Governor Moore Proposes Major Tax Changes in Maryland to Address Chronic Budget Deficits

Facing a projected $3 billion budget deficit in fiscal year 2026, with forecasts of a growing gap over the next five years, Governor Wes Moore (D) has included about $1 billion in proposed taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increases in his budget proposal. The package features changes to individual income taxes (such as restructuring tax bracketsA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. and deductions, increasing the top marginal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate, and introducing a surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on capital gains income), the repeal of the inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. offset by broader applicability of the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. , medium-term corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. reforms, and modifications to excise taxes. While several elements of the package are structurally sound and align with the principles of simplicity, transparency, and neutrality, increasing the top marginal individual income tax rate and introducing a capital gains surtax could hurt Maryland’s competitiveness, especially given the wave of income tax reforms implemented in other states in recent years.

Individual Income Tax Changes

The most important revenue raisers in Governor Moore’s tax proposal are individual income tax provisions. Several structural changes are proposed, including the replacement of the four lowest tax brackets with a single 4.7 percent rate, two additional brackets for top earners (with rates of 6.25 percent and 6.5 percent), a 1 percent surtax on capital gains income for households earning more than $350,000 in federal adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” , and several modifications to standard and itemized deductions and tax credits.

According to the budget documents, these changes would generate close to $820 million for the state’s general fund in fiscal year 2026 ($691.5 million from the restructuring of brackets and deductions and $128 million from the temporary capital gains surtax).

Individual income tax rates and brackets under the current system and the proposed tax changes are shown in the table below. The number of tax brackets decreases from eight to seven, the top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. increases by 0.75 percentage points (from 5.75 percent to 6.5 percent), and the four lowest brackets are consolidated into one. Additionally, the marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. remains in the new system, perpetuating the unequal treatment of single filers and married couples filing jointly, favoring the former tax status.

Current and Proposed Individual Income Tax Rates and Brackets in Maryland

Other elements of the proposal include eliminating itemized deductions and doubling the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. (which, in tax year 2024, was $2,700 for single filers and $5,450 for married couples filing jointly), while also removing the standard deduction phase-in. This is a step in the right direction and generally aligns with the principles of simplicity and transparency. Notably, even the modified standard deduction in Maryland would still be low compared to Virginia (currently $8,000 for single filers) and DC (currently $15,000 for single filers, reflecting the District’s conformity with the federal tax code).

The proposal does not address inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. adjustments for any of the income tax provisions. In a volatile economic environment with higher inflation compared to the pre-pandemic era, the absence of such adjustments could lead to unlegislated tax increases in future years. This issue should be addressed by annually adjusting brackets and the standard deduction for inflation to prevent unintended tax burdens.

One of the most problematic aspects of the proposal, from a tax competitiveness perspective, is the 1 percent surtax on capital gains. The positive aspect of this surtax is that it is a temporary measure designed to boost revenues in the short term and is scheduled to expire in four years. However, if enacted, Maryland would become only the second state after Minnesota to implement such a surtax. While this change would not affect individuals with federal adjusted gross income of $350,000 or below, it would negatively impact high earners—the group most mobile and responsive to tax increases. This point has been emphasized in recent academic studies and is supported by IRS migration data. If the goal of the proposal is to accelerate economic growth in the state, it may be challenging to achieve if some of the most productive and entrepreneurial residents have more reasons to relocate to other jurisdictions.

In total, high earners (individuals with an adjusted gross income of $1 million or more) living in counties with a 3.2 percent local income tax should expect their combined state marginal tax rate to reach 10.70 percent for some income. This includes the state’s top rate of 6.5 percent, the local rate of 3.2 percent, and the 1 percent capital gains surtax.

The map above shows that this combined marginal tax rate for high earners in Maryland would be one of the highest among the state’s neighbors, only 0.05 percentage points lower than in DC and more than 4 percentage points higher than in Pennsylvania, Virginia, and West Virginia. This differential is significant if Maryland aims to attract more high-net-worth individuals, especially given that the state is currently experiencing net outmigration and ranks in the bottom 10 by this metric, according to the most recent data from IRS, Census, and U-Haul. Importantly, the District of Columbia is prohibited from taxing nonresident income, which has historically made it attractive for many DC workers to live in Maryland or Virginia. Should Maryland’s income tax rates begin to approximate the District’s, that advantage—weighed against other considerations, including proximity to work—could disappear.

Other Tax Changes

Corporate income tax changes are also included in the package, but they take effect in fiscal year 2028, meaning there will be no immediate fiscal consequences in fiscal year 2026. Specifically, the corporate income tax rate would decrease from 8.25 to 7.99 percent over two years starting in 2028. Additionally, the state would adopt water’s edge combined reporting, which is significantly less problematic than the worldwide combined reporting proposed in Maryland last year.

Another positive development is that the inheritance tax would be eliminated. Maryland is currently the only state in the nation that imposes both inheritance and estate taxes. This change would be paid for by lowering the estate tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. , which is not ideal but keeps this proposal revenue neutral.

Several excise taxes would see higher rates under the proposal, specifically the sports wagering tax (increasing from 15 to 30 percent) and the table game tax (rising from 20 to 25 percent). These changes are projected to generate nearly $130 million for the state’s general fund. Additionally, the governor proposes increasing the cannabis tax rate from 9 to 15 percent, starting in fiscal year 2027.

Finally, the bill imposes a $0.75 tax on deliveries, with certain exemptions. Colorado and Minnesota currently impose retail delivery fees, though at lower rates ($0.28 and $0.50, respectively). These fees are an inefficient way of raising revenue, especially compared to alternatives like a very modest increase in the diesel tax, which would better capture the cost of road usage by shippers without creating a new narrowly tailored tax with high compliance costs.

Is the Proposal Sound?

While several proposed changes align with the principles of sound tax policy (e.g., doubling the standard deduction, reducing the number of income tax brackets, and eliminating the inheritance tax), the overall proposal will affect Maryland’s economic growth potential. And while any effort to raise $1 billion in taxes will have some impact on the economy, the administration passed on some options that would be less economically harmful. Sales taxes, which are entirely omitted from the proposal, are generally less damaging to economic growth than income taxes—the main revenue raiser in the plan. Maryland’s sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate of 6 percent is below the national average (especially since localities in Maryland, unlike those in most other states, are not authorized to impose local sales taxes), and its sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. is relatively narrow. Expanding the sales tax base to include consumer services or modestly increasing the rate presents an opportunity to raise much-needed revenue in a less distortive way while preserving Marylanders’ incentives to live and work in the state—factors that are likely to be negatively affected under the current proposal.

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