Tuesday, June 10, 2014

DC's Tax Reform still leaves us taxing the wrong people and the wrong things

The tax reform that Council Chair Mendelson rushed through last week represents a very large change in DC's tax code. In addition to being rushed through quickly, it also contains several flaws.

The District of Columbia has perhaps the most progressive tax system in the United States, nonetheless one of the goals of the commission in the authorizing legislation was to make it more progressive as the tax rate for the bottom 20% (6.6% of income) is higher than for the top 1% (6.1% of income). The commission therefore takes several steps to make DC's taxes more progressive, such as expanding the Earned Income Tax Credit (EITC) and reducing the tax on income between $40,000 and $80,000. But other changes, like raising the threshold for the estate tax and lowering the tax rate on high income earners, counteract those changes. DCFPI points out that the cuts for high earners are a "minority" of the total cuts, but what isn't clear - in either the tax commission's proposal or the budget that the council voted for last week - is whether or not it will actually be more progressive once all the changes are considered, and if so, by how much. The chart below is from the commission's report and shows the current DC tax paid by income group, with the middle 20% paying the highest rate. What would such a chart look like under the bill approved last week? That's a question that isn't answered.

Some of the counter-progressive proposals don't even make much sense when the justification is considered. The tax rate on income above $350,000 is lowered to a rate below Maryland's to send "a positive signal about the District's commitment to controlling taxes." That's an expensive signal and not one of the committee's goals.

In addition, the threshold for the estate tax is raised (meaning people inheriting large sums pay less tax) not to keep the wealthy from moving away (it will, after all, lower tax receipts), but to simplify the tax code and make auditing easier - also not a goal. When Congress voted to raise the threshold for the "death tax", DC's lone voice in Congress disagreed with it, but now DC is following Congress' lead, even though a reduced estate tax works against the goal of making the tax code more progressive. Even if cutting taxes for the wealthy is a good idea, an argument for cutting taxes on work is easier to justify than one on inheriting is.

The new budget doesn't even eliminate the exemption for out of state bonds even though the commission admitted that they struggled "to find a policy justification for the exemption," noting that it mostly benefits high-income residents and that, because DC gives a blanket exemption instead of reciprocal exemptions, it "not only represent substantial lost revenue for the District, but such broad relief eliminates an incentive for residents to purchase District bonds over those from other jurisdictions. In other words, it essentially subsidizes investments outside the District."

In addition to the inclusion of these bad ideas there were several ideas that were not considered at all, ones that would make the system more progressive, while also reducing the total federal burden of DC tax payers.

For example, if DC were one taxpayer, their accountant might recommend that they pay as much of their local tax in the form of property tax and either income or sales tax, since that money would then be deductible on federal returns. Instead DC assesses all three taxes on citizens and charges some fees that aren't based on property value, but could be.

DC could reduce or eliminate the sales tax. Many DC residents are unable to deduct this tax, and eliminating it would make the DC tax system more progressive while making DC businesses more competitive. It's at least as positive a signal about the District's commitment to controlling taxes as lowering taxes on the wealthy is. This could be offset with an increase in property and/or income taxes or with a tax on pollution.

DC could replace vehicle registration, license and inspection fees with a revenue-neutral annual vehicle property tax based on the value of the car similar to the excise tax. Such a tax would then be tax deductible, with the added advantage of being more progressive.

A Pivgovian tax on pollution, as referenced earlier, could help make the city cleaner while raising revenue. One way to to that would be to raise the gas tax. Last year, DC modified the gas tax to index it to inflation, but DC's gas tax is still lower than Maryland's and in the bottom half nationwide. Raising the gas tax would do more to capture the negative externalities associated with gasoline use, and make those who use gasoline responsible for paying those costs.

Or DC could tax carbon. Adding carbon to the atmosphere causes global warming and ocean acidification, and a tax on this would pass the cost of these side effects on to polluters. Though DC doesn't have any coal burning power plants left, DC could still join Maryland and eight other states in the Regional Greenhouse Gas Initiative and use the allowance proceeds to cut the sales tax. For example, Maryland has made $190 million on its proceeds over the last 4 years.

