May 4, 1999
Misconceptions in the D.C. Tax Debate
by Iris J. Lav
On May 4 the D.C. City Council passed a tax reduction package that includes deep cuts in individual income tax rates. Throughout the debate on the tax package, two misconceptions continue to be repeated.
- The first misconception is that a proportional income tax cut provides an equal benefit to all residents. This is not true because much of the total tax burden of lower- and moderate-income D.C. residents is made up of sales and excise taxes, which are not reduced. The income tax rate reductions will reduce total taxes by about 13 percent for moderate-income families. For very high income families, total taxes will decline by about 23 percent.
- The second misconception is that D.C. taxes are much higher than Maryland's. Maryland's top income tax rate for residents of most counties is 8 percent, not 5 percent.
D.C. "Tax Parity Act" is Not a Proportional Tax Cut
As noted in our previous report, two-thirds of the benefits of the individual income tax cut would go to the highest-income 20 percent of District residents. One-quarter of the benefits will go to the highest-income one percent of D.C. taxpayers, those with incomes exceeding $500,000. The top one percent of D.C. taxpayers would get an average tax cut of $23,000 apiece.
Several members of the Council, while not disputing these statistics, have argued that this is the appropriate distribution of a tax cut because it mirrors the distribution of who pays the taxes. They argue this is fair because everyone will get about the same proportional tax cut.
This is not the case. The claim that the tax cut is proportional considers only the income tax. It ignores the other D.C. taxes that fall more heavily on lower-income households and that are not relieved by the legislation. As a result, a proportional cut in the income tax increases the extent to which low-income working D.C. residents carry a higher total tax burden than their wealthy fellow-residents.
If all taxes are considered, poorer D.C. residents already have a higher tax burden than high-income D.C. residents. A family in the second 20 percent of the income distribution (income between $16,000 and $27,000 in 1998) pays 11.7 percent of income for D.C. income tax, property tax, and sales and excise taxes combined. For the highest-income one percent of families, however, the total burden for all taxes is 9.3 percent of income.
Moreover, most of the tax burden of moderate-income working D.C. residents comes not from the income tax, but from sales and excise taxes. For families in the second 20 percent of the income distribution, the D.C. income tax takes 3.8 percent income, while sales, excise, and property taxes absorb another 7.9 percent of income. For the highest-income one percent of families, however, the income tax accounts for most of the tax burden. Of the total tax burden of 9.3 percent of income for the highest-income one percent of families, the income tax takes 6.6 percent of income. (1)
This differential means that cutting the income tax proportionately does not cut total taxes proportionately. For the moderate-income family, the income tax cut reduces the total tax burden about 12.8 percent, from 11.7 percent of income to about 10.2 percent of income.(2) For the very high income family, the income tax cut reduces total tax burden by about 22.6 percent, from 9.3 percent of income to about 7.2 percent of income. The proposal thus increases the extent to which the moderate-income family pays a higher percentage of income in taxes than the highest-income District families pay.
Misleading Comparisons with Maryland
In discussing the "Tax Parity Act," the D.C. top income tax rate of 9.5 percent is often compared with the Maryland top income tax rate of 5.0 percent. This is a misleading comparison because Maryland has a "piggy-back" income tax that goes to counties. For residents of most Maryland counties, including those adjacent to D.C., the income tax is 8.0 percent, not 5.0 percent. It is appropriate to count the combined state and county income tax rate; from the point of view of the Montgomery or P.G. County resident, the income tax rate paid is 8.0 percent and not 5.0 percent.
1. District of Columbia Tax Revision Commission, Taxing Simply, Taxing Fairly, September 1998, p. 29.
2. This analysis does not incorporate the property tax changes in the Council plan.