Testimony of Ed Lazere, Executive Director, Dc Fiscal Policy Institute At the Public Hearing on Bill 16-18, The Estate and Inheritance Tax Re-Coupling Act of 2005 Bill 16-19, The Pension or Other Retirement Income Exclusion from Income Tax Amendment Act of 2005, and Bill 16-22, The Public School Teachers Income Exclusion Act of 2005 District of Columbia Committee on Finance and Revenue

Chairman Evans other members of the Committee, thank you for the opportunity to speak today.  My name is Ed Lazere, and I am the executive director of the DC Fiscal Policy Institute.  DCFPI engages in research and public education on the fiscal and economic health of the District of Columbia, with a particular emphasis on policies that affect low”‘ and moderate”‘income residents.

This is a great time to be talking about the District’s finances.  The recent announcement of a $300 million surplus in 2004, resulting from adherence to an enacted budget and better-than-expected revenues, is a sign that the District’s economy is strong and its fiscal operations well managed.  The additional revenues flowing into DC’s coffers are likely to present opportunities both to make badly needed investments in infrastructure and services and to reduce DC taxes.

Of course, resources are not unlimited and decisions over where to invest or where to cut taxes must be made carefully.  While I believe some tax relief may be warranted this year, I do not believe the bills before us represent the highest priorities for tax relief.  Let me take the estate tax bill, pension exclusion bill, and teacher’s income exclusion bill in turn.


Estate Tax

In 2001, the federal government passed legislation to phase out the federal estate tax by 2010.  Because most states tie their estate tax to the federal, the elimination of the federal tax also affected state-level estate taxes in many states.  DC and 17 states have preserved their estate tax.  Under current law, DC taxes estates of $1 million or more and will continue to do so if the federal estate tax is eliminated.  Bill 16-18, if I understand correctly, would partially re-couple to the federal tax, by matching the federal filing thresholds through 2009.  The bill would not fully re-couple to the federal tax, which would mean elimination of DC’s estate tax in 2010 when the federal estate tax is set to be eliminated.

I appreciate the bill’s recognition of the need to maintain an estate tax in the District of Columbia, but I believe it makes sense to keep the current $1 million filing threshold rather than raising it to $3.5 million, for these reasons.

  • The estate tax already is limited to a very small share of estates.  Only two percent of all estates nationally are subject to the estate tax.  As noted, DC levies a tax only on estates worth $1 million or more.  A national study found that in nine of 10 estates subject to federal tax, the decedent had annual income of more than $190,000.  In short, the estate tax applies only to very wealthy households and thus makes our tax system progressive.
  • The estate tax generates substantial revenue:  Over the past 10 years, DC’s estate tax revenues have averaged nearly $40 million per year.  Greatly reducing the estate tax would require raising other, less progressive taxes, or cutting services.
  • Even if DC’s tax is retained, the total taxes paid on estate will be reduced greatly.  Under current law, the combined federal and DC estate tax burden for an estate worth $1.5 million will be 80 percent lower in 2009 than in 2001.
  • The effective rate of DC’s estate tax is low.  For an estate worth $1.5 million, the DC tax equals about four percent of the estate’s value.

Bill 16-18 would raise the threshold at which DC estates are taxed to $3.5 million, matching changes in the federal threshold.  This is, in effect, a tax break for estates worth $1million to $3.5 million.  There is an administrative advantage in doing so, in that DC would only tax estates already paying a federal estate tax.  But the federal estate tax is scheduled to phase out in 2010.  This means that if DC wants to maintain its estate tax, it will need to administer a tax separately from the federal tax in 2010.  For the reasons cited above, it would make sense to maintain a DC estate tax even in the absence of a federal tax.  Considering that the $1 million threshold in DC’s estate tax already excludes most estates, it would be appropriate to consider maintaining that threshold rather than raising it.


Pension Income Exclusion

Bill 16-l9 would increase the amount of DC and federal pension income excluded from tax from the current $3,000 to $20,000.  I understand that this bill was motivated largely by the fact that the pension exclusion in DC’s income tax was set years ago and has not been adjusted for years for inflation.  This is a legitimate concern, since the failure to index elements of the income tax effectively can cause unintended tax increases.  Nevertheless, I have concerns about the specific design of this legislation.

Most important, senior citizens in the District already receive preferential tax treatment in several ways.  The DC income tax excludes 100 percent of Social Security income.  While this bill addresses people with pension income, it is likely that many with such income also have social security income, either through their spouse or because they worked outside of the government for a part of their career.  The DC income tax also allows senior citizens to claim an additional personal exemption.  Under the property tax, seniors with incomes under $100,000, which represents nine of 10 senior citizens in the District, qualify for a 50 percent reduction in their tax bill.  Moreover in 2004 the District implemented a five percent cap on property tax increases for low-income homeowners who have lived in their home for seven years or more.

Given the existing preferential tax treatment of seniors, it does not make sense to expand the pension income exclusion, particularly since the bill is not limited to seniors with low or moderate incomes.  Instead, it would be available to all senior citizens with DC or federal government pension income.  It is not clear why a resident who worked as a lawyer for a federal agency and now receives a $75,000 pension should have a lower DC income tax liability than a working DC resident with the same income.

It also is worth noting that the failure to index DC’s income tax provisions is a broader problem than this exclusion. DC’s standard deduction and personal exemption also have not been adjusted for years and now are well below the federal deductions.  The DC Tax Revision Commission recommended raising the personal exemption and standard deduction and to adjust them annually for inflation.


Teacher Income Exclusion

Bill 16-22 would exempt from the income tax all income earned by DC public school teachers who live in the District.  I have two children in DC public schools and want to do everything I can to support the teachers.  At the same time, I do not believe this bill is the right way to do so.

In particular, I am concerned about giving special treatment to teachers but not to other worthy groups.  If helping teachers live in DC, why not nurses and doctors, fire fighters and police, librarians and UDC professors, social workers and clerical workers?  All DC workers would have a legitimate claim to an income exclusion as well.

Second, it is not clear whether this policy would encourage a lot more teachers to live in DC or not.  To answer that, we need to understand more why teachers and other DC workers who live outside the city choose to do so.  In general, studies have shown that DC residents do not leave the District for tax reasons.  In the 1990s, residents leaving the city were most likely to end up in Prince George’s County, arguably the highest-tax jurisdiction in the region.

Finally, this income tax exclusion would have significant costs in terms of lost revenue.  This is true in part because it would provide substantial tax relief to teachers already living here or would who have lived here even in the absence of the tax break.  The revenue loss would make it harder to make public investments in things like libraries, roads, and parks that enhance the quality of life in the District and are critical to attracting and retaining residents.

In conclusion, I think it is healthy for the District to discuss the kinds of tax relief that we should consider given our strong finances.  In general, I would hope that tax relief would address the regressive features of our tax system and would target relief to address pressing needs.  The District could consider, for example, revising its outdated property tax credit for low-income residents or expanding the DC EITC.

Thank you again for this opportunity to speak. I am happy to answer any of your questions.