Progressive Tax Reform that Makes Sense: Eliminating DC’s Tax Break for Investing in Other States’ Bonds
No politician is fond of increasing taxes. So you know this recession must be severe when more than half of the states have adopted tax increases to help balance their budgets.
This summer, the District crossed that bridge as well, voting for about $50 million in new taxes to help address a $340 million shortfall. (Program cuts played a much larger role.)
That allowed many services to be spared from the budget ax. But DC’s specific tax choices — including an increase in sales, cigarette, and gas taxes — will fall hardest on low-income residents, while more progressive options were set aside. Working poor families will pay higher income taxes due to elimination of inflation adjustments to DC’s standard deduction, for example. Yet the DC Council kept a tax break that goes mostly to high-income residents, for their investments in bonds issued by other cities and states. The District is one of the few places in the country to offer this tax break, by the way.
As the District braces for its next budget shortfall — whenever it comes — it’s important to think about not only whether to raise taxes — but what kinds of revenue increases make most sense. The economic downturn offers an opportunity to close tax loopholes or reform ineffective parts of DC’s tax code. We have written before, for example, about expanding the sales tax to more services — such as pet grooming — as well as to tickets for live-theater events.
It also makes sense to adopt progressive tax changes — so that tax increases fall on higher-income residents rather than on lower-income families that already struggle to make ends meet. Studies show that DC’s overall tax system is regressive.
Eliminating the income tax exemption for interest on out-of-state bonds is a good place to start. Every state offers an exemption for interest on in-state bonds, which provides an incentive to support that state’s infrastructure projects. But only DC and Indiana give a tax break for bonds issued by other cities and states. It’s a policy that doesn’t make sense. Why should DC provide a tax incentive to invest in other states’ infrastructure?
Moreover, changing DC tax policy to be in line with the vast majority of states — including Maryland and Virginia — would be a progressive step. Two-thirds of the interest on tax-exempt bonds goes to DC households with incomes of $200,000 or more.
Raising taxes may not be very popular. But we should at least start with the ones that make sense.
Fine with me to tax other states’ tax-exempt bonds. Nonetheless, I am wondering if you would apply the tax on interest from all new out-of-state bond acquisitions (after the law’s effective date), or would you also tax the interest earned from bonds acquired before the effective date of your new tax law?
Individual bonds are not totally liquid. Bonds are acquired when they are better than other investment instruments, and a tax changes the desirability of the out of state bond relative to DC bonds. Just wondering your policy on this?
We would recommend applying it both to existing investments and to future investments, for these reasons. First, when other tax policy is changed — such as the recent increase in the sales tax or the elimination of inflation adjustments to DC’s standard deduction — it also affects people based on their current income or current consumption. It is normal in tax policy to start taxing something tomorrow more than in was taxed yesterday – such as raising property sales, or income tax rates. Second, many people investing in municipal bonds do that through bond mutual funds, which they can sell and re-invest if they want. They can be fairly liquid investments. Third, people who hold these bonds still get a tax exemption on their federal tax return, so most of the benefit of holding the bonds would stay even if the DC tax exemption disappears.
Increasing sales taxes falls on the lower end residents who dont have a way to purchase online or in VA/MD who have lower sales taxes.
The shortfall on consumer goods taxes can be addressed if a system was created to receive the sales tax on online purchases that are shipped into the district through UPS/USPS. This can be done through the declared insurance value of the product. The shipping companies would hold the tax until owed, just like retail business’s currently do. It would provide the shipping companies with some added cashflow for the thirty days they are holding the thousands of sales tax dollars owed to the district.
People are not purchasing less consumer goods, they are buying them online. Increasing the sales tax, parking meters, local fee’s only hurts the lower-mid-income-resident who can only depend on higher priced DC taxes and fees. We also suffer based on the high taxes charged to the tourist industry. Fortunately grocery stores are not taxed.
I’ve been involved in taxations for longer then I care to acknowledge, both on the private side (all my employed life story!!) and from a legal stand since satisfying the bar and following tax law. I’ve furnished a lot of advice and rectified a lot of wrongs, and I must say that what you’ve put up makes impeccable sense. Please carry on the good work – the more people know the better they’ll be armed to handle with the tax man, and that’s what it’s all about.