State Tax Imbalance Could Sway Debate
Low Sales Tax Revenue May Draw Scrutiny During Drive to Close Budget Gap

By Philip Rucker
Washington Post Staff Writer
Sunday, October 28, 2007

When Maryland lawmakers convene for a special session tomorrow to close a potential $1.7 billion budget shortfall, they will consider overhauling a state tax system that is currently weighted more toward the personal income tax and away from sales and property taxes than most states'.

Maryland relies more heavily than almost any state on personal income taxes for revenue, according to a national analysis. It generates $1,638 per capita in personal income tax, well above the national average of $813 and ranking Maryland third in the nation.

Meanwhile, Maryland's sales tax revenue is among the lowest in the nation, according to the study by the state's nonpartisan Department of Legislative Services. The state's sales tax rate of 5 percent, which does not apply to groceries and pharmaceuticals, ranks 27th nationally. But the state generates just $1,030 in revenue per capita by the tax, ranking it 43rd among states nationally and below the national average of $1,293.

About half of Maryland's $14.9 billion annual tax revenue comes from the personal income tax. Just a quarter is generated by the sales tax, and an even smaller portion comes from taxes on property, fuel and other items, according to state budget records.

"Our overall tax burden is very moderate, but our income tax is very high and our sales tax is very low," said state House Majority Leader Kumar P. Barve (D-Montgomery).

The state generates about $3.6 billion from its sales tax, a figure relatively lower than that of other states because Maryland also exempts many services. Out of 168 potential services to be taxed, Maryland taxes 39, according to the Federation of Tax Administrators. The District taxes 70 services, and Virginia taxes 18, according to the study.

"Our sales tax is one of the lowest in the country," said House Speaker Michael E. Busch (D-Anne Arundel). "We exempt food and pharmaceuticals because we think that's the most regressive tax to charge."

Gov. Martin O'Malley (D) has proposed increasing the sales tax to 6 percent -- the same as Pennsylvania's and West Virginia's and 0.25 cents higher than the District's. The governor also proposed expanding the sales tax to cover some luxury services, such as tanning, health club memberships, massage and real estate management.

A recent Washington Post poll found that seven in 10 Marylanders oppose O'Malley's proposed sales tax increase.

Fiscal analysts said Maryland, which this year was named the nation's wealthiest state by the U.S. Census Bureau, relies so heavily on the personal income tax to generate revenue because it is one of the only states to allow local jurisdictions to levy additional personal income taxes.

Many counties, including Montgomery and Prince George's, use this "piggyback" tax to generate revenue for such services as public schools while keeping local property taxes moderately low.

John Rohrer, a fiscal policy analyst with the Department of Legislative Services, said the piggyback levies set Maryland's tax system apart nationally.

"In Maryland, the use of the local income tax is probably greater than everywhere else," Rohrer said. "On the one hand, that keeps the property tax side down, but it boosts the income tax component."

But Maryland has one of the most outdated personal income tax structures in the country, analysts said.

"I think the tax structure has been missing the boat in a few different ways in terms of modernization," said Iris Lav, deputy director of the Center on Budget and Policy Priorities, a nonpartisan national organization that recently studied Maryland's tax structure.

Maryland is one of six states with a flat-rate personal income tax. Using a structure that was set in 1967, it collects a 4.75 percent tax from everyone earning more than $3,000.

"There's not a lot of gradations in the rates," said Warren G. Deschenaux Jr., also of the Department of Legislative Services. "We have introduced a good level of progressivity at the bottom end through the earned income tax credit. But when you get out to the $40,000, $50,000, $60,000 range, everybody's paying basically the same rate."

Marylanders appear divided over whether the tax structure is fair, according to The Post's poll. When asked about the overall state tax system, 55 percent said it was "very fair" or "moderately fair" and 44 percent said it was "not too fair" or "not fair at all."

O'Malley has proposed the first major overhaul of the state's tax structure in four decades. "There's nothing terribly progressive about it," he said of the existing structure. "It's flat." Under his plan, the system would become more "progressive" by shifting the personal income tax burden more heavily to the state's wealthiest residents.

O'Malley is proposing two new income brackets. Single filers with taxable income between $150,000 and $500,000 and married couples with a combined taxable income between $200,000 and $500,000 would be taxed at a 6 percent rate. All filers with taxable income of $500,000 or more would be taxed at 6.5 percent.

The governor's plan also calls for lowering the rates for the first $15,000 in taxable income for single filers and the first $22,500 or joint filers, which O'Malley said would help lower-income workers.