Tax Day: What Do We Pay For, and Who Pays?

Tax Day is a good day to remind ourselves that taxes allow our state to make investments that benefit our economy and all Maryland’s residents, and that we must continue to work to make our tax code fairer.

What Do Our Taxes Pay For?

Taxes pay for important public services such as schools and health care that also help the state’s economy thrive. Residents and businesses alike depend on roads, bridges, and safe communities. Taxes make these investments possible.

Residents’ federal taxes mainly pay for national defense and major public programs such as Social Security, Medicare, Medicaid, and the Children’s Health Insurance Program. The largest items in the state budget include education, health care, transportation, and public safety.

Who Pays?

While the investments that taxes pay for play a large role in the lives of Maryland residents, the tax code itself plays an equally important role in determining who pays for these investments, and how much.

There are elements to the tax code that are beneficial for working Marylanders but others that favor the rich and well-connected. Like virtually every other state in the country, Maryland residents with moderate and low incomes pay a larger share of their incomes in taxes than do wealthy residents.

Source: Institute for Taxation and Economic Policy

Note: Data includes sources of family income for non-elderly taxpayers

In this regard, the tax code perpetuates and exacerbates inequality, which is particularly troubling as earnings for the wealthy in Maryland have increased while they have stagnated or declined for working Marylanders.

Unfortunately, the General Assembly has compounded this problem by raising the income exemption for the estate tax, allowing millionaires to withhold a higher level of income from estate tax filings. And although state lawmakers were unwilling to index the minimum wage to inflation during the 2014 legislative session, they passed legislation that has the withholding level for the millionaire estate tax eventually rise with inflation.

Thankfully, there are elements of the tax code in Maryland that benefit working families. Maryland has its own Earned Income Tax Credit (EITC) for people who work at low-wage jobs which complements the federal EITC and helps reduce inequality and lift residents out of poverty. This year, the General Assembly approved an expansion of the state EITC which will help the state’s workers keep even more of their money and further reduce poverty and inequality. This was an important victory for working Marylanders.

Maryland also employs a graduated rate income tax structure that rises with earnings, helping ensure that the wealthy pay their fair share. Maryland increased tax rates for high earners in 2012. Research shows that high-income residents do not leave a state in response to taxes (instead moving for family, job, and weather reasons. Indeed, Maryland remains the wealthiest state in terms of household income and the state with the most millionaires per capita.

Like the wealthy, large corporations operating in Maryland are not paying their fair share in taxes. Lawmakers failed to close a loophole that allows companies to avoid state taxes, and Maryland can do more to make sure its tax incentives are targeted toward moderate and low income residents that need them most.

As another Tax Day comes and goes, residents and lawmakers should be mindful that while taxes are necessary to pay for investments in Maryland’s residents and economy, there remains a need to improve the tax code so that it is fairer and promotes broad prosperity. 

Closing Corporate Loophole Would Make MD’s Taxes More Fair and Generate Needed Revenue

By closing a loophole in the way corporations report their earnings, Maryland can make its tax system fairer and generate needed revenue for schools, public safety and other services.

The Senate Budget and Taxation Committee will take up legislation today that would close the door to a range of currently legal accounting tactics businesses use to avoid paying taxes to the state. The Maryland Center on Economic Policy will join others in testifying in support of the Business Relief and Tax Fairness Act (HB 1298/SB 395).

The legislation  would treat a parent company and its subsidiaries as one corporation for state income tax purposes, a concept known as ‘‘combined reporting.’’

Combined reporting provides a more complete and accurate accounting of the profits corporations earn from their activities in Maryland. For example, under current law, a company can  establish a subsidiary in a state with a lower tax rate and shift its earnings there on paper by purchasing goods from the subsidiary at artificially high prices. The legislation would end this tax avoidance tactic.

Combined reporting also helps put smaller, locally-owned corporations with no presence outside of Maryland on a more equal tax footing with larger companies that operate in many states. This level playing field helps protect local jobs.

By stemming the flow of profits earned here to other states, combined reporting will also have the benefit of raising  revenue for education and other public services that bolster Maryland families, businesses and our economy. The Department of Legislative Services estimates that Maryland would collect tens of millions of dollars in additional revenue annually.

