A last chance to undo an unfair tax in D.C.

September 17, 2011

In May, the District did something that appears to be unprecedented. As part of an effort to raise revenue to balance the city’s budget, the D.C. Council approved a tax on income from currently held out-of-state municipal bonds (as well as from future bond purchases). It chose to take this step over a rival proposal: a small tax increase on incomes above $200,000.

Many of the out-of-state bonds targeted by this retroactive tax carry maturities of 20 to 40 years, and all were bought, as both bought ours, in good faith under tax-exempt rules. When Indiana opted to tax proceeds from such bonds this year, it made sure to grandfather already-held bonds, to avoid placing an unfair burden on those who couldn’t easily liquidate their holdings without substantial losses and costs.

The issue hasn’t gone away since the May vote. Last month, Mayor Vincent C. Gray (D) used a pocket veto to kill a bill that would have shifted the effective date of the tax to Jan. 1. Another push — to grandfather currently held bonds while increasing the tax rate on incomes over $350,000 by 0.4 percentage points — foundered in July. While this approach was never formally introduced, Chief Financial Officer Natwar M. Gandhi determined it would generate sufficient funds to keep the budget in balance.

So let’s take a step back and examine how the groups affected by this last proposal compare.

A June 1 report from the D.C. Office of Revenue Analysis indicated that holders of out-of-state municipal bonds are mainly retirees with incomes significantly below $350,000. The tax on their bond proceeds would be 8.5 percent. This comes to $4,250 on $50,000 of income — funds that, remember, these taxpayers would have generated by investing their savings with the understanding that it would be tax-free.

With the tax increase on incomes above $350,000, however, an affected taxpayer would pay only $200 more on the same $50,000 in income. Such a person would need to earn more than $1.4 million in taxable income above $350,000 to end up paying $4,250.

It seems almost surreal that there would be any question about what to do. Now that it has returned from recess, the D.C. Council has little time to lose to remedy the situation. If the majority still wants a tax increase, the question we pose is: Which approach is fairer?

Beth Marcus and Alma Hardy Gates, Washington

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