Earlier this year, Maryland Governor Martin O’Malley proposed a number of 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. proposals, including increasing income taxes,[1] applying the 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. to gasoline,[2] raising cigar taxes,[3] and doubling the “flush” tax, a septic system levy.[4]
Last month, despite the bevy of options that were suggested, the Maryland General Assembly failed to reach a revenue deal by a matter of minutes before the end of their session. What is traditionally a confetti- and balloon-filled final night celebration was replaced by a stern 1 AM press conference by Governor O’Malley.[5] Since then, O’Malley has called a special session to begin on May 14 to discuss an income tax hike which could affect all earnings over $100,000. While specific details are still scarce, we will here review some of the options that were on the table at the end of the regular session and discuss impacts on Maryland’s fiscal situation and national competitiveness.
Budget “Cuts” and the Doomsday Fallacy
When the regular session ended without a new revenue deal, many onlookers feverishly decried the austerity of the “doomsday” budget that took effect instead, which would cut $500 million in expenses over the next year. However, these “doomsday” cuts are actually applied to planned spending increases, and even under this “doomsday” scenario the budget will still increase by $700 million, or 2 percent over last year.
Figure 1 shows Maryland’s budget expenditures, which have grown steadily since 2004.
Figure 1
The editorial board of the Washington Post has argued that simply allowing the “doomsday” budget to proceed might be the most appropriate course of action, while a special session is likely to bring more complications than solutions:
The truth is that if lawmakers in the General Assembly were to stay home and skip the special sessions, the effect would be to cancel plans for a tax increase; spare the state a senseless expansion of casino gambling; eliminate some dubious spending programs; and ensure that Maryland’s $35 billion budget still manages to grow by a respectable $700 million, about 2 percent.[6]
Income Tax Proposal
An income tax proposal was put forward on May 14 which would increase rates for singles earning above $100,000 and for joint filers earning above $150,000. This plan also phases out the exemption more aggressively than the current tax system, meaning that more income from high-income filers will be taxed, resulting in higher effective rates. Table 1 shows rates proposed under this plan.
Table 1: New Tax Rates Under Maryland Proposal
|
Single Filers |
||
|
Bracket |
Current Rate |
Proposed Rate |
|
>$0 |
2% |
2% |
|
>$1,000 |
3% |
3% |
|
>$2,000 |
4% |
4% |
|
>$3,000 |
4.75% |
4.75% |
|
>$100,000 |
4.75% |
5% |
|
>$125,000 |
4.75% |
5.25% |
|
>$150,000 |
5% |
5.50% |
|
>$250,000 |
5% |
5.75% |
|
>$300,000 |
5.25% |
5.75% |
|
>$500,000 |
5.5% |
5.75% |
|
Married Filing Jointly, Head of Household |
||
|
Bracket |
Current Rate |
Proposed Rate |
|
>$0 |
2% |
2% |
|
>$1,000 |
3% |
3% |
|
>$2,000 |
4% |
4% |
|
>$3,000 |
4.75% |
4.75% |
|
>$150,000 |
4.75% |
5% |
|
>$175,000 |
4.75% |
5.25% |
|
>$200,000 |
5% |
5.5% |
|
>$225,000 |
5% |
5.75% |
|
>$350,000 |
5.25% |
5.75% |
|
>$500,000 |
5.5% |
5.75% |
This proposal, though not a substantial increase from last year, could have palpable effects on the tax bills of high-income Maryland residents and businesses. Table 2 shows back-of-the-envelope calculations for a dual-earner, two child family with $250,000 in federal adjusted income living in Maryland, the District of Columbia, and Virginia. If enacted, they would pay $989 more in state income taxes:
Table 2: Two Child Family with $250,000 In Income
|
State |
Currently |
Under Maryland Proposal |
|
Maryland |
$16,786 |
$17,775 |
|
District of Columbia |
$16,612 |
$16,612 |
|
Virginia |
$11,651 |
$11,651 |
Before 2007, when Maryland first adopted a “millionaires tax,” the state had a fairly flat income tax system, and this latest episode is just a continuation of a trend where the state is gradually tilting the income tax code to rely more heavily on high-income earners (See Table 3, below).
Table 3: Maryland 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. Rates for Single Filers, 2007
|
Bracket |
Rate |
|
>$0 |
2% |
|
>$1,000 |
3% |
|
>$2,000 |
4% |
|
>$3,000 |
4.75% |
As we have seen at the federal level, progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. codes make for volatile revenue collections. High income earners are often businesses, which are especially sensitive to economic expansions and contractions.[7] Additionally, there is a negative incentive affect associated with high top marginal rates. In the long run, laborers are less likely to gain additional skills and aspire to higher wages if more of that potential income is taken by tax authorities.[8] So while income tax hikes on the wealthy are often popular with voters, because of the interconnectedness of the economy, the resulting decreases in labor productivity negatively affect everyone.
