An overview of Montana taxes.

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Tax reform is an ongoing process in Montana--not a one-time event. This article describes Montana's current taxes, how they compare with other states, and important changes since 1990. Some of the most divisive political issues of recent years have concerned taxes. How, in fact, has Montana's tax structure been changed?

Are Taxes High in Montana?

First consider the overall level of taxes (Table 1). These data include all state and local taxes--property, income, sales, severance, etc.--levied by all levels of Montana governments including state, county, city, schools, and various other special districts.

Montana's taxes are 48th highest among the states on a per capita basis, and 39th highest as a percentage of income. Total taxes are similar in Idaho, while South Dakota has exceptionally low taxes relative to income. Wyoming's taxes have increased significantly in recent years, reflecting rapid revenue growth from the natural resource boom in that state.

Are Montana's Taxes Rising?

Taxes declined from about 12 percent of income in 1970 to 9.8 percent in 2002 (Figure 1). The decline was especially rapid since 1998, because taxes grew only 11 percent while incomes grew 26 percent (U.S. Bureau of Economic Analysis).

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Figure 1 also illustrates the two other sources of Montana government revenues. Fees and miscellaneous revenues is a broad category including charges for services (university tuition is the largest, but also including parks and recreation, sewerage, and others) and other revenues such as interest earnings. The rise in fees and miscellaneous revenues in the early 1980s resulted from growth in the coal and other trust funds, and the record high interest rates at the time. Some readers will remember mortgages that carried interest rates of 15 percent or more.

The third revenue category is intergovernmental transfers from the federal government. This category includes only transfers to state and local governments--not transfers and other payments to individuals--so Social Security, Medicare, Crop insurance, CRP, etc. are not included. In the 1970s, the largest portion of these transfers were for highways, and Montana governments still receive a lot of Federal gas tax money. But the largest transfers now are for health and human services including the Medicaid program, which in Fiscal Year 2004 totaled $575 million, up 64 percent in just 5 years. Medicaid provides health care services, including nursing home care, to low income Montanans.

The mix among taxes, fees and miscellaneous revenues, and federal transfers has changed quite dramatically over the years. Taxes were 58 percent of revenues in 1970 but only 42 percent in 2002. Federal transfers are at an all-time high of 31 percent. With the federal budget substantially out of balance, and with no end in sight to rising health care costs, dependence on federal transfers may be a problem in the future.

Property Taxes

One of the most dramatic changes has been in Montana's property tax base. As Figure 2 indicates, residential and commercial property is now 60 percent of the statewide property tax base, up from 43 percent in tax year 1990. Thus, residential and commercial property pays over half the total taxes for the 101 mills levied state-wide for schools and the university system. The shares of the other classes have shown a corresponding decline.

This "shift" in the property tax burden has resulted from two major factors: changes in property tax laws and changes in the economy. Among the legal changes, the taxable value rate for most business equipment dropped from 9 percent to 3 percent, electrical generation and telecommunications equipment dropped from 12 percent to 6 percent, and livestock dropped from 4 percent to zero. The taxable value rate for residential and commercial property fell from 3.86 percent to 3.37 percent, and 31 percent of the value of residential property is now exempted from tax (13 percent for commercial property).

Changes in the economy also affect the tax base. Substantial in-migration to Western Montana resulted in new construction and rapidly rising property values, which would have increased the residential and commercial share even if the laws hadn't changed. Figure 3 illustrates this idea: The market value of property in 2003 is used to compute the property tax base under 1990 law; i.e. what the 2003 property tax base would have been if there had been no changes in the law. The striking feature of the chart is that residential and commercial property would have grown to 59 percent of the tax base even if the law had not changed. That is, most of the shift in the property tax burden has resulted from changes in the economy itself--specifically the growth of residential and commercial property--not from changes in the law.

