How the Fiscal Cliff Deal Could Make Maine’s Budget Gap Even Bigger than We Thought

We already know that Maine faces an $881 million shortfall over the two-year period beginning July 1st. State lawmakers are also working to close a $153 million hole in the current fiscal year, which ends in June 30th. Both of those budget gaps will grow larger if Maine policymakers choose to conform Maine tax law to changes in the federal tax code resulting from the recent “fiscal cliff” deal. How much? About $500,000 this year and a massive $81 million over the coming biennium.

Maine Revenue Services (MRS) yesterday released analysis of the Maine impacts of the “American Taxpayer Relief Act of 2012” (ATRA)- the deal to step away from the “fiscal cliff” that Congress and President Obama reached in early January.

Why does ATRA matter for Maine policymakers and Maine’s budget? Maine policymakers must decide how far they want Maine tax law to “conform” to these new changes in federal tax law. In general, Maine bases its income tax laws on the federal tax code, since federal adjusted gross income is the starting point for calculating Maine income tax liability. But for Maine tax law to conform to new changes in federal law, Maine lawmakers must pass legislation.

If federal lawmakers enact a new law that reduces taxpayer liability for the federal income tax, Maine lawmakers must pass legislation for the state tax code to conform to the new change in the federal tax code. If they don’t, then Maine automatically decouples from federal law in that particular instance. That’s why the Maine income tax form has a section for “income modifications,” which are adjustments to federal adjusted gross income. In 2004, for example, federal policymakers created a new income tax deduction for “qualified production activities.” Maine lawmakers wisely did not pass legislation to conform state law to this new generous new federal tax break. As a result, Maine taxpayers must “add back” to their state taxable income the amount they deducted from their federal taxable income under the new law.

When state revenue analysts conducted Maine’s most recent revenue forecast in December 2012, the law of the land was that the Bush and Obama tax cuts would expire and federal tax law would largely return to where it was in early 2001. The current revenue forecast for the state was therefore based on the assumption that all of the recent tax changes made by Bush and Obama due to expire on January 1st, 2013 would, in fact, expire. But with the passage of ATRA that assumption fell apart.

ATRA dealt with some parts of the “fiscal cliff,” like the expiration of the Bush and Obama tax cuts, and postponed action on others, most notably the automatic spending cuts resulting from the debt ceiling crisis of 2011. ATRA also included numerous changes to the federal income tax code, such as extending relief for married couples filing jointly, raising the caps on personal exemptions and itemized deductions, extending improvements to the Earned Income Tax Credit and the Child Tax Credit.

The upshot is that Maine policymakers must now decide whether and how to conform Maine’s tax code to all of these changes contained in ATRA. According the MRS analysis, if Maine conforms to all the changes, the state can expect to see even less revenue—about $500,000 in the current fiscal year and $81 million over the coming biennium—than is currently forecast. And that will worsen the $881 million shortfall and make their task of producing the new biennial budget even more daunting.