Maryland faces serious and well-documented needs in education, healthcare, public safety , environmental quality, and many other areas. But the state doesn’t have adequate resources to meet those needs, threatening further damaging cuts . The additional revenue from combined reporting is  crucial to preventing those cuts.

Combined Reporting WOULD BRING NEEDED REVENUE TO MARYLAND 

Source: Maryland Department of Legislative Services

(Click to enlarge)

Combined reporting is well-established around the country. Twenty-three of the 45 states with corporate income and similar business taxes and the District of Columbia use combined reporting. Because it is so common, most large corporations that would be subject to a Maryland combined reporting law already have experience using it elsewhere. Maryland will not be breaking any new ground with this proposal.

States with Combined Reporting
Alaska	Kansas	New Mexico
Arizona	Maine	New York
California	Massachusetts	North Dakota
Colorado	Michigan	Ohio
District of Columbia	Minnesota	Utah
Hawaii	Montana	Vermont
Idaho	Nebraska	West Virginia
Illinois	New Hampshire	Wisconsin

Though corporate accounting practices may seem obscure, they have major implications for whether Maryland is able to collect enough revenue to fund  the public services and investments that support Maryland residents and business. By implementing combined reporting, Maryland would create a more fair, effective, and productive corporate tax system. 

Cut business taxes only if other reforms come too

After seven years of budget crises, Maryland’s finances are in better shape now, which has some policymakers in Annapolis floating trial balloons about tax cuts. But let’s not go overboard. We’ve barely started recovering from the devastation of the Great Recession, and the state absolutely cannot afford a big tax cut.

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There is, though, a case to be made for lowering Maryland’s corporate income tax rate. It would help many local businesses, and it could bring corporate income tax rates into line with typical individual income tax rates.

There are two practical problems. If we just lower rate, that would provide a huge windfall to many big multistate corporations that do not in any way need the help. And it would cost Maryland a lot of money that we need for education, health care, transportation, public safety and other proven tools for job creation and building a strong economy. Maintaining these services is critical for businesses and households to thrive in our state.

We could, however, make room for a corporate tax cut if we take other steps to shore up our tax laws, namely, closing loopholes that today allow profitable multistate companies to dramatically reduce their taxes in Maryland or avoid them altogether.

The corporate income tax is a small but important part of Maryland’s resources. It is over one billion dollars a year. The individual income tax and sales tax together provide 12 times as much revenue. The corporate tax dollars help ensure that profitable corporations are doing their part to support the public services that all businesses need to operate:  schools, colleges and universities that educate and train a productive workforce; roads, bridges, the port and airport that help get their goods to market;  a timely and impartial court system to enforce contracts and settle disputes; adequate and effective police and fire departments to protect their property.

The problem is, big multistate corporations have many opportunities for avoiding Maryland’s tax regardless of the rate. They can arrange transactions among their affiliates and subsidiaries to shift their profits to other states that have lower business taxes or none at all. They can avoid taxes on profits allocated to states where they have no physical presence and so do not owe tax. They can avoid taxes on profits from selling property, equipment, or other assets. Little of the money they save on Maryland taxes is used to create jobs here. It’s going to out-of-state investors and managers.  Smaller businesses that operate principally in Maryland generally can’t use  these legal tax-avoidance tools, so the playing field is uneven.

One thing we could do is plug the loopholes.  Most of the states that have corporate income taxes have laws that prevent these tax avoidance maneuvers. But attempts to bring this reform to Maryland have been blocked year after year by big business groups in Annapolis.

These reforms have technical-sounding names: “combined reporting,” “non-operating income,” and “the throwback rule.” What they do is to help make sure that multistate companies have to pay tax on the full amount of their actual profits. If we enacted  these reforms, we could reduce the tax rate to 7.5 percent (the 2007 level) from 8.25 percent) for all corporations. In the process of making the system fairer for Maryland-based businesses we would be increasing the revenue available to the state to meet growing public needs.

 Maryland can’t afford to be reckless about corporate tax revenue. The continued weak economy and federal cutbacks that will cost jobs here mean that the state’s financial capacity still is fragile. Maryland needs to maintain its public investment in education, healthcare, and public safety to continue strengthening its economy, now and for the long run.

