How Does Montana’s Tax System Measure Up?

Montana State Capitol building in Helena, Montana. (Shutterstock)
Montana State Capitol building in Helena, Montana. (Shutterstock)

Taxes are an important and often contentious public policy issue. What one pays and what those taxes pay for varies state to state. So, how does Montana’s tax system compare to other states? Before discussing the numbers, it’s worth considering what constitutes a “good” tax system.

First, a good tax system is one that promotes economic opportunity. For many years Montanans have seen large numbers of young people leaving the state for better opportunities elsewhere, and most of us wouldn’t mind an increase in our own incomes as well. To the extent that a tax system can improve that situation, or at least not discourage opportunity, is desirable.

A second criterion for evaluating a tax system is fairness – this has to do with who bears the burden of paying taxes. It is very difficult to pin down exactly what constitutes a fair tax system. In fact, most people’s definition of a fair tax is one that somebody else pays, which accounts for the popularity of taxes on tourists and to some extent natural resource taxes.


 

A third factor is low administrative and compliance costs. These are the costs borne by the government in collecting taxes, and also the costs borne by the private sector in complying with the tax code. A complicated tax system has greater administrative and compliance costs than a simpler system.

A fourth factor is stability. You may recall that the Montana Legislature was called back into a special session in the fall of 2017 – only six months after it had adjourned not expecting to return for 21 months. The primary reason for the special session was that tax revenues had fallen short of projections. The special session cut planned expenditures for mental health, nursing homes and other programs, shifted funds around, and eventually balanced the budget.

A good system also provides adequate revenues. In fact, revenues to fund government services are just about the only good thing about taxes. If it weren’t for the police and fire, roads, schools, health care and other services that are provided by taxes, we could just go home and forget the whole thing.

Are Taxes High in Montana?
Montana’s overall tax burden is much lower than the national average and significantly lower than three of the four neighboring states, as shown in Table 1. Total taxes include property taxes on residential, commercial, industrial, agricultural and any other property, personal and corporate income taxes, all kinds of sales and excise taxes, and severance and other taxes levied on natural resources. They include taxes levied by all levels of state and local government, including the state, counties, cities and towns, school districts, right down to mosquito control districts.

Table 1. Total taxes, FY 2016. Sources: Tax Foundation, U.S. Bureau of Economic Analysis.
Table 1. Total taxes, FY 2016. Sources: Tax Foundation, U.S. Bureau of Economic Analysis.

Montana’s taxes in 2016 totaled $3,827 per person compared to a national average of $4,496, making Montana the 37th highest among the states.

The last two columns show taxes as a percentage of personal income, one measure of one’s ability to pay. Montana’s per capita income in 2016 was 88 percent of the national average, suggesting that the burden may be greater than the per capita tax figures suggest. But taxes are also below the U.S. average when expressed as a percentage of income and have a similar ranking (38th highest).

Natural Resource Tax Revenues
Montana’s tax revenues from natural resources are much lower today than in the 1980s, as Figure 1 shows. In the early 1980s they brought in more than $700 per person each year in today’s dollars. That was about the amount that a typical state received from its general sales tax. But natural resource revenues declined in the late 1980s as oil and other energy prices fell, there was a partial recovery in the late 2000s, but those revenues have again diminished in recent years.

Figure 1. Natural resource tax revenues. Source: Montana Department of Revenue.
Figure 1. Natural resource tax revenues. Source: Montana Department of Revenue.

Composition of Taxes
Montana relies relatively heavily on property, income and other taxes as shown in Figure 2. Montana gets 40 percent of its tax revenues from the property tax, while a typical state gets only 31 percent.

Montana does not have a general sales tax, but it does levy a variety of excise or selective sales taxes on tobacco, alcohol, gasoline, motel rooms, life insurance policies and other items. Altogether, Montana’s selective sales taxes are 18th highest in the country as a percentage of income. Still, when general and selective sales taxes are added together, Montana gets less than half as much from these sources as a typical state does.

