A Review of the DC Tax System
It’s that time of year when we get the forms needed to file our taxes, which triggers thoughts about how much we contribute to the DC and federal treasuries. It’s an important thing to think about, but it’s hard to get a full picture of why we tax the way we do from our individual perches. So lucky for all of us, there’s been a group of people who just spent 18 months looking at the DC tax system – whether it is fair and easy to follow, whether it supports our ability to attract residents and businesses, and whether it follows sound taxing principles.
That was the mission of the DC Tax Revision Commission, of which our own Ed Lazere was a member, which spent more than a year taking a comprehensive look at our tax system. It approved a package of recommendations at the end of 2013 that soon will be considered by the DC Council.
The Commission was tasked with addressing issues of fairness, broadness, and competitiveness, and it reached consensus on alterations to personal income, business, and sales taxes. The commission did not feel any major changes were needed to property taxes, yet the Council recently considered two property tax cuts: One bill, which seems to be on a path to be adopted, would lower property taxes for longtime senior homeowners. The other, which was tabled but will be reconsidered this month, would tightly limit how much a homeowner’s property tax bill could grow each year. Both raise red flags about fairness and seem to undo the commission’s goals.
It’s important to keep in mind that tax changes don’t occur in a vacuum. There’s a cost to lowering a tax rate that has to be made up either through reduced services, higher taxes for another group of residents or businesses, or growth in tax collections from an expanding economy. Luckily, revenue is projected to be on the upswing for the District given the influx of new residents, so many of these recommendations could be adopted without affecting funding for things like education, health care, or libraries.
Making the Income Tax Fairer
The Commission heard early on in its deliberations that DC’s tax system was not balanced and that low- and moderate-income DC residents pay more than anyone else in combined sales, property and income taxes, as a share of their income. There were several recommendations to try to level the playing field for individuals.
- Expanding the earned income tax credit (EITC) for childless workers. The EITC helps boost the wages and take-home pay of low-income workers. Unfortunately, the current benefits are very low for workers without children. A parent with one child qualifies for a maximum credit of $1,300, while a single person with no children can get no more than $190. The commission recommended raising the maximum EITC benefit for childless workers to about $500.
- Raising the personal exemption and standard deduction to match the federal levels. DC’s current deductions offer far less relief than the average state. Raising these deductions to federal levels would help reduce taxes for a large share of DC households, particularly low and moderate-income residents. The Commission also proposed phasing out the personal exemption for households with incomes over $150,000, which is similar to federal income tax provisions.
- New income tax brackets and rates. Currently, DC’s tax system imposes high marginal tax rates on low-and moderate income residents. The commission proposed lowering rates for households with income between $40,000 and $60,000 (or $40,000 and $80,000 for married couples and heads of household).
- Maintaining a top tax rate. Until recently, DC’s top income tax rate was 8.5 percent and started at $40,000 of taxable income. That changed when DC adopted a higher tax rate of 8.95 percent on income over $350,000. However, that top rate was set to expire at the end of 2015. The Commission recommended maintaining a top tax rate on incomes above $200,000 ($350,000 for married couples and heads of household) but at 8.75 percent.
- Broadening the Sales Tax Base. The Commission also proposed to make important changes to the sales tax by expanding the base of goods and services that are covered by the sales tax. The Commission examined research that expanding the sales tax to cover services is important because services represent a steadily growing share of personal purchases. The commission proposed to broaden the sales tax base by including the following services, based on expert research: construction contractors, carpentry and other construction related services, storage of household goods, mini-storage, water for consumption at home, barber and beautician services, carpet and upholstery cleaning, health clubs and tanning studios, carwashes, bowling alleys and billiard parlors.
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The commission proposed cutting the income tax rate paid by businesses in DC, in order to match Maryland’s tax rate. Yet research presented to the Commission showed that DC has out-performed surrounding jurisdictions in business and job growth in the last decade, despite having a higher corporate income tax rate. The experts who testified before the commission did not endorse a commercial property tax cut.
The commission also recommended exempting all estates worth less than $5.25 million from tax. Currently, estates under $1 million are exempt. A number of states phased out their estate taxes in the mid-2000s, yet there is no evidence to suggest residents are leaving DC to find lower estate taxes – our estate tax collections have remained solid. Researches who have studied the impact of residential migration due to estate taxes find the effects are very modest – and not large enough to justify exempting wealthy estates.
Cutting Property Taxes: Not A Top Priority
The District has the lowest residential property taxes in the metropolitan Washington region. In fact, most homeowners pay tax on only three-fourths of what their home is worth.
In addition, the District offers substantial property tax help to seniors and to all lower-income homeowners – through a 50 percent break for seniors with incomes below $125,000 and a property tax credit for any homeowner with income below $50,000 who faces high property taxes.
Those are big reasons why the Commission did not recommend changes to the property tax, and the DC Council should heed that decision. However, the Council is currently debating two property tax bills that both give disproportionate benefits and raise questions about tax fairness.
The Residential Real Property Tax Relief Act of 2013, which was tabled last month but will likely come up this month, proposes to reduce property taxes in a way that will give the biggest benefits to owners of the most valuable homes in the District and will create large disparities in tax bills among owners of similarly valued homes. The legislation proposes to reduce the property assessment cap – which limits the yearly growth in a homeowner’s taxable assessments – from 10 percent to 5 percent. On the surface, it may sound like a good way to help all District homeowners deal with increasing property taxes. But if DC’s property taxes already are on the low end, it doesn’t make sense to put broad-based property tax reductions a priority.
Then there’s the Senior Citizen Property Tax Relief Act of 2013, which passed on a first reading last month. DCFPI agrees with the goal of this bill – to provide assistance to DC residents struggling with high-housing costs – but believes it is not the most effective way to target property tax assistance to those who need it the most. Most important, the bill would leave out half of all seniors, who rent their homes and are actually more likely to have housing cost challenges. DCFPI recommends expanding the city’s property tax credit, which has provisions to help renters as well as homeowners, while adopting provisions to provide extra help to lower-income seniors.
Instead of creating these inequities, the DC Council should prioritize proposals that provide tax relief to low- and-middle income residents. Enacting the tax commission’s proposals would be a great place to start.