Montana's Income Tax Reform

Montana's income tax underwent substantial changes effective January 1, 2005. As Table 2 indicates, the top marginal tax rate declined from 11 percent to 6.9 percent. However, Montana previously allowed taxpayers to deduct the full amount of their federal income taxes when filling out their state returns. Thus, the "effective rate," which takes account of both the deductibility of federal taxes on state returns and state taxes on federal returns, was considerably less than the statutory rate. Beginning in 2005, a married couple filing jointly will be able to deduct a maximum of $10,000 ($5,000 filing single). For most taxpayers, the deductions limits won't be binding. But the new limitations will be binding for about 15 percent of taxpayers, mostly at the highest income levels. For a taxpayer in the new 6.9 percent bracket who can continue to deduct all federal taxes, the marginal effective rate declines to 3.5 percent. Taxpayers who reach the limit on federal tax deductions will have a top effective rate of 4.8 percent.

One of the unusual features of Montana's income tax was that capital gains from asset sales were taxed at a higher rate than ordinary income. Many states and the federal government tax capital gains at lower rates, because the so-called "gain" is often partly a phantom result of inflation, and partly to encourage investment and entrepreneurial activity. Montana's higher effective rate actually resulted from lower rates of federal tax on capital gains: With lower federal taxes, the taxpayer had less to deduct on the Montana return and thus owed more to the state. Beginning in 2005, capital gains receive a 1 percent tax credit that more than offsets the lower Federal rate, and so effective rates are substantially reduced. Even taxpayers whose federal tax deductions are limited will see the top effective rate reduced from 6.5 percent to 4.1 percent. The tax credit for capital gains is scheduled to increase to 2 percent in 2006, further reducing the effective rate.

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Summary

Montana's taxes have declined relative to income and in comparison with other states, especially in recent years. The property tax base has changed dramatically, reflecting the equally dramatic changes in the economy of Western Montana. Income tax reform will lower overall bills by about 7 percent and significantly change the taxation of capital gains. But income taxes remain high in comparison with many other states, including most of our neighbors. While the state budget is at least temporarily in balance, paying for education and health care is likely to become more difficult. Thus, tax reform will continue to be an important issue.

Douglas J. Young is a professor of economics at Montana State University-Bozeman.

Table 1
Total Taxes

                   Dollars              Percent of
State             Per Capita    Rank      Income      Rank

Montana                $2,346    48            9.8%    39
Idaho                  $2,451    44           10.0%    37
North Dakota           $2,721    31           10.5%    19
South Dakota           $2,423    45            9.0%    48
Wyoming                $3,644     8           12.2%     4
U.S. Average           $3,143                 10.4%

Source: U.S. Bureau of the Census, Government Finances in FY 2002.

Table 2
Top Income Tax Rates

                                                  Effective

                                Deduct                  Capital
State           Statutory      Federal?      Ordinary    Gains

Montana             11.0%        Yes             5.6%      6.5%
2005                 6.9%      Max=$10k          4.8%      4.1%
Idaho                7.8%         No             5.5%      5.5%
North Dakota         5.5%         No             3.9%      2.6%
South Dakota                No Income Tax
Wyoming                     No Income Tax

Note: Assumes taxpayer is in the 30 percent federal tax bracket.

Source: Federation of Tax Administrators, author's calculations.

Figure 2

The Changing Property Tax Base
1990 and 2003

                              1990   2003
Net & Gross Proceeds            2%     1%
Ag & Forest Land, Livestock    11%     8%
Residential & Commercial       43%    60%
Personal Property              14%     9%
Utilities, RRs, Airlines       31%    22%

Source: Biennial Reports, Montana Department of Revenue.

Note: Table made from bar graph.

Figure 3

Tax Base Under 1990 and 2003 Laws

                              1990 Law   2003 Law
Net & Gross Proceeds            1%         1%
Ag & Forest Land, Livestock     6%         8%
Residential & Commercial       59%        60%
Personal Property              14%         9%
Utilities, RRs, Airlines       20%        22%

Source: Biennial Reports, Montana Department of Revenue.

Note: Table made from bar graph.