remaining
questions under each of the two proposals, and their presentation at its public
hearing, scheduled for the following week.
1. Quarterly estimated tax payments.
The committee debated whether quarterly estimated payments should be
required from taxpayers who do not have employer withholding. This was an
issue in the drafting of H.462, as well, and in that bill, quarterly estimates
were not required. Since Vermont has a large proportion of its taxpayer
population which is self-employed, it was felt that quarterly estimates might
be a good idea, and that it would be more fair to make the education income tax
parallel the requirements of the personal income tax in that regard. The
committee believes that quarterly estimates should be required, but no
penalties should be imposed for failure to report in the first year, because
there could be some confusion among taxpayers, which we would not want to
penalize.
The committee also decided that due to first-year confusion, no penalties
should be imposed on taxpayers who under-withhold in the first year. This
approach for withholding might raise issues which are not raised by waiving the
penalty for quarterly estimates. Any cash flow issues raised by the proposal
would also need to be examined.
2. Renter relief from education income tax. The committee
decided that the proposal should include some manner of credit for the
education income tax paid by renters. A credit of this sort was a feature in
H.462. The committee also decided to recommend that the standing tax
committees review the costs and impact of providing this credit to renters, and
whether and how to limit the credit, as necessary.
3. Administrative savings and cost control. The committee noted
that education spending control would ease the property tax burden, but that
cost control measures were outside the committee’s purview. In the proposal
with the low education tax base rate of 30 cents and an income tax component,
the prebate program could be discontinued at a savings to the Education Fund of
about $1 million in administrative costs. Similar administrative savings would
also be created by the proposal that combines the prebate and rebate programs
into a single, two-step adjustment.
4. Additional savings of each proposal. In addition to any administrative
savings, another $10 million would be saved annually under each proposal from combining
the prebate and rebate programs or eliminating the prebate program. The Joint
Fiscal Office estimated that $10 million would be saved by combining the
prebate and rebate programs, because payments under both programs would be
based on household income from the same year.
5. Proposal summaries. The committee then discussed the final
draft of its summary of the proposals which were, as initially agreed, to
create a new income-based system and to simplify the current system. The
summary of the two proposals is attached to this report as Appendix E.
VIII. Public
Hearing
A. The study committee held a public hearing on November 7, from four o’clock to seven o’clock. In advance of the hearing, the committee published, in a
press release and on the Legislative Website, the summary of its two proposals
for education finance reform, and invited public response at the hearing.
B. Fourteen people attended and seven people addressed the
committee. A list of those who attended is attached as Appendix H. Most of
the comments were generally about the current education finance system and were
not direct responses to either of the proposals.
C. At the following meeting, the committee discussed comments,
questions, and proposals from the public hearing which related to the
committee’s charge, as follows.
1. Is there a revenue-neutral way to remove
the cliff on prebate eligibility?
The committee felt that it would be difficult to maintain revenue
neutrality if the income eligibility limit were changed to a graduated
phase-out of the benefit. If “revenue neutral” means maintaining the same
overall cost of the system, the change would be possible, but would reduce the
benefits of those below the current income limit; whereas if “revenue neutral”
means no change in the benefit currently available to claimants below $85,000,
then the program would cost more, to cover the benefits (though phased‑down)
provided to those over $85,000.
2. Can the homestead property tax rate be applied to rental
buildings so that renters are not subject to the higher property tax rate on
nonresidential property?
In an increasing number of towns (eighty-three this year), the homestead
property tax rate is actually higher than the nonresidential rate. But even if
an apartment building were allowed to have the lower of the two rates, there is
no guarantee that this lower property tax would be passed along to renters in
the form of lower rent. Renters eligible for a rebate are able to take into
account in the benefit calculation the actual amount of property tax allocable
to their rental unit. This feature does not help renters who have household
income above $47,000, though, and are ineligible for a rebate.
3. Is there a way to eliminate the split grand list and return to
a single statewide education property tax rate?
One member of the committee noted that the listers were “heard on this
issue – loud and clear.” The committee agreed that the split grand list does
create some difficult issues for local officials and requires some additional
work, but that at this point, perhaps the bulk of the initial data gathering
and setting-up of procedures has been accomplished, and that the work will
lessen as the split list becomes a more-established practice.
With regard to returning to a single statewide rate, it was noted that,
while it would resolve some issues, it would create others, including three
significant problems: First, a single rate would not take into account local
spending votes; second, it would not prevent fund raising by districts; and
third, it would most likely not satisfy the requirements of the Brigham
case.
IX.
Final Report
At its final meeting, the committee reviewed the committee report prepared
by staff and requested additions and amendments.