Figure 2. Tax composition, FY 2016. Source: U.S. Census Bureau.
Figure 2. Tax composition, FY 2016. Source: U.S. Census Bureau.

On the other hand, Montana’s personal and corporate income taxes provide about 33 percent of total tax revenues, above the national average of 27 percent.

Finally, Montana gets more taxes from other sources than a typical state. These include motor vehicle taxes and natural resource taxes, and while Montana’s natural resource revenues are much diminished from 35 years ago, they are still more than a typical state.

Property Taxes
Data suggests that Montana’s average effective tax rates on residential properties are well below the national average and near the midpoint for states in the region (Table 2).

Table 2. Effective tax rates on residential property, FY 2018. Source: Tax Foundation and Minnesota Center for Fiscal Excellence.
Table 2. Effective tax rates on residential property, FY 2018. Source: Tax Foundation and Minnesota Center for Fiscal Excellence.

“Average” is an important word here, because property taxes vary dramatically around the state. Property values and mill levies vary across school districts, counties, cities and other taxing districts.

The effective tax rate is the property tax bill divided by the market value of the property – what it would sell for in an arm’s length transaction between a willing and informed buyer and seller. Table 2 displays two sets of estimates – one from the Tax Foundation and the other from the Minnesota Center for Fiscal Excellence. While the Tax Foundation estimates are based on a statewide sample, the Minnesota Center estimates are specific to the largest city in each state, which for Montana is Billings. Unfortunately, Billings is not representative of the state as a whole or even the larger cities: In any case, both sets of estimates suggest that Montana’s average effective tax rates are well below national averages and near the midpoint for states in the region.

The estimated tax rates are even lower for small industrial properties, but higher for larger industrial properties, as Table 3 shows. The small property is based on $100,000 of land and buildings, while the large property is based on $25,000,000 of land and buildings. In addition to the real estate values, each property is assumed to have machinery and equipment, inventories and fixtures, which are taxable at various rates in some states.

Table 3. Effective tax rates on industrial property, FY 2018. Source: Minnesota Center for Fiscal Excellence.
Table 3. Effective tax rates on industrial property, FY 2018. Source: Minnesota Center for Fiscal Excellence.

Montana’s property tax classification system is one of the most complicated in the nation, dividing taxable property into 14 different groups valued by four different methods and taxed at 10 different rates.

Income Taxes
Montana’s individual income taxes are slightly below the U.S. average on a per person basis, and above average as a percentage of income (Table 4). Idaho and North Dakota’s taxes are somewhat lower, and neither South Dakota nor Wyoming has an individual income tax. Montana’s top marginal tax rate of 6.9 percent ranks 13th highest in the country.

Table 4. Individual income taxes. Sources: Tax Foundation and U.S. Bureau of Economic Analysis.
Table 4. Individual income taxes. Sources: Tax Foundation and U.S. Bureau of Economic Analysis.

Montana’s individual income tax is more complicated than that in a typical state because Montana law mandates a relatively large number of adjustments to federal adjusted gross income, credits and deductions. Some states just use federal taxable income. Adjustments and deductions, which reduce taxable income in turn require higher tax rates in order to raise a target amount of revenue.

Montana’s tax rate on corporate income of 6.75 percent is the 22nd highest in the country, slightly lower than Idaho’s (6.92 percent), and considerably higher than North Dakota’s (4.31 percent). Corporate income tax collections per person in Montana are the 27th highest in the U.S. Neither South Dakota nor Wyoming has a corporate income tax.

Business Tax Climate
What does this all mean in terms of encouraging or discouraging business in Montana? The overall level of taxation is below average, but Montana relies relatively heavily on property and income taxes. On the other hand, Montana does not have a general sales tax, a significant part of which is paid by businesses in many states. The Tax Foundation has combined information on all these taxes and the unemployment insurance tax into an index of Business Tax Climate. Montana has the fifth best overall business tax climate.

