A Distributional Analysis of the District of Columbia Tax System

Prepared by the Institute on Taxation and Economic Policy for The District of Columbia Tax Revision Commission

December 19, 1998 At the request of the District of Columbia Tax Revision Commission, the Institute on Taxation and Economic Policy has undertaken a distributional analysis of the District of Columbia tax system, conducted using the Institute on Taxation and Economic Policy Microsimulation Tax Model. A detailed description of the model is attached. Overall Distribution The District of Columbia, like most states, relies on a mixture of property, consumption and income taxes. The impact of all of these taxes on the residents of the District is reflected in the tables that follow. In general, the District's overall tax system can be characterized as "flat" or "modestly regressive." Although the best-off one-percent of residents pays less, as a share of income, in District taxes than any other income group, the effective tax rate on the highest earners is not as substantially less than other families as it is in most states. Across the rest of the income spectrum there is no clear-cut correlation between income level and tax burden. This lack of an overall pattern is actually the result of several distinct patterns in particular taxes overlaying each other. Thus, the city's consumption taxes are clearly regressive, taking more as a share of income from lower- and middle-income families than the well-off. On the other hand, the personal income tax is somewhat progressive. The city's property tax burden by income level is, of itself, the result of the interaction of several different phenomena. Underlying the distribution of property taxes paid by families (including individuals) is the distribution of property values. Although residential values rise with income, they tend not to be as high relative to income at the top of the income spectrum. At lower income levels, however, property values tend to be quite high compared to income. Thus, the underlying distribution of residential property taxes is usually regressive. The District, however, has several provisions to counteract this underlying pattern. First is the city's $30,000 homestead exemption. This provision is of much greater proportional value to those with lower-value homes than those with higher value homes. In addition, the city has two "circuit-breaker" programs that provide relief from the property tax burden for those with lower incomes. At different income levels, different elements of the underlying property value distribution and the impact of these property tax relief provisions have different impacts. When the patterns of the income tax, consumption taxes and property taxes are summed, the "bumpy" overall distribution emerges.

Distributional Tables This analysis consists of four distributional tables. These tables show taxes as a percent of income for different income groups. The first table is a distribution for all resident taxpayers in the District. This table is divided by income quintiles. Each quintile represents 20 percent of the population, ordered by income. The top quintile is split into sub-groups so that differences between upper-middle income and wealthy taxpayers can be observed. The other three tables show incidence for sub-groups of the District's population. These groups are the non-elderly married, the non-elderly unmarried and the elderly. These tables are structured around commonly used income breakpoints instead of the quintiles. The percentage of the group in each income category is shown in the first line of these tables. Note that the non-elderly married table has income breakpoints double those of the tables for the non-elderly unmarried and the elderly. This is to better capture the income range seen in the distribution of married couples. Also, it is meant, to some extent, to reflect that a given dollar income amount means something very different for a married couple than a single person. To a large degree, the distribution of taxes for the subgroups shown differ from each other for reasons of homeownership patterns, targeted tax breaks for the elderly and different income levels for different subgroups. The Married Non-Elderly Married Non-elderly couples generally show the highest tax level. This reflects several characteristics of the group. First, incomes are significantly higher in this group than in the others. Thus, this group pays more in the progressive income tax. Also, married couples who are not able to split their incomes most advantageously on their District tax returns may pay more income tax than their single counterparts. These married couples also pay more in property tax. This reflects greater homeownership in the group and more valuable homes that benefit less from the homestead exemption. Consumption taxes are very slightly lower for the non-elderly married than for the non-elderly unmarried. This reflects two offsetting phenomena. First, the married group is analyzed at higher incomes so these regressive taxes are less, as a share of income. On the other hand, consumption is higher when there are two adults than when there is one. Consumption taxes for the non-elderly married are higher than for the elderly. This reflects the somewhat lower consumption patterns of the elderly. Overall, the non-elderly married show a more consistently regressive pattern than do the other groups. To a significant degree, this reflects their higher incomes. In the overall distribution discussed above, the tax system is more consistently regressive at incomes above $40,000. Eighty-four percent of non-elderly married couples have incomes greater than $30,000 and 60 percent have incomes over $60,000. And, the income breakpoints were chosen to reflect the relative wealth of this group. Thus, it isn't surprising that the distribution would appear regressive for this group

Unmarried Non-Elderly The unmarried, non-elderly, pay relatively low property taxes. This reflects low-levels of homeownership, lower value homes and benefits of income-based tax relief provisions. This group pays income taxes in a similar pattern as married couples. At lower incomes, the burden is lower-possibly reflecting an inability of married couples to split their income to take maximum advantage of the District's rate structure. This also may reflect more un-taxed income among the unmarried. Elderly The elderly show lower levels of tax than do the non-elderly. This reflects several aspects of District tax law. First, the low-income elderly receive more generous property tax circuit-breaker relief than do the non-elderly. In addition, a significant portion of elderly income is not subject to the personal income tax. This income includes social security income, a significant portion of pension income and tax-exempt interest. In addition, consumption as a share of income tends to be lower for the elderly, reducing their consumption tax burden. Business Taxes and "Exporting" Included in these distributional tables are business taxes. Business taxes are, of course, ultimately borne by individuals--either in the form of higher prices for purchased goods, lower returns on investments or lower wages. The economic assumptions and data used in this distribution of business taxes are described in the attached methodology. One important additional note is that a great deal of business taxes are, effectively, exported out-of-state. Taxes paid by non-resident owners of District businesses are not reflected in the distributional tables presented here. These tables show only District of Columbia taxes paid by its citizens. Business taxes are, for the most part, shown on separate lines in the tables. Business income reported on the personal income tax is, however, included in the single personal income tax line. Also, half of rental residential property tax is included in the "Property taxes on families" line. This is consistent with our incident assumption, discussed further in the methodology, that half of rental residential property tax is borne by renters. The Districts "circuit-breaker" property tax relief is also included, as an offset, in this line. Comparisons With States Although a comprehensive comparison with other states is beyond the scope of this analysis, previous work by the Institute on Taxation and Economic Policy provides some insight. An analysis of 1995 taxes in all 50 states and the District showed that the District has a less regressive tax system than is typical nationally. This study of the non-elderly married found that, nationally, the burden on the lowest quintile was, on average, about 1.6 times than on the wealthiest one-percent of the study population. Middle-income taxpayers were found to pay 1.2 times as much. In the District, the study found that both the middle and lowest income quintiles paid 1.1 times as much as the best-off one-percent.(1)

1. Who Pays? A Distributional Analysis of the Tax Systems in All 50 States (1996), Ettlinger, et. al.