Tax Justice Digest stories about Maryland

Earlier this month, Maryland Comptroller of the Treasury Peter Franchot submitted a letter to Governor Martin O’Malley and the state’s legislative leadership that, among other things, maintained that the number of millionaires filing tax returns in the state had dropped significantly.  News outlets, such as the Washington Examiner, subsequently seized on his assertion, arguing that tax changes enacted over the past two years were driving the affluent out of the Free State.  As this latest release from ITEP demonstrates, Maryland’s millionaires may be moving, but their likely destination is a lower income group.  Preliminary data from the Maryland Comptroller’s Office suggest that the number of returns falling in the ranges of income below a million dollars have grown at above average rates in the past year.  This, in turn, may indicate that the wealthy haven’t left; rather, they’ve just been left with less money due to the economic downturn.  Nevertheless, as ITEP’s release points out, using preliminary data at this point in the tax collection process to draw conclusions about tax policy changes is a fool’s errand.  In 2007, preliminary returns for filers with taxable incomes over $1 million comprised less than one-third of the total returns the state ultimately received from taxpayers in that income group.

Despite their obvious unfairness, tax amnesties are a tool frequently used by states during tough budgetary times.  By waiving late fees and sometimes reducing the interest rate charged on overdue taxes, state policymakers can provide their state with a quick band-aid fix without having to make the much harder choice of raising taxes or cutting valued services.  But penalizing similar taxpayers at different rates dependent only upon whether they decide to pay up during an amnesty period is plainly unfair.  The problems associated with amnesties become even worse, however, as soon as a state establishes a habit of repeatedly offering amnesties during tough economic times.

With the possibility of another amnesty always on the horizon, delinquent taxpayers will think twice before settling their debts with the state during normal times, and at normal penalty rates.  Creating multiple sets of penalties (one for normal times, and one, lower penalty when budgets shortfalls are projected) therefore reduces fairness by penalizing similar taxpayers differently based only on the timing of their payment, and can also reduce the effectiveness of enforcement efforts and the tax system broadly.  These effects can continue long after the most recent amnesty period ends.  (Note that this is very similar to the argument against allowing corporations to "repatriate" their profits to the U.S. at a lower rate, a proposal which was recently rejected at the federal level).

Despite the obvious problems, Maryland and New Mexico are both considering legislation to once again provide temporary tax amnesty programs some time in the coming months.  New Mexico last provided an amnesty less than a decade ago, while Maryland's last amnesty came in 2001.  After that 2001 amnesty, the Maryland comptroller's office noted that "repeated use of amnesties is likely to create cynicism among law-abiding taxpayers, and lessen the need for voluntary compliance with state tax laws, which is vital for our system of taxation".  Should another amnesty be offered less than a decade after the 2001 amnesty, growth in taxpayer cynicism seems unavoidable, especially in light of the fact that a similar program offered in 1987 in the state was billed as a "once-in-a-lifetime" opportunity for delinquent payers.

Without a doubt, the momentum in favor of such programs is strong.  Alabama is already in the mist of an amnesty period (the state last offered an amnesty in 1984).  Massachusetts is currently in the process of deciding upon a date for its amnesty program (Massachusetts last provided amnesty in 2003).  Connecticut's program is already slated to take effect on May 1st (Connecticut's last amnesty took place in 2002).  And Oklahoma just recently closed its most recent amnesty period, just seven years after its 2002 amnesty.

In this environment, it is extremely important for state policymakers to not only oppose more amnesties, but also to convincingly state that another amnesty will not be offered any time in the near future.  For states looking to responsibly close their tax gaps, stepping-up enforcement spending is often a route that can produce sizeable returns, and is undoubtedly much more fair than trying to get something for nothing by arbitrarily waiving penalties in an effort to boost voluntary "compliance".  For more specific alternatives to the tax amnesty approach, take a look at these recent enforcement recommendations from Oregon's Department of Revenue.

