Gray vetoes delay in bond tax, seeks income tax hike instead

August 3, 2011

Saying he wants to keep the District in good standing with credit raters, Mayor Vincent C. Gray has vetoed a proposal that would have delayed collecting a new tax on out-of-state municipal bonds, a move that could reopen debate about whether the city should raise taxes on the wealthy.

With just hours left to act, Gray (D) vetoed the amendment to the fiscal 2012 budget late Tuesday. The use of a pocket veto all but ensures that the council, which is on summer recess, will not be able to override his decision, setting off a heated dispute between the first-term mayor and several of his former colleagues on the council.

“For the mayor to create this 11th-hour turmoil, for a justification I find flimsy, is just baffling to me,” said D.C. Council member Mary M. Cheh (D-Ward 3), a Gray ally who angrily confronted him Wednesday at the dedication of a recreational center in Glover Park. “I find this inexplicable.”

To help close a $320 million budget gap, the council approved a controversial plan this spring to charge income tax on municipal bonds not issued by the District. The move, which applied to all interest earned on out-of-state bonds after Jan. 1, 2011, allowed the council to avoid a tax increase and deeper cuts to some social programs.

But in early July, under pressure from those with municipal bonds, who include many retirees, the council approved an amendment to delay the collection of the bond tax for a year. The council then diverted about $13 million from the city’s reserve fund to keep the budget balanced until the tax is collected in 2012.

Gray said he had little choice but to quash the move because Chief Financial Officer Natwar M. Gandhi was concerned that using the city’s reserve funds to close budget gaps could undermine the city’s fiscal integrity. In February, Gray added, both he and Gandhi promised credit-rating agencies in New York that the city would safeguard efforts to rebuild its reserves account.

Under former mayor Adrian M. Fenty (D), the city used more than $800 million in reserve funds to keep the budget balanced amid the recession. Continuing to rely on that fund, Gray said, could result in agencies downgrading the city’s healthy bond ratings.

“I am deeply concerned about the commitments we made to our rating agencies,” Gray said Wednesday. “We see the precarious condition of the nation’s finances . . . and given the fund balance has been spent down over the last four years, the conversations we have had in New York left me with a very uncertain feeling.”

With Gray’s veto, residents who purchased a non-District-issued municipal bond this year are subject to the city’s 8.5 percent income tax starting Oct. 1. But Gray said he hoped to forge a compromise with the council so the bond tax will not be collected until 2012.

To do that, Gray hopes the council will raise the city’s income-tax rate from 8.5 percent to 8.9 percent on residents who earn $350,000 or more annually. According to Gray budget officials, that would generate $10 million more a year.

Gray’s veto sets up a potential confrontation with D.C. Council Chairman Kwame R. Brown (D), who has opposed increasing the wealthy’s income-tax rate. And as he seeks to rehabilitate his own image after ethics controversies, Brown has pointed to his role in crafting the 2012 budget as an example of his leadership skills.

“I strongly disagree with Mayor Gray’s assertion that this relatively minor council action would be a precipitating factor in a future bond downgrade,” said Brown, who noted that the council approved diverting several million dollars to the reserve fund.

If the debate shifts toward a possible tax increase, which Gray proposed in February, it’s unclear whether it has enough council support for approval.

Supporters of higher taxes on the wealthy hope to gain new momentum now that Congress and the White House have agreed not to increase federal taxes. The income-tax rate for District residents who earn $40,000 or more annually is 8.5 percent, and some liberal interest groups have said that the District needs a more progressive tax structure.

Earlier this summer, council observers believed that there was a 7 to 6 majority in favor of a tax increase on the wealthy, with Cheh being the swing vote.

But Cheh, who is angered by Gray’s veto, said she is not sure whether she would support a tax increase. She also noted that it may take nine votes to approve a tax increase if the council has to enact it as emergency legislation.

“A lot of this is in flux, because no one was anticipating that act by [Gray], and he did it in the dead of night,” Cheh said. “This takes a budget that was finalized and roils the whole system.”

Tim Craig is The Post’s bureau chief in Pakistan. He has also covered conflicts in Iraq, Afghanistan and within the District of Columbia government.
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