Coming Soon to You: a Tax Cut!

There is a good chance that you will soon get a tax cut from the District government.  In something of a surprise move, the DC Council approved sweeping changes to the District’s tax code in late May, based on recommendations from DC’s blue-ribbon Tax Revision Commission.  It includes income tax cuts for nearly all District residents, with special help for middle- and lower-income households.  It also includes the first cut in DC’s business income tax rate in decades.  

The tax package includes a small number of tax increases, including an expansion of the DC sales tax to gym memberships and other services.  As often is the case when a tax exemption is eliminated, some gym owners and members have opposed this change.  But their arguments about maintaining their special treatment run counter to the principle that the best approach is to broaden the tax base and keep rates low.

Making the Income Tax Fairer for All District Residents

If your income is below $500,000, you can probably expect a tax cut.  District residents with low-and moderate-income residents, who face tax bills that are higher than middle-income families in most parts of the country, will get special help.  The council’s tax package will be phased in over the next five years, but only if the city’s economy and revenues continue to grow.

Here is how the key tax changes will affect us: 

Expanding the Earned Income Tax Credit (EITC) for low-income workers without children.  The EITC, a tax credit for the working poor, lifts many families with children out of poverty, but it provides very small benefits to workers without children in their home. The maximum credit for childless residents is less than $200 and only goes to workers earning under $14,000 a year. The new tax package expands eligibility to $23,000 and increases the maximum credit to almost $500. For example, a single person earning $18,000 will go from owing $533 this year to getting a refund of $102, largely as a result of the new EITC. 

Raising the personal exemption and standard deduction to federal levels. The District’s personal exemption and standard deduction, which exempt a certain portion of income from taxes, are small compared with states and the federal income tax. This is especially hard for low- and moderate-income families that rely heavily on these deductions. The tax package will raise these deductions to the federal levels – a best practice followed by six other states.  A single parent with two children and $30,000 income currently gets a $146 refund as a result of the EITC. With her taxes reduced as a result of a higher standard deduction and personal exemption, her refund will jump to $724.  

Cutting the tax rate for middle incomes. The package cuts the tax rate for income between $40,000 and $60,000 from 8.5 percent to 6.5 percent. The rate cut plus the increase in personal exemptions means that middle income families will keep a lot more of what they earn – helping them pay for things like school uniforms, work supplies, and music lessons.  For example, a married couple earning $100,000 will see their taxes cut more than $500. 

These cuts will help families cope with DC’s rising cost of living, leaving them in a better position to make investments for future needs and thrive economically. 

Creating a strong and fair sales tax. Consumption patterns in the U.S. have shifted over time from an economy based mostly on goods to one dominated by services. That means that a sales tax tied largely to the purchase of goods becomes weaker every year at raising revenue to pay for services like police protection and libraries.  Fiscal policy experts recommend broadening the sales tax to include as many consumer purchases as possible. 

With that in mind, the Council chose to broaden the sales tax to include several more services, including carpet cleaning, health clubs, and billiards parlors and bowling alleys. The expansion will not only align our sales tax to consumer expenditure patterns, but also raise revenue that will help offset income tax reductions for both individuals and businesses.

Some—especially the affected businesses—have raised concerns about this approach, fearing that the expansion of sales tax to gym memberships will be a fitness deterrent, a so-called “fitness tax.”

However, expanding the sales tax is sound policy, and there are several reasons why claims opposing the expansion are unfounded:

Convenience and location factor into purchasing decisions. Shoppers always look for good prices, but they also want convenience. The District’s sales tax applies to dry cleaning, yet there is no evidence that people travel elsewhere to get their clothes cleaned. It is hard to believe that District residents will choose to travel outside of the city to work-out, when the sales tax will only add a couple of dollars a month to their fee or membership.   

Income tax reductions in the package will more than offset any increases residents see in sales tax. Individual residents will benefit from significant tax reductions with the Council’s package, giving consumers more purchasing power. Residents with incomes between $50,000 and $75,000, for example, will receive a tax cut of about $400. Given that gym membership costs around $70 a month, the benefits from the income tax would far outweigh the additional $50 members would pay in annual sales tax. Businesses affected by the tax expansion will also benefit from reductions in the business franchise tax.

Expanding the sales leaves fewer exemptions to the tax, making it fairer for the business community. Affected businesses feel targeted, but that is because they are among the small group of consumer purchases not taxed now. Adding gyms to the sales tax makes sense not only for base broadening but also as a matter of fairness. If a resident pays sales tax to buy weight-lifting equipment, someone who buys a gym membership should pay sales tax, too.

The Council’s tax package will make the District a fairer place. The reforms will help ensure that low and moderate-income residents can continue to afford the city and that DC has a robust sales tax that continues to pay for important city services. 

Wes Rivers is a policy analyst at the DC Fiscal Policy Institute (www.dcfpi.org). DCFPI conducts research on tax and budget issues that affect low- and moderate-income DC residents.