Maryland Tax Changes: Glass Half Full

After close to a month of intense debate and lobbying, Maryland lawmakers have agreed upon a plan to increase the state's taxes by over $1 billion a year. After a marathon weekend session, lawmakers came to an agreement at about 2 AM Monday morning-- and Governor Martin O'Malley signed the plan into law before the end of the day.

The full-year effect of the plan's tax provisions won't be felt until fiscal year 2009 (at which point the plan will bring in $1.35 billion a year). And the main non-tax revenue raiser, the much lamented "video lottery terminals," or VLT's, won't bring in their estimated $400 million a year until FY 2012, at which point the package at a whole will be bringing in $1.9 billion a year.

In FY 2009, about 67% of the tax hike is coming from the state sales tax-- most of it by increasing the tax rate from 5 to 6 percent, and a couple hundred million from expanding the tax base to including "computer services."

Here's how the remaining 33% breaks down:
Cigarette tax hike 12%
Car sales tax hike 7%
Corporate tax 10%
Personal income tax 2%

Put another way, 88% of the tax hikes in 2009 are coming from things that hit low-income families hardest (sales and cigarette taxes), and 12% is coming from things that hit upper-income families harder (income and corporate tax).

So it shouldn't be surprising to know that on balance, these tax changes will make Maryland's tax system more regressive. A new report from the Institute on Taxation and Economic Policy, published earlier today, shows the biggest tax hikes, as a share of income, from the agreed-upon tax plan will fall on the very poorest Maryland families.

Today's Washington Post headline on the plan's fairness impact said that experts were "Divided" on the fairness impact of the plan. But the numbers don't lie. The only folks who are defending the legislature plan on tax fairness grounds are those who have a vested interest in seeing it pass-- and who haven't seen the numbers.

But, of course, fairness isn't everything. And it's not even the main goal lawmakers wanted to achieve over the last month. The name of the goal has been adequacy: making sure there's enough tax revenue to fund needed public services.

And, from a short-term adequacy perspective, the legislature has obviously done a good thing here.

But from a longer-term adequacy perspective, the plan doesn't look so good either.

By "longer-term adequacy," I mean sustainability-- the ability of a tax system to bring in enough revenue in the long term. In general, the way to achieve this is through having a broad tax base, eliminating loopholes, and ensuring that your taxes are designed to keep up with economic growth.

The way NOT to achieve this is to ignore the structural flaws, loopholes, etc. in your tax system and just jack up the tax rates.

At every turn, Maryland lawmakers had a choice between raising taxes the smart, sustainable way (by using combined reporting to close a variety of harmful corporate tax loopholes, for example) and doing it the dumb way (hiking the corporate tax rate, for example). And seeminly at every turn, they chose the dumb way.

To stick with the example, Maryland will realize more corporate tax revenues because they hiked the rate. But in the long run, they may not, because they chose not to close the single most threatening corporate tax loophole in the Maryland tax code.

The same song and dance happened with the sales tax, where lawmakers largely squandered an opportunity to redefine the tax base to include more of the services (haircuts, health clubs, etc) that Marylanders are buying these days, and ending up getting most of their money out of a higher tax rate.

On balance, the Maryland legislature has done a good and necessary thing. Their #1 goal was to figure out a way to pay for public investments next year, and they've achieved that.

And while lawmakers failed to fix the leaks in the roof, they can always come back in 2008 to deal with corporate combined reporting, and with an expanded sales tax base.

But it's hard to be thrilled with the legislative outcome here, simply because lawmakers had it in their power to do things in a much smarter way: less rate hikes, more loophole closing.

Wait til next year...