Maryland Senate raises taxes in a more progressive way
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The Maryland Senate voted today to increase income taxes to prevent large-scale cuts to schools, higher education, low-income health care and public safety. Last night, the full Senate made changes to the plan to make the tax increase more progressive.
The revenue package is one part of an effort to close a $1.1 billion budget shortfall. Other pieces of the budget plan involve shifting school pension costs to county school systems, requiring “maintenance of effort” for county schools, and freezing or reducing some state programs.
The Senate Budget & Taxation Committee recommended a bill originally filed by Sen. Roger Manno (D-19). It increased each tax bracket’s tax rate by 0.25 percentage points. To reduce the impact for lower income earners, it also created two new brackets and expanded the earned income tax credit.
The committee also adopted some elements of Governor O’Malley’s plan by closing a few corporate tax loopholes and raising the state’s tobacco tax on cigars.
All told, this is expected to raise about $500 million toward the $1.1 billion gap.
The committee plan did not restore the recently-expired bracket for households making more than $1 million per year, often called the “millionaires’ tax.” That flaw kept Maryland from making its income tax more progressive. It also make it harder to close the budget gap.
However, a compromise emerged in the full Senate. Instead of creating a higher bracket, the top bracket rate of 5.75% for those earning above $500,000 would apply to all income instead of just income above $500,000. The additional funds of about $30 million will be used as aid to schools and counties.
Maryland’s regressive taxes
The state’s current tax system, like most states, is regressive. Higher income earners pay a smaller share of their income in taxes than lower income earners.
A December 2011 report by the Maryland Comptroller’s office shows that the first 80% of earners pay about 6% of their income in state taxes. As household income rises above $100,000, the effective tax rates fall to a low of about 3% for those with more than $500,000 annual income.
The table below shows the percent of income different groups pay, including the effects of federal deductibility of state tax and the federal earned income tax credit.
Maryland 2008 effective tax rates by household income:
| Population quintile | Income range | Individual income tax | Sales & use tax | Excise taxes | Combined taxes | |
|---|---|---|---|---|---|---|
| FIRST 20% | $0 | $12,151 | -0.20% | 3.35% | 2.22% | 5.37% |
| SECOND 20% | 12,151 | 30,560 | 1.00% | 3.32% | 2.18% | 6.49% |
| THIRD 20% | 30,560 | 55,716 | 2.54% | 2.00% | 1.34% | 5.88% |
| FOURTH 20% | 55,716 | 100,405 | 2.61% | 2.32% | 1.44% | 6.37% |
| TOP 20% | ||||||
| NEXT 10% | 100,405 | 144,896 | 2.71% | 1.66% | 0.91% | 5.27% |
| NEXT 5% | 144,896 | 201,293 | 2.89% | 1.14% | 0.52% | 4.54% |
| NEXT 4% | 201,293 | 493,121 | 2.85% | 0.78% | 0.33% | 3.97% |
| TOP 1% | 493,121 | & over | 2.64% | 0.35% | 0.11% | 3.10% |
| TOTAL | 2.56% | 1.51% | 0.87% | 4.94% | ||
These are similar to the results of a study of 2006 Maryland taxes. The first 80% pay about the same share of income, but then the percentage begins to drop off steeply, with the highest earners paying the smallest share of their income.
The 2008 effective rates included the state’s “millionaires’ tax,” an income tax bracket at $1 million per year which ended last year. Removing that likely increased the spread between what the top 1% and other income groups actually pay.
Progressive effects of Senate Committee plan
A quick analysis by the Institute for Taxation & Economic Policy (ITEP) of the proposal that passed the Budget & Taxation committee shows that the plan slightly decreased the average tax burden for the first 40% of taxpayers, and raised it for the next 59% but somewhat less for the top 1%.
Effects of Senate Budget Committee proposal on different income groups:
| Income group | Lowest 20% | Second 20% | Middle 20% | Fourth 20% | Next 15% | Next 4% | Top 1% |
|---|---|---|---|---|---|---|---|
| Income range | Under $24,000 | $24,000- $44,000 | $44,000- $69,000 | $69,000- $113,000 | $113,000- $222,000 | $222,000- $500,000 | $500,000 or more |
| Average income | $13,000 | $33,000 | $55,000 | $89,000 | $152,000 | $319,000 | $1,597,000 |
| Tax chg. | -0.18% | -0.02% | 0.07% | 0.07% | 0.09% | 0.15% | 0.13%* |
The actual effect on the overall tax burden between different income groups would have been fairly small, although it would have narrowed the 2.3 percentage point gap between the very poorest residents and the most wealthy by 0.3 percentage points. The narrowing between other groups would not have made any significant dent in the overall regressive nature of Maryland taxes.
The committee plan allowed Maryland to avoid significant reductions to Medicaid, education, higher education and public safety.
Increasing effective tax rates for upper income earners
From 2008-10, Maryland had a tax rate of 6.25% for income over $1 million per year. The bracket expired last year, which has contributed to the budget shortfall as well as making the tax system more regressive.
The bracket was pilloried by many conservative columnists and featured in a Wall Street Journal editorial after the Maryland Comptroller reported that the number of millionaires had dropped after the bracket was imposed. Editorials decried Maryland’s “fleeing millionaires.”
However, a more academic examination by ITEP found that millionaires overwhelmingly suffered a drop in income due to the recession. A similar examination by Governor O’Malley’s office found that the number of millionaires dropped in the same percentages in a previous recession and rebounded in similar percentages.
Others have argued that it will stifle economic development in the state, but ITEP found no correlation between economic growth and income tax rate. By many measures, the highest income tax states performed as well or better.
Under the compromise plan, Maryland’s state income tax would be well below the top income tax states and would still not near the top tier when adding in the highest rates imposed by some counties through the “piggyback” income tax.
The specific setup of the compromise plan could also create some problems, as taxpayers making $499,999 would pay significantly less in taxes than those making $500,001. Many higher-income Maryland residents around this cutoff will probably be paying a lot of money to accountants to play with deductions and tax shelters to avoid hitting the cliff.
It would have been much fairer to restore the “millionaires’” bracket instead, which would have raised more money and not created awkward discontinuities in the tax code. However, this compromise will raise some needed revenue and increase the percentage of tax paid by the top 1%. The Senate took a step in the right direction today.