October 26, 2007

Governor O’Malley’s Tax Plan Puts Maryland at Risk in Regional Tax Competition (text of speech)

This speech was presented at a press conference at the Maryland legislature on October 26, 2007.

Thank you all for coming. And thank you, Chris and the Maryland Public Policy Institute for having us.

The Tax Foundation is a non-profit, non-partisan tax policy research group based in Washington, DC. Founded in 1937, we study the economics of taxation at the federal, state and local levels.

Governor O’Malley’s proposal increases five taxes, decreases one and promotes a state-run gambling operation in order to close what he calls a $1.7 billion structural deficit. The governor has been quick to point out that the revenue is necessary to close budget holes and increase spending on transportation, education and health care.

Lost in the rush to increase taxes is the crushing impact these tax increases will have on Maryland’s competitiveness.

Maryland needs to be mindful of its competitiveness because investment capital is more mobile now than ever before. Companies can up and move their operations in the blink of an eye, and those states with the most competitive tax systems will be more likely to attract new or expanding businesses.

While global outsourcing gets the headlines, states must remain wary of their standing in relation to other states, since the Department of Labor reports most job relocations still occur from one state to another, rather than to foreign destinations.

Tax Foundation Rankings
The Tax Foundation has two ways to measure the competitiveness of a state’s tax system.

First, our state and local tax burdens measure how much taxpayers in each state pay in state and local taxes as a percentage of their income. The tax burdens are widely cited as the most accurate measure of state and local tax burdens.

Second, the State Business Tax Climate Index measures how each state collects its tax burden, because an overly-complicated tax system can be as punitive for businesses as a high tax bill.

Together, the burdens and Index rank give Maryland a complete picture of its competitive stance compared to the other 49 states.

Maryland’s Tax Burden
Marylanders currently pay 10.8 percent of their income in state and local taxes. This is right near the national average of 11.0 percent and ranks Maryland 23rd overall nationally.

If Governor O’Malley’s plan had been in effect for 2007, however, Marylanders would have paid 11.5 percent of their income in state and local taxes, ranking 11th highest nationally.

Maryland would have jumped over West Virginia and competed with New Jersey for the highest-taxed state in the region. In fact, Maryland would only be a few hundredths of a percentage point behind New Jersey, meaning it would be knocking on the door of the top ten.

Maryland’s State Business Tax Climate Rank
In addition to a higher tax burden, Governor O’Malley’s plan will also damage Maryland’s rank on the State Business Tax Climate Index. Maryland’s tax system ranks 24th best in the 2008 Index, making it 3rd best in its region behind Delaware (ranked 9th) and Virginia (ranked 14th), but ahead of Pennsylvania (ranked 27th), West Virginia (ranked 37th) and New Jersey (49th).

If the governor’s plan were in place at the start of the 2008 fiscal year, July 1, 2007, Maryland’s ranking would have plummeted 19 rankings to 43rd overall-ahead of only lowly New Jersey in its region.

Maryland’s rank falls so drastically because the governor’s plan lowers the state’s score on three of the State Business Tax Climate Index‘s five component indexes: Corporate Tax; Individual Income Tax; and Sales Tax.

Maryland’s score on the Corporate Tax Index would have fallen from 7th best to 14th best because the corporate income tax rate increases from 7% to 8% under the governor’s plan. While the rate increase doesn’t hurt Maryland regionally, nationally the rate goes from the 24th highest to 15th highest.

Maryland’s score on the Individual Income Tax Index currently ranks below average at 37th. The governor’s plan to increase taxes on singles making over $150,000 and married couples over $200,000, and the greater complexity added by increased progressivity would’ve caused Maryland’s individual income tax system to rank second worst overall at 49th had they been in place for the 2008 fiscal year.

It is important to keep in mind that Maryland taxpayers pay the highest local income taxes in the country. Only 14 states allow local income taxes, and none to the extent of Maryland. Statewide, the rate averages 2.75%, almost one full percentage point higher than the statewide average in Ohio, the state with the second highest average local income tax rate.

Maryland’s top income tax rate is often incorrectly reported as 4.75%. But when adding the steep local income taxes, Marylanders currently pay 7.5% on taxable income over $3,000-the 14th highest rate nationally.

Residents in Montgomery County, Prince George’s County and Baltimore City pay 3.2 %. High earners in these areas will pay a marginal income tax rate of 9.7% on taxable income over $500,000 under the governor’s plan. The only place they’d face a higher marginal rate is in Rhode Island.

Far outweighed by these wage tax hikes are smaller cuts offered at the low end, to singles making $15,000 or couples making $22,500.

Finally, Maryland’s rank on the Sales Tax Index would have fallen from 7th best to 13th under the governor’s plan. Governor O’Malley’s plan to raise the sales tax from 5% to 6%, the cigarette tax from $1.00 to $2.00 and the gas tax by indexing it for inflation all hurt Maryland’s score.

A higher sales tax rate will serve as added incentive for Maryland shoppers to head for Delaware where they will pay no sales tax. Marylanders will also find a lower sales tax rate in nearby Virginia where the combined state and local rate is 5%.

The increase in the cigarette tax will make Maryland’s rate per pack 4th highest nationally and greatly increase the incentive for smugglers to bring cigarettes into the state illegally. The $1.70 disparity between Maryland’s $2.00 per pack rate and Virginia’s $0.30 per pack rate means a smuggler can earn up to $17 for illegally selling just 1 smuggled carton.

The governor’s plan does propose lowering one tax: the statewide property tax. Most property taxes in Maryland, however, are paid at the local level. In 2007, Marylanders will pay close to $7 billion in total property taxes. The governor’s proposal only slight lowers this amount and is not enough to help Maryland’s rank in the Property Tax Component Index.

Slot machines
An integral part of the governor’s plan, and one that should not be forgotten, is to introduce slot machines at locations across the state to try and recapture lost revenue from Pennsylvania and Delaware. Relying on gambling to raise revenue is a risky proposition and poor policy since the burden will fall mostly on the poor and the burden of funding government operations should fall on the broad population-not just a targeted few like gamblers.

In conclusion, the governor and legislature might be better served to wait and see if the budget deficit materializes before pushing forward with these massive tax hikes. Maryland’s rankings if the governor’s plan was in place for 2007 suggest that if the deficit does occur, lawmakers could be better served by cutting spending instead of severely hampering Maryland’s competitiveness.

Thank you for your time. I’d be happy to answer any questions.