Personal Tax Burden by Income Level
The estimated burden of all personal taxes in Montana is below average for both low income and high income families, as shown in Table 5. Personal taxes include individual income, general sales, property and auto taxes. Estimates are shown for hypothetical families of three. At the $25,000 income level Montana’s taxes are among the lowest in the country at 7.5 percent, in comparison with a national average of 10.6 percent. One reason for this is the absence of a sales tax – the average family in the country pays almost $1,000 in sales taxes at this income level. However, the absence of a sales tax is not necessary for low taxes.

Table 5. Personal tax burden by income level. Source: Government of the District of Columbia.
Table 5. Personal tax burden by income level. Source: Government of the District of Columbia.

At the $150,000 level, Montana’s taxes remain below the U.S. average, but our rank moves up from 47th to 37th. Property and sales taxes in Idaho are each about $1,500 more than in Montana at this income level. South Dakota and Wyoming have much lower taxes at the $150,000 income level, because neither state has an income tax. And North Dakota has used a portion of its Bakken revenues to lower other taxes, or at least not increase them.

Montana’s tax structure is progressive – taxes rise as a percentage of income as income increases. In Montana the tax rate increases slightly, from 7.5 percent to 8.8 percent as income rises from $25,000 to $150,000. Not a big increase, but greater than zero. In most other states taxes decline as a percentage of income as income increases, indicating a regressive tax structure.

Evaluation
How does Montana measure up relative to the criteria for a good tax system?

Promote economic opportunity: Montana’s overall tax burden is much lower than the national average and lower than three of the four neighboring states. The Tax Foundation’s index of Business Tax Climate ranks Montana as one of the best in the country. Of course, tax structure affects different types of business differently. For example, some businesses benefit a great deal from the absence of a general sales tax, while this is less important for other businesses. And Montana’s property taxes on large industrial businesses are relatively high. But overall Montana’s tax structure is friendly to business.

Fairness is very hard to objectively define and often in the eye of the beholder. Direct taxes on individuals in Montana are less regressive than in most other states, which many people view as desirable. Despite evidence that residential property taxes are not especially high in Montana, many citizens are concerned that they are rising rapidly and not reflective of income, thereby making them unfair.

Administrative and compliance costs: Montana’s property tax classification system is one of the most complicated in the nation, and the income tax has an exceptionally large number of adjustments, credits and deductions. However, the absence of a sales tax reduces these costs.

Stability: Property taxes are typically the most stable of revenue sources, followed by sales taxes and then income taxes. Resource tax revenues often fluctuate dramatically along with prices for coal, oil, gas and other resources. Thus, Montana relies especially heavily on one stable source (property tax), and on two relatively unstable sources (income and resource taxes).

Adequate revenue: The decline in resource revenues over the past 30-plus years has raised concerns about revenue adequacy. In the end, whether one views current revenue as adequate or not depends primarily on whether one favors more or less government spending. While taxes themselves are a burden, the government services they finance – including education, health care, public safety and infrastructure – help to provide a skilled, productive work force and community environment that make Montana an attractive place to live and do business.

Tax Reform?
If Montana wishes to provide property tax relief and at the same time compensate for the loss of resource revenues, it will need to find additional revenue elsewhere. Some additional income tax revenue would be garnered from adjusting rates and brackets, and eliminating some deductions and credits, but Montana’s income tax is already above national and regional averages as a percentage of income.

Proposals for sales taxes are again under discussion. They range from expanded taxes on tourists to local option sales taxes to a statewide general sales tax. The latter option would generate the most revenue and therefore provide both for property tax relief and revenue adequacy. Sales taxes take a larger share of income from the poor than the rich; this regressivity could be offset with a refundable income tax credit for low income Montanans.

A sales tax has been controversial issue in Montana for decades. Gov. Tim Babcock proposed a sales tax in the 1970s that was defeated. The very popular Gov. Marc Racicot got a sale tax referendum on the ballot in the 1990s – it was voted down 3 to 1. Will a sales tax be adopted this time around? We’ll have to wait and see.