At the state level, the usual response to recommendations that taxes be increased to preserve vital state services has generally been: "Now is not the time".  The most notable exception to this trend so far has been with the cigarette tax, as we've explained before.  Increasingly, however, policymakers appear to be coming around to the idea of boosting gas tax rates in order to raise the revenue needed to maintain our nation's infrastructure.  Given that most state gas taxes haven't been increased for quite a few years, and that during that time inflation has significantly eroded the value of most gas tax rates, our only response can be, "It's about time."

In Maryland, for example, the Senate President recently expressed an interest in raising the gas tax, urging that "there's got to be an increase in the transportation trust fund somewhere, and there's got to be a way we can find people with the political will to make it happen".  Numerous governors have echoed this call as of late, most recently in Massachusetts, and Idaho. 

In Idaho, especially, the Governor was able to hit the nail on the head with his observation that, "[we last raised] the fuel tax … 13 years ago. And now here we are trying to accomplish 2009 goals with 1996 dollars. Everyone in this room or listening to me throughout Idaho today -- everyone who has a household budget or runs a business -- knows that just doesn't work".

In response to this problem, Idaho Governor "Butch" Otter has recommended bumping the gas tax upward by 2 cents in each of the next 5 years.  Addressing the root of the problem even more directly, Wisconsin Governor Jim Doyle has proposed indexing the gas tax rate to inflation -- a practice that had existed in Wisconsin up until 2006.  Maine and Florida continue to index their gas tax rates today, with very favorable results in terms of providing each state with a somewhat more adequate and sustainable source of transportation revenue.

Importantly, the federal gas tax is not indexed to inflation, meaning that the Federal Highway Trust Fund is suffering from many of the same problems we see plaguing the states mentioned above.  The federal gas tax has not been increased in over 15 years.  President Obama's new Energy Secretary, Steven Chu, has previously gone on the record as supporting raising the gasoline tax.  The views of Transportation Secretary Ray LaHood are not yet clear.  What is clear, however, is that something will have to be done at the federal, as well as the state level, if gas tax revenues are to be restored to their previous purchasing power.

Kansas Governor Kathleen Sebelius this week again voiced support for a 50 cent cigarette tax hike, proposing that the revenue be dedicated to expanding health care coverage to more low-income Kansans.  This story should sound familiar, as numerous tax-phobic states in search of ways to pay for popular government services have recently turned to the cigarette tax.

The benefits that a higher cigarette tax would produce in terms of reduced smoking deaths and improved public health are well-documented in the recommendations included in a recent report from the Kansas Health Policy Authority.  But it’s the tension such an arrangement would create between efforts to reduce smoking, and efforts to fund health care, that is controversial.

Arkansas this year attempted to pass a similar cigarette tax hike dedicated to funding a new health trauma system.  South Carolina pursued similar legislation (eventually vetoed by the Governor) that was designed to direct new cigarette tax hike revenues into a popular health-care expansion.

In each of these cases, legislators were seeking to fund vital programs (each of which naturally increases in cost over time) with a revenue source that is sure to decline with time.  South Carolina briefly considered one interesting approach to this problem (indexing the amount of its tax to a measure of medical cost inflation) but that proposal was ultimately dropped from the final bill.

Sustainability issues arise not only from inflation, however, but also from decreases in the popularity of smoking, and increases in the incentives to purchase cigarettes in low-tax areas.  This latter component of the sustainability problem, in particular, has received a good bit of attention as of late.

With cigarette tax rates having increased substantially in many parts of the country, the rewards to smokers associated with shopping in low-tax areas have grown.  A recent study by Howard Chernick entitled “Cigarette Tax Rates and Revenue” found that a 10% increase in the cigarette tax rate of one state can boost the revenue collections of a neighboring state by about 1%.  Maryland provides one stark example of this phenomenon, where a recent tax hike has yielded significantly less than expected as a result of cross-border cigarette purchases and smuggling.  The experience of New Hampshire, however, may suggest that this point has only limited applicability (see next story).

