Tax Ideas for Maryland
The focus of tax policy debates tends to be at the Federal level, but there is much about state taxation that can be improved. Like many other states, Maryland can make its tax system both more progressive and — paradoxically — more welcoming to business, while at the same time raising the revenue needed for State spending priorities.
Income tax is an important revenue source. Here, there is a tension between state and federal policy. A state can depart from Federal income tax rules, but the price is complexity. Ideally, the state would just piggyback on the income tax rules at the federal level. Where federal tax policy is retrograde, because of political impasse, there is an argument for progressive states like Maryland to adopt more enlightened policy. This is particularly the case with provisions that affect the wealthy, since they are in a better position to deal with the added complexity involved in reporting different amounts of taxable income federally and to Maryland. It would make sense to review significant items where a departure from federal rules would make sense for Maryland, but the list should be kept within bounds so as to avoid overloading the system.
At the very bottom of the scale, increasing exemption levels would both make Maryland’s tax system more progressive and reduce the administrative burden of tax collection. Of course, the revenue from tax relief at the bottom needs to be made up, and it tends to be expensive because everyone gets this relief. In principle, however, upping the exemptions so that Marylanders without Federal liability also don’t have to file a Maryland return would be a worthy goal.
Another option for increasing progressivity and raising revenue is simply raising the top income tax rates. A key difficulty with this is that, wealthy people can avoid the tax by moving to a neighboring state with lower rates, or not coming to Maryland in the first place. A partial remedy is that, if state tax is deductible for federal income tax purposes at the margin, about 40% of the state tax does not represent a burden for the taxpayer because it reduces federal tax. State and local taxes (SALT) are now not deductible to the extent they exceed $10,000, which is a very low limit for higher-income individuals. I have suggested that a full federal deduction for SALT be allowed, but subject to a floor of 5 percent of adjusted gross income (AGI). This would give states like Maryland room to raise rates (or broaden the tax base) at the top, without driving taxpayers away. Federal legislators need to be urged to adopt this approach. (This approach costs much less revenue and is more progressive than just repealing the SALT limitation.)
There is great potential for tax reform in Maryland by reviewing the sales tax. Reform should follow two broad directions: broaden the tax base to include more goods and services, and remove sales tax on intermediate goods and services. Overall, this should result in a revenue pick-up which should allow the general sales tax rate to be reduced. The exclusion of intermediate goods and services from tax removes the tax burden from business and increases economic efficiency. There is a political challenge because businesses currently not taxed will resist, and consumers may not appreciate paying tax on grocieries, for example, even if their rates on other things go down and even though a more broad-based system is more progressive.
There may be other areas where Maryland taxes can be simplified, for example eliminating miscellaneous taxes on services that could instead be taxed under the sales tax. Possibly taxes on gifts and inheritances could be increased, or other changes made, to contribute to progressivity.
While identifying reforms involves some work, the heaviest lifting is political. Will politicians want to do the right thing for voters in the face of opposition by business, even if that opposition makes little economic sense? Political courage is a key ingredient of reform.
