THREE METHODS FOR REFUNDING THE 1997 MAINE TAX SURPLUS by John Sanders, Associate Professor of Accounting, and Philip Jagolinzer, Professor of Accounting, both at the University of Southern Maine

For the first time in many years, the state of Maine has ended a fiscal year with a budget surplus. For fiscal-year 1997 (July 1, 1996 - June 30, 1997) it was apparently about $73 million. According to local newspapers, both the governor and the legislature have already committed part of this surplus for past borrowing and deficit spending in shortfall years.

The committed surplus amounts consist of the following items:

• $14.9 million to pay down debt in the state pension fund used during the early 1990s to assist budget shortfalls
•$7.5 million to erase bad debts that have accumulated over the years due to spending tax revenues never collected
•a special fund of $6.2 million for a new health insurance program for poor children⁽¹⁾

Of the remaining amount, $16.3 million has apparently been committed to reduce property taxes, and to provide tax credits for investments in computers and other high tech equipment.⁽²⁾ The purpose of this article is to address only the residual fiscal surplus, of about $28 million, and not the increase in the cigarette tax that is expected to generate approximately $50 million in additional revenues over the next two years. To develop a relief package, legislative committees have held, or plan to hold, meetings that are expected to take into account both the current surplus and the new cigarette tax revenues.

Recognizing that tax surpluses will occur from time-to-time, we are proposing methods to use both in this year and in others when a surplus arises from individual income taxes. Our suggestions serve two purposes: (1) to be administratively efficient especially as to cost, and (2) to be fair to those who provide the surplus. Since the bulk of the fiscal-year 1997 surplus has come from individual income taxes, our suggestions address these taxpayers.

Millions of dollars can be returned to taxpayers in a number of different ways. Two possible proposals are to provide equal amounts to individuals, or to increase the amount of the individual income tax exemption.

An equal amount could be provided to individuals by dividing the $28 million by the number of taxpayers filing individual income tax returns in 1998, for tax year 1997, and giving each the same dollar amount. For example, if approximately 800,000 taxpayers are expected to file tax returns in 1998, for tax year 1997, then $28 million divided by 800,000 would result in a refund, probably by check, of $35 per taxpayer.

Alternatively, the surplus could be returned to taxpayers by increasing the exemption amount per taxpayer from the current $2,150 for tax year 1997 to an amount better reflecting the higher 1997 federal exemption of $2,650. An article in a local newspaper argued that an increase in the exemption to $2,650 would use up the $28 million dollar surplus.⁽³⁾

Both of these proposals would provide one-time relief, since future surpluses could not be assured.

At least two weaknesses exist with the above ideas. First, the major portion of the surplus came from withholdings and final payments (paid in 1997) from 1996 filers. Those who will file in 1998 for tax year 1997 may not be the same taxpayers, and therefore they may well be unjustly compensated if they received a refund or increased exemption. Second, an equal refund repayment does not take into consideration varying marginal tax rates from the year of overpayment. Thus, these two propositions are inconsistent with the desire to be fair to those who contributed the surplus.

The first weakness could be overcome by limiting a direct payment or an increase in the exemption to those who filed returns in the year of the surplus (tax year 1996). Of course, certain administrative costs would be involved in matching current taxpayers with those from the surplus year to ascertain that they are eligible for the refund, or exemption. On the other hand, the administrative costs for the increased exemption would likely be less than choosing to refund an equal amount to taxpayers, since the refund method has the additional costs associated with issuing checks.

The second weakness, as noted, is that individuals whose tax payments may have varied greatly in the surplus year would receive very similar dollar amounts. This could be overcome by making the refund a percentage of taxes paid in the year of the surplus. In fiscal year 1997 approximately $772 million was paid by individual income taxes (mostly from 1996 filers), of which approximately $28 million is to be returned. Twenty-eight million divided by $772 million provides for a 3.6% refund. The Maine Revenue Service (formerly the Bureau of Taxation) could prepare a listing of all 1996 taxpayers and amounts paid. These amounts would be multiplied by 3.6%, and a check mailed to each taxpayer. Again, administrative and mailing costs would be high.

A third method, where the primary refund is in the form of a tax credit on the taxpayer's 1998 income tax returns (filed in 1999), provides for proportional refunds based upon the size of income tax overpayments. Space would be provided on the form for taxpayers to record what the individual paid in 1996, followed by another showing the multiplication by 3.6% of that amount to give the 1998 tax credit. Using this method, the legislature would only need to decide whether or not to make refunds to those who filed in the year of the overpayment but were not filing for 1998 (for example, those moving out of state, those deceased after 1996, and those with no 1998 taxable income). Those individuals could be given the opportunity to obtain refund checks in 1999 by filing a request with the Maine Revenue Service. This method would be both administratively efficient as well as fair to those who contributed substantially to the overpayments for tax year 1996. Ideally, this method could be available in 1998 for tax year 1997. Unfortunately, the legislature will not be deciding what to do with the surplus until after tax forms have been distributed for tax year 1997. Relief during 1998, using a tax credit, would therefore require that amended returns be filed, and thus would not be practical.

Implementation, using the equal-amount refund method, could take place immediately, upon legislative approval, and result in a benefit to taxpayers in 1998. If either the exemption or credit method is used, benefits will likely be postponed until 1999, for tax year 1998, since legislative approval would not be timely. The delay would likely have little impact on the economic lives of most taxpayers because the amounts involved are relatively small.

While all three methods have advantages, we believe that the tax credit would probably be the fairest while being reasonably cost efficient. It could be utilized in any year, and should probably be adopted as a standard process for returning to taxpayers most forms of future income tax surpluses. If a surplus were identified early enough, the credit could routinely be applied to the following year's income taxes.

1. "King: Taxpayers Due $45 Million Refund," Portland Press Herald (August 1, 1997): 14A.

2. Ibid.

3. "Tax-cut Plans Jockey for Position," Maine Sunday Telegram (August 17, 1997): 7B.