By Xander Landen and Lola Duffort/VTDigger
A long-awaited report recommends wide-ranging reforms to make Vermont’s state taxes fairer and more resilient in a changing economy.
The Vermont Tax Structure Commission proposes broadening the sales tax and expanding Vermont’s income tax base by promoting the state as a destination for remote workers.
But the top-line recommendation is eliminating the homestead property tax for education and replacing it with a straightforward income tax to fund Vermont’s public schools.
Taxes on property contribute about two-thirds of all revenues to the state’s $1.8 billion Education Fund, which pays for preK-12 schools. The homestead levy provides about 25% of all revenues to the fund, and the non-homestead tax, which is applied to second homes, rentals and commercial properties, brings in about 40%. The commission’s recommendations would keep the non-homestead tax in place.
Most Vermont homeowners receive a property tax break based on their income, but the levy on homes is still criticized for being regressive. The report’s authors argue that income, not the value of one’s home, is a better proxy for wealth. An income tax would also be much simpler to administer than the current scheme’s byzantine income-sensitivity program, they wrote.
“The reason for going to income as opposed to property to simplify it is that basically, we don’t feel that the value of your house is a good indication of your ability to pay,” said Deb Brighton, chair of the tax commission.
The commission was formed at the beginning of 2019 to conduct a holistic review of Vermont’s tax structure. It examined whether it is fair, in sync with the economy, and equipped for the future. The report, which is under review and is subject to public comments, has yet to be finalized, though the recommendations were outlined to lawmakers on Friday, Jan. 15.
For decades, Vermont has tweaked the education property tax in an effort to make it “behave like an income tax,” said Paul Cillo, president of the Public Assets Institute, a left-leaning Montpelier think tank.
“It just creates complexity. And I think at some point, you have to just say: The property tax is not a good tool for this purpose,” Cillo said.
Several lawmakers have pushed previously to have the income tax finance schools, arguing that would lessen the burden on low- and moderate-income families and require wealthier residents to pay a larger share of the cost.
Too complicated
Sen. Anthony Pollina, P/D-Washington, who has repeatedly introduced legislation along those lines, hopes the report will move the dial.
“I put these bills in, and … sometimes you get to present it to the Finance Committee, and then the Finance Committee says, ‘OK, thank you very much,’ and moves on to something else, because they think it’s too complicated or too controversial to do,” he said. “And I think this report is going to make it more clear that it’s mainstream thinking.”
Rep. Janet Ancel, D-Calais, chair of the House Ways and Means Committee, said the last time her committee tackled an income-based proposal, it was watered down and then died in the Senate.
“The issue is that whenever you make big changes in tax policy, you inevitably have some people do better, and some people do less well. And so, without putting a whole lot more money in the system, it’s very hard to make these changes,” she said.
Ancel said she wasn’t ready to endorse any particular recommendation in the commission’s report, but she liked the idea of eliminating the property tax credit. The current system is too complicated, she said.
“There are a great many things about [the current] system that are good, and then there are things that are problematic — one of them being that it’s very confusing, and taxpayers don’t really understand how it works,” she said.
Tax changes of this magnitude are politically challenging. The last time the education tax system was fundamentally changed was 1997, under orders from the Vermont Supreme Court in a ruling about tax fairness. A previous tax commission report in 2011 was largely ignored.
What will Scott do?
If Democrats managed to move the recommendations forward, the ball would be in Republican Gov. Phil Scott’s court.
Jason Maulucci, Scott’s press secretary, said that the governor is “willing to have the conversation about changing how we pay for education.” But he said that conversation must also examine the state’s spending on education “with a focus on equity.”
“Because right now, there is unacceptable inequality of opportunity from district to district,” Maulucci said. “With the nearly $2 billion we already spend, Vermont’s kids should have more opportunities, more choices, and better outcomes.”
In general, Scott has opposed new taxes and fees since taking office in 2017. Maulucci said the Scott administration looks forward to reviewing the report’s recommendations, but the governor “has been clear since he took office that he is only interested in proposals that reduce the tax burden on Vermonters and make Vermont more affordable.”
The commission’s education finance proposals are fundamentally about what to tax. But the discussion at the State House is likely to be paired with consideration of another study, issued last year, which lawmakers commissioned on the subject of how to calculate school tax rates.
The local education tax rate is based on how much a district spends per pupil. The per-pupil spending rate is calculated using a weighted formula that takes into account the higher cost of educating certain students. Last year’s study made suggestions about how the formula could be more fair, in particularly that poverty ought to be weighted more heavily.
“It appears that a combination of district consolidation, heavier weighting for poverty, and moving to an income-based tax for residents will improve the equity of the education tax,” the tax commission members wrote.
Local school officials have argued for decades that they have little control over increases in K-12 spending. The commission also recommends moving expenditures for mental health services and employee health insurance, a leading cause of rising budgets, from the Education Fund to the General Fund, along with proportionate revenue streams.
With Covid-19 at the top of the agenda, lawmakers are being pressured not to tackle too many non-pandemic topics. Ancel said she couldn’t say yet whether the pandemic will derail the possibility of a tax overhaul this biennium.
“I will say that it’s very hard-to-do, complicated legislation on Zoom,” she said.
Broadening the sales tax
The report also recommends expanding the sales tax to almost all consumer goods and services. The commission notes that Vermont has among narrowest sales tax bases in the U.S.
Policymakers have avoided taxing items like groceries and clothing, in large part to protect low-income Vermonters from an added expense for essential goods. They have also refrained from taxing many “public goods” such as higher education, sporting instruction, and membership in professional or social organizations, the report notes.
But the commission recommends broadly expanding the sales tax to these goods, services and almost all other consumer transactions, except those in the health care sector, and those between businesses.
Under the recommendations, consumer services such as repair labor, laundry, landscaping, taxis, environmental consulting and construction, would be subject to the sales tax. Higher education would also be taxed.
But they note that broadly expanding the sales tax will allow state officials to lower the rate from 6% to 3.6%.
And they say the reforms should go into effect only after state officials restructure financial support systems for low-income residents “to ensure they are not harmed by these changes.” Brighton said that could include providing an income tax credit for low-income residents who pay sales tax on food.
A more stable system
Bram Kleppner, one of the three members of the tax commission, told the House Ways and Means Committee Friday that broadening the sales tax will make the state’s tax system more stable if there are sudden changes in the economy and consumer spending.
“The broader the base, the more likely things going up and down over the next 20 years as everything changes will balance each other out and we’ll be in a more stable situation,” Kleppner said.
He said the economy has moved away from goods and more toward services over the last 20 years and the state’s tax structure should reflect that change.
“There’s a fairness issue in the fact that we tax the output of the work of Vermonters who produce goods, and in many cases we don’t tax the output of the work of Vermonters to produce services,” he said.
Last year, the commission released a separate report examining how Vermont’s demographic trends could affect state revenues in the coming decades. Among the many findings was that Vermont is at risk of losing income tax revenue as baby boomers, the largest segment of the state’s tax base, retire in the next 10 to 15 years.
In the latest report, the commission recommends that, to increase the income tax base, the state should “promote the remote workers living in Vermont” and expand broadband access and cellphone service to attract more remote workers to the state.
“This will increase the taxpayer base in the state, providing additional personal income tax revenue and future stability to the personal income tax,” the report says.
The commission states that all the proposals are aimed at helping Vermont weather the economic challenges expected in the coming years, including climate change and the state’s aging population.
“Underlying all our recommendations is a belief that our economy and our climate and our population are all becoming less stable, and Vermont will need to be ever-vigilant and ever-agile to be successful in continuous adaptation to a changing world,” the commission said.
