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.

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