Increasing the District’s Personal Exemption and Standard Deduction Would Help Provide Greater Tax Relief to Low- and Moderate-Income DC Residentsby Wes Rivers | June 25th, 2013 | PDF of this report
The District’s personal exemption and standard deduction are parts of the DC income tax that are available to all residents, but they provide the greatest benefits to families and individuals with low-and-moderate incomes. Despite the importance of these tax provisions, the DC deductions are far lower than the federal personal exemption and standard deductions and similar deductions in many states. The low value of these deductions means that the DC income tax does not do as much to shield lower-income families from taxes as the federal income tax or the income tax in many states.
For example, the combined standard deduction and personal exemption for a single parent family of three reduces taxable income by $10,700 in DC, compared with $15,300 in the average state and $19,600 at the federal level.
Raising the DC standard deduction and personal exemption to match the federal deduction would exempt all working poor families from owing DC income tax, increase the effectiveness of DC’s earned income tax credit for lower-income working residents, and provide substantial tax benefits to low- and moderate-income working families with incomes above poverty. This also would make DC’s tax system more progressive.
The personal exemption and standard deduction are part of the federal and DC income tax codes, as well as the tax codes in many states. They serve to exempt a certain amount of income from tax. The personal exemption, which generally is available to all families and individuals, provides a flat deduction for every person in a tax filing unit. (DC allows an extra exemption for families filing as a single head of household.) The DC personal exemption is currently $1,675. The standard deduction also is available to all tax filers, but taxpayers with certain eligible expenses — such mortgage interest, property taxes, and charitable contributions — can choose to take an itemized deduction over the standard deduction. The DC standard deduction, which is currently set at $4,000, is especially important to renters and to lower-income residents because they typically do not have sufficient deductions to itemize. In DC, for example, some 75 percent of filers with incomes below $75,000 claim the standard deduction. The vast majority of filers above that threshold, 88 percent, itemize deductions.
These deductions help make the income tax progressive. For some very low income families, the personal exemption and standard deduction eliminate taxable income and tax liability entirely. Among other families, the personal exemption and standard deduction offset a higher share of income for moderate-income families than for others. For example, the combined personal exemption and standard deduction at the federal level is $26,400 for a married couple with two children. That offsets more than half the income for a family earning $50,000, but only about a quarter of the income for a family earning $100,000.
A small number of states and the District have another mechanism to shield lower-income residents from income tax, in addition to their personal exemption and standard deduction. It is typically known as a no-tax floor or a no-filing floor, meaning that income must meet a certain level before a unit starts owing income tax. In five states and DC, the no-filing floor is greater than the combination of the personal exemption and standard deduction, which means that some families owe no income tax even though they have taxable income (income minus personal exemptions and the standard deduction.).
The District has a tax credit, the Low-Income Credit, which acts like a no-tax floor. If a household’s income exceeds the combination of the District personal exemptions and standard deductions but is less than the combination of its federal exemptions and deductions, the household can claim a Low-Income Credit. In most cases, the credit eliminates the entirety of an eligible family’s tax liability.
Nevertheless, the personal exemption and standard deduction are more effective ways to limit tax liabilities for lower income families, especially in DC. All no-tax floors create a “cliff” effect. If a household’s income exceeds the no-tax floor by a dollar, it is disqualified entirely from claiming the no-tax benefit. While all families can benefit from the personal exemption and standard deduction, only households below the income limit of the no-tax floor benefit from it. Instead of a gradual phasing-out, a dollar of income above the no-tax floor is a “cliff” that can result in a significant increase in in tax liability. In DC, for example, an increase in income for a married couple and two children from just below the Low-Income Credit limit to $1 above it moves the family from having no tax liability to owing $742.
DC’s Low-Income Credit has an additional shortcoming that a household cannot claim both the Low-Income Credit and the refundable DC Earned Income Credit. This results in very few families with children claiming the Low-Income Credit. Overall, only a small fraction of low-income residents in DC use the Low-Income Credit.
For these reasons, strengthening DC’s personal exemption and standard deduction are important to reducing income taxes for low- and moderate-income households and for making the income tax more progressive.