Sales Tax Proposal
Another potential tax increase proposal that might resurface in the special session is a one percent sales tax increase from 6 percent to 7 percent that was discussed mid-April.[9] If passed, the sales tax increase would tie Maryland for the second highest statewide sales tax rate in the country. Further, it would move Maryland out of step with its neighbors, particularly Delaware, which has no sales tax. Figure 2 shows sales tax rates around Maryland.
Figure 2
These disparate sales tax rates would instigate an increase in cross-border shopping, which would have a negative effect on revenue collections and hurt business activity in the state as consumers make purchases in neighboring states.[10]
New Jersey, which already has a 7 percent statewide rate, is well aware of this problem. In response to cross-border shopping, the state implicitly acknowledged that their sales tax rate is uncompetitive by halving the state sales tax rate in Salem County (on the Delaware border) from 7 percent to 3.5 percent.
Transparency
One of the problems with using a special session to make major tax and spending decisions is that the process tends to be opaque. Leading up to the special session, there was no formal tax plan that was available in writing. As of press time, a preliminary income tax bill has been released and we have done our best to analyze it here, but given the short time span of the session, it is difficult for citizens and commentators to keep up with the various bills’ progress and voice opinions on legislation.
Conclusion
Maryland’s latest income tax increase proposal fails to meet the criteria of sound tax policy. By opting to raise taxes on high-income earners, the proposal seeks to raise taxes in a politically expedient way, but one which will have distortive long-term effects. If a sales tax increase re-emerges as proposal, this too will make Maryland less competitive among its neighbors and in the nation.
[1] Joseph Henchman, Maryland Looking to Raise Income Tax on Middle-Earners, Tax Foundation Tax Policy Blog (Mar. 20, 2012), https://taxfoundation.org/legacy/show/28059.html.
[2] David Hill, O’Malley springs sales-tax surprise on assembly, The Washington Times, Jan. 11, 2012, http://www.washingtontimes.com/news/2012/jan/11/omalley-springs-sales-tax-surprise-on-assembly/.
[3] General Assembly of Maryland, Department of Legislative Services, The 90 Day Report: A Review of the 2012 Legislative Session (Apr. 13, 2012), at B-13, http://mlis.state.md.us/2012rs/90-Day-report/The90DayReport.pdf.
[4] Joseph Henchman, Maryland Governor Proposing Increases in Income, Sales, Gasoline, Cigar, and ‘Flush’ Taxes, Tax Foundation Tax Policy Blog (Jan. 19, 2012), https://taxfoundation.org/legacy/show/27903.html.
[5] Aaron C. Davis & John Wagner, Officials in Md. fail to vote on tax, casino bills, The Washington Post, Apr. 9, 2012, http://www.washingtonpost.com/local/md-politics/md-legislature-scrambles-in-closing-hours-to-finish-major-tax-and-casino-bills/2012/04/09/gIQAKBl66S_story.html.
[6] Editorial Board, Who’s afraid of Maryland’s ‘doomsday’ budget?, The Washington Post, Apr. 27, 2012. http://www.washingtonpost.com/opinions/maryland-lawmakers-should-go-easy-on-the-budget-fixes/2012/04/26/gIQA5HT0jT_story.html.
[7] R. Alison Felix, The Growth and Volatility of State Tax Revenue Sources in the Tenth District, Federal Reserve Bank of Kansas City Economic Review (2008), http://www.kansascityfed.org/Publicat/Econrev/PDF/3q08Felix.pdf.
[8] Edward C. Prescott, Why Do Americans Work So Much More than Europeans?, 28 Federal Reserve Bank of Minneapolis Quarterly Review 2-13 (2004), http://www.minneapolisfed.org/research/QR/QR2811.pdf.
[9] Scott Drenkard, Maryland Considers Raising Sales Tax Rate, Would Tie Second Highest in Nation, Tax Foundation’s Tax Policy Blog (Apr. 12, 2012), https://taxfoundation.org/legacy/show/28122.html.
[10] Mehmet Serkan Tosun & Mark Skidmore, Cross-Border Shopping and the Sales Tax: A Reexamination of Food Purchases in West Virginia (Working Paper, 2005), http://www.rri.wvu.edu/pdffiles/Tosunwp2005-7.pdf. See also Randolph T. Beard, Paula A. Gant, & Richard P. Saba, Border-Crossing Sales, Tax Avoidance, and State Tax Policies: An Application to Alcohol, 64 Southern Economic Journal 293-306 (1997).
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