By John Wagner and Philip Rucker
Washington Post Staff Writers
Thursday, March 27, 2008; B05

Gov. Martin O'Malley (D) has floated a compromise that would allow for the repeal of the state's new tax on computer services by imposing a surcharge on the income of millionaires, diverting some funding for transportation projects and requiring additional budget cuts in state agencies.

The proposals, which were shared at a closed meeting with legislative leaders Tuesday and described by several participants yesterday, are an attempt to resolve one of the most difficult issues pending before the General Assembly's April 7 adjournment.

Momentum has swelled in recent weeks to repeal the new tax, which was enacted in a special session in the fall and is projected to yield more than $200 million a year for the state once it takes effect July 1. But lawmakers have not agreed on how to compensate for the lost revenue. Divisions run particularly deep in Montgomery County, where officials have been cool to both the "tech tax" and alternatives to replace it.

As Montgomery County Executive Isiah Leggett (D) put it yesterday: "How do you select your poison?"

Under the scenario offered by O'Malley, the state would recoup about $100 million a year by imposing a surcharge on those reporting personal income of more than $1 million. Those filers would pay a top marginal rate of 6.25 percent instead of the current 5.5 percent.

The new rate would affect about 0.2 percent of filers statewide, about 40 percent of whom live in Montgomery, the state comptroller's office said.

The proposal amounts to a scaled-back version of a bill stalled in the Senate that would raise rates on those with taxable income of more than $750,000 a year.

O'Malley has also suggested diverting $50 million from new funding of about $450 million a year approved during the special session for transportation projects. Some lawmakers have suggested diverting as much as $200 million a year, a move opposed by many legislators in the increasingly traffic-snarled Washington region and by House Speaker Michael E. Busch (D-Anne Arundel).

O'Malley would compensate for the rest of the lost revenue through budget cuts, said participants at the Tuesday meeting, who spoke on the condition of anonymity because O'Malley was not making formal proposals. O'Malley aides said he remains open to other ideas that gain traction in the closing days of the session.

"The governor supports the repeal of the computer services tax and has been talking to the legislature about some combination of additional resources and cuts to make up for the $200 million hole," said O'Malley spokesman Rick Abbruzzese. He said O'Malley advocated a "more progressive" overhaul of the state's income tax structure during the special session called in the fall to address the state's long-term financial problems.

The proposal to apply the state's 6 percent sales tax to computer services was not among the ideas O'Malley advanced. The levy was added to a tax package by the Senate and remained in the final version of the bill sent to the governor, much to the surprise of many in the information technology industry.

Montgomery officials have been among the leading voices calling for the repeal of the tax, which would apply to a wide range of services, including custom software design and data processing.

Leggett said he favors a repeal, partly because the planned tax significantly affects the thriving technology industry in the Washington suburbs. Leggett said, however, that he opposes raising the top personal income tax rate because a large number of wealthy Marylanders live in Montgomery and that he is wary of cuts to transportation funding.

"I want to be supportive of resolving this, certainly as it relates to this computer tax, but Montgomery County cannot be the sole source of solving a statewide problem," he said.

In 2005, 6,150 of the state's 2.6 million filers reported personal taxable income of more than $1 million, according to the comptroller's office. Of those, 2,535, or 41 percent, resided in Montgomery. The second highest total was in Baltimore County, which had 1,011 filers reporting more than $1 million. Ninety-four filers who reported income of more than $1 million resided in Prince George's County.

Sen. Richard S. Madaleno Jr. (D-Montgomery) acknowledged that the number of those who would be affected by the millionaires' tax is small. "But this is a class of people who generate a lot of tax revenue for Maryland and Montgomery County," Madaleno said. "To create a disincentive for them to stay would be damaging to the rest of us."

Opponents of the millionaires' tax also said it would hurt small businesses, many of which pay their business taxes on their owners' individual income tax returns.

But some of Montgomery's legislators said they favor a more progressive income tax structure, even if it has a disproportionate effect on their county's residents.

"I have to represent all my constituents, not just the millionaires," said Del. Tom Hucker (D-Montgomery). "I think those folks can afford to pay more state income taxes, especially in the wake of enormous federal income tax cuts that they have benefited from for the last six years."

Sen. Brian E. Frosh (D-Montgomery) said he thinks lawmakers should step back and consider whether raising the tax rate is good public policy, irrespective of the consequences for his county.

"I understand that people say it would hit Montgomery County harder than some other jurisdictions, but we don't get taxed by jurisdiction," Frosh said. "I don't perceive it as a geographic issue."