If we are going to cut corporate income tax rates, we should make sure that the big multistate corporations that operate in Maryland and benefit from Maryland’s public services pay their fair share.

Unfinished Business in the 2013 Session

MBTPI supported a number of proposals which were not successful this year. We plan to continue working on these issues.

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Earned Sick Leave

The Maryland Budget and Tax Policy Institute (MBPTI) supported HB 735 and SB698, requiring that employers provide employees with earned sick and safe leave and requiring employers to allow employees to use earned sick and safe leave. The bill would have benefited Maryland’s economy, reduced health care costs, and helped working families provide and care for their members. Earned sick leave is an important public health tool, enabling employees to take care of their health or the health of their children in a timely manner, and protecting coworkers, diners, or other customers from infection.

The cost to Maryland businesses would have been low, amounting to about 25 cents per hour per employee according to the Institute for Women’s Policy Research. More importantly, the business savings – primarily due to reduced turnover but also to increased productivity as a result of less sickness in the workplace, healthier customers, and other effects – completely offset these costs. The experiences of Connecticut and San Francisco show that earned sick leave requirements can be part of a vibrant, growing economy.

Unfortunately, the bill was opposed vigorously by business organizations. The House bill was withdrawn; the Senate bill died in committee. Yet the evidence shows that paid sick leave is not just a humane practice; it is good economic policy. MBTPI will support this legislation in the future.

Life-saving cigarette taxes

MBTPI supported legislation to add $1 per pack to Maryland’s tobacco taxes (HB 683/SB 700). This would have improved Maryland’s health by discouraging smoking, especially among young people. And it would have provided revenue which could be directed to health services. Both House and Senate bills died in committee, though. MBTPI will continue to support this measure on the principles of promoting good health and providing needed revenue.

Reforming corporation taxes

The state corporation tax got a lot of attention this session. Many bills were submitted to reduce the corporation income tax rate. Others proposed reforms to modernize the corporation tax, most notably by requiring “combined reporting” a tax system that prevents multi-state corporate groups from using subsidiaries and affiliates to avoid Maryland corporate income tax.

MBTPI supported a joint strategy of broadening the tax base and lowering the rate. The Institute supported combined reporting and other reforms to discourage corporate tax shifting and to broaden the corporate income tax base. A majority of the states with corporate income taxes have closed these loopholes.

We also supported a reduction in the corporation tax rate from 8.25 percent to 7.5 percent. Lowering the corporate income tax rate to 7.5 percent would put it near the same rate at which most Maryland personal income is taxed (including both state and local income taxes). We believe that this package would protect the revenue base needed to fund public services that are important to the economy, make Maryland’s tax system fairer and more modern, and help local Maryland businesses.

All of the bills to alter the corporation income tax either died in committee or were reported unfavorably. MBTPI continues to support sensible business tax reform.

Protecting resources for schools

MBTPI supported legislation to protect future education funding (HB 1474/SB 958). Over a decade ago, Maryland enacted a groundbreaking set of education finance reforms know as the “Thornton Program.” These reforms were based on a rigorous study of the actual costs in the state’s best-performing schools. They were intended to assure adequate education funding for all students, and to provide the resources necessary to reduce systematic performance gaps between students of different income categories and racial and ethnic groups. During the period of the Great Recession and its aftermath, the state found it necessary to limit the growth in the formula amounts. HB 1474 would have helped to prevent further erosion in Maryland’s commitment to full and fair public school funding. The bill died in committee. MBTPI will be calling on Governor O’Malley to fully fund the inflation increase in school costs in the next budget, and will again support legislation to protect future school funding.

Evidence-based policies

MBTPI supported legislation to promote evidence-based policy outcomes. SB 831 would have established a Committee on State Budget Evidence-Based Policy Options. The Committee would have reported annually on areas of opportunity within the operating budget where the state could benefit from evidence-based policies. This bill also died in committee. Over the summer, we will look at other states that have adopted this practice to gauge its success.

Unlike some states (Texas), Maryland’s legislature meets every year. MBTPI will be keeping track of these issues, and others, and pursuing them further in the 2014 legislative session.