DC could also increase the impervious area charge

Do some councilmembers support such changes and modifications over the ones in the budget? Possibly, but we'll likely never know. Because no one got a chance to discuss it.

DC Tax reform and cuts should not be rushed through without debate

A couple of weeks ago, the DC council held an initial vote on the District's 2015 budget that includes tax reform that was recommended by the District of Columbia Tax Revision Commission.

As part of the fiscal 2012 budget, the District of Columbia created a Tax Revision Commission to analyze the District's tax system and propose innovative approaches to meet future revenue needs. In February the commission completed its work and produced a set of recommendations that it hopes will make taxes more progressive, while attracting more business and ensuring future revenue. After the proposals became public in December, Mayor Gray only supported a few of them and it looked as though the proposals would not become law. But then, starting Memorial Day weekend, Chairman Mendelson announced that he would attempt to implement many of those recommendations.

While the commission's plan has much to admire and gets kudos from outside groups like the Tax Policy Center and the DC Fiscal Policy Institute, these reforms are very complex, and Mendelson's attempt to enact them at the last minute has left almost no opportunity to debate them. A final vote on the package is set for June 17, and Mendelson says it will be difficult to make any changes to it before then. I think this is all by design. In fact, I hate to say it, but I agree with Marion Barry. Mendelson is behaving like a “tyrant” for arranging the last-minute vote on the tax package and for limiting debate.

Now, normally the "going to fast" claim is one made by NIMBY's who want to stop a change, and I normally oppose it. But this is different. The equivalent would be for DDOT to put together a committee to redesign 16th street and then after that committee submits its recommendations for DDOT to decide not to implement them, but then for DPW to announce that they were creating a final design based on the recommendations that they would make available for approval the next day (with limited debate) and then implement two weeks later. The committee part went at a normal speed, but the end was rushed. Legislation shouldn't move this fast from recommendation to implementation.

There are three problems here:

1. Once Gray made it clear that he was not going to implement the recommendations of the commission to which he appointed half of the members, everyone quit paying attention. This is why the yoga tax has now become such a big deal. But this budget modifies dozens of taxes, in ways that have not been studied, and people need time to consider that.

2. There might be an argument for moving quickly on this if the Council is just going to rubber stamp the committee's recommendations, but there should still be some time for debate on the actual law proposed, not just the recommendations. Nonetheless, the Council really shouldn't act as a rubber stamp for a commission that most of its members had no say in selecting (only the Mayor and Council Chair picked members).

3. The council isn't even acting as a rubber stamp. They've made several critical diversions from the recommendations, and so this pacing is particularly inappropriate then.

Among the recommendations that Mendelson ignored, this most critical was to make the tax reform into a tax cut. This tax cut is a result of the decision to ignore commission recommendations to raise the sales tax (an increase I oppose) and to levy a "local service fee" on employers that is designed as a proxy to the commuter tax. The only way to fund this cut was to cut future funding for the streetcar.

Mendelson dismissed criticism of the late addition of these changes, and the limits he placed on debate, "saying the recommendations of the tax commission had been public since December." This is true, but he never let it be known that he would pursue these recommendations. If he done that in December, instead of the day before the vote, the public and the council would have had adequate time to consider and debate them. Such a radical change at such a late point is all-too-reminiscent of the District's controversial last-minute settlement with Jeffrey Thompson's company in 2011.

As an example, the yoga tax isn't actually mentioned in the recommendations, and the word yoga is nowhere in the report. Instead it is a tax on health clubs. So it would be reasonable for the public to not realize that yoga is to be taxed. Add to this that a specific function of the commission was:

"To identify economic activities which are either beneficial or detrimental to the District's economy and which should be either encouraged or discouraged through tax policy."

and one can see how yoga enthusiasts were caught off guard, despite the recommendations being out since December.

The tax reform represents some pretty big changes. Ones that I'm sure that many on the council oppose. Such large changes, some submitted at the very last minute, deserve more debate than the council of residents have been afforded.

In my next post, I'll discuss flaws in the proposed tax reform.

ESPN borrows my idea

I actually very much doubt they got the idea from me. But this post on how Mack Brown's leaving Texas rippled through the college coaching world is similar - if broader in scope - to mine.