Maryland Governor Martin O’Malley signed a temporary income tax increase on millionaires this week to make up a portion of the revenue lost by the repeal of a recently passed 6 percent sales tax on computer services that had not yet taken effect.  Originally intended to be part of a service tax increase on about six different services, the computer services tax ended up being singled out after its lobbying presence was demonstrated to be much weaker than that of the other services legislators were thinking about taxing.  That quickly changed as the sector set up a formidable lobbying presence in only a matter of months.

Though the tax on millionaires is a more progressive option than the computer services tax, this story ultimately has to worry those who appreciate the merits of expanding the sales tax to include services.  What lessons can be learned from this failed attempt to carry out a much needed expansion of Maryland’s sales tax base?

The failure of this service tax may have been a result of its narrow scope.  By going after only one type of service, rather than trying to comprehensively expand the base as Hawaii, New Mexico, and South Dakota have done, Maryland set its sights too low.  The debate was focused on an issue much less important than the broader issue of taxing the state’s enormous and growing service sector.  The position of tax fairness advocates was weakened as a result of this narrowing of the debate.  By focusing on only one type of service, advocates of the tax were also left vulnerable to criticisms that they were unfairly singling out certain businesses to pay more.  And even if Maryland had succeeded in expanding the sales tax base to include computer services, it would ultimately be only a small step towards the bigger goal of modernizing the sales tax base.

Fortunately for Marylanders, though, the progressive income tax change the legislature enacted was much better than most alternatives.  But it certainly would have been nice to get the ball rolling on service taxation in Maryland.

New York is no different than most states in at least one respect – it too must confront a major budget deficit, estimated at $4.7 billion for the fiscal year starting April 1.  It may, however, follow a much more responsible path than Georgia and other states attempting to cut taxes in the midst of dire financial straits.  The state Assembly has approved a plan that would levy a temporary income tax surcharge on people with incomes over $1 million and that would yield roughly $1.5 billion per year.  The plan is opposed by the Senate, but new Governor David Paterson has yet to rule it out.

Maryland faces a situation similar to New York and is also considering an increase in personal income taxes for some of its wealthiest residents. But rather than devote that additional revenue to current appropriations, lawmakers want to use it to repeal a change in tax policy that isn’t scheduled to take effect until this summer.  Recent tax projections in the Free State are now $333 million lower than previously expected and, just this past week, the Maryland House adopted a FY 2009 budget that reduces spending $250 million below Governor Martin O’Malley’s initial request. 

Yet, one topic that continues to dominate conversations in Annapolis is the extension of the state’s sales tax to computer services.  Enacted as part of a larger tax package during last fall’s special session, the tax change isn’t slated to take effect until July 1, but is the target of a major lobbying campaign by the computer industry.  The Governor recently threw his weight behind a Senate plan to repeal the computer tax and replace the lost revenue with an increase in the personal income tax:  specifically, the creation of two new tax brackets with rates of 6.0 percent and 6.5 percent for taxable income above $750,000 and $1 million respectively.  Such a move would improve the progressivity of Maryland’s tax system, but could be a step back for sustainability. Maryland – like most states – needs to expand its sales tax base to include more services or be left with a tax system that is poorly matched to today’s economy.

Read ITEP press release.

Victory for Tax Adequacy, Missed Opportunities on Tax Equity and Essential Reforms

The tax plan approved by the Maryland General Assembly on Monday will help provide the revenue necessary to fund vital public services in Maryland, but, according to the latest analysis from the Institute on Taxation and Economic Policy (ITEP), working families will bear the brunt of the tax changes contained in the plan. All told, taxes for the poorest Marylanders will rise, on average, by more than 0.7 percent of their incomes under the Assembly’s plan, while taxes for the wealthiest one percent of Marylanders will climb by just over 0.5 percent of their incomes.