A push to reduce state taxes on some businesses gained new momentum with last month's election of Republican Larry Hogan as governor.
But the state's nearly $600 million budget gap could stall the effort, which is focused on lowering the burden for firms that are organized so that profits are taxed at the owner's individual rate.
Maryland's personal tax rates — ranging from 4.75 percent for most incomes under $100,000 to 5.75 percent on income over $250,000 — are lower than the 8.25 percent corporate rate.
That may seem an advantage for pass-through entities such as limited liability companies, which are structured so that profits flow directly to the owners for tax purposes. But when federal and local taxes are included, the total tax paid may be higher.
A 2013 survey by the nonpartisan, fiscally conservative Tax Foundation found that Maryland's rates, which can reach 49 percent depending on the business and how much it earns in profits, were among the highest in the country for pass-through entities.
That can hurt growth, some say, discouraging owners from reinvesting their profits and using them to expand and hire.
"I really don't have a lot of incentive to leave profits in the business and reinvest them, because I'm going to have to pay tax on the full amount," said Paul Skalny, managing director of the Columbia-based law firm Davis, Agnor, Rapaport & Skalny, which has four owners and 20 employees and is structured as an LLC. "We reinvest a lot into the company, but it ends up hurting us from a cash-flow perspective."
The number of pass-through entities has increased in the last two decades, fueled by the growing popularity of limited liability companies, which combine the benefits of corporate legal protection with increased flexibility and more favorable tax treatment.
By 2008, pass-through entities — often smaller than a typical corporation — represented 94 percent of all U.S. businesses and employed 54 percent of the private workforce, with similar figures in Maryland, according to an analysis by professional services firm Ernst & Young.
In fiscal 2013, taxes from pass-through entities accounted for 11.5 percent of state and local taxes collected in Maryland, compared with 9.3 percent from corporations, Ernst & Young found.
The proliferation has led some advocates concerned about the burden on businesses to call on legislators to focus on reducing personal tax rates, rather than corporate.
In the last General Assembly session, the Maryland Chamber of Commerce supported a bill put forward by Democratic state Sen. Edward Kasemeyer that would exempt $50,000 of a pass-through entities' profits from the owner's state income tax, with the hope of encouraging businesses to reinvest the money in the company — using it to hire or for research and development that could lead to future growth.
The proposal applied only to pass-through entities whose owners are engaged in daily operations and have at least one person on the payroll in Maryland, working a minimum of 30 hours a week.
"It didn't pass last year, but we certainly have a receptive audience in [Kasemeyer], and given the message that was sent by the election, we're very encouraged that tax reform generally — and this kind of proposal specifically —will be introduced again in the legislature," said Brien Poffenberger, CEO of the Chamber of Commerce. "I frankly think there's an enthusiasm for tax restructuring in Annapolis right now. I think over the next six or eight weeks … we're going to see that enthusiasm expressed in actual legislation."
A legislative analysis of Kasemeyer's 2014 proposal found that its implementation would reduce state revenue by an estimated $110 million each year, while increasing costs by at least $100,000 each year in the comptroller's office. Local income taxes would also decline by about $70 million.
Such losses, coupled with the $600 million budget shortfall facing the state, could delay action on such a change.
"I have to respect the governor saying we have to do one thing at a time. I think he's looking at the budget," said Washington County Del. Andrew Serafini, a Republican who has also introduced legislation that would reduce individual income tax, with the goal of helping businesses. "Will it happen his first year or would it happen in the next four? I would like to think we would have some tax reform as soon as possible, but we have to be realistic."
During the campaign, Hogan voiced support for reducing the state's corporate and personal income tax rates, but he also said in April his first priority would be to "get spending under control."
He has made few specific policy comments since winning the election, and declined to comment for this article through a spokeswoman, who said he was waiting to get into office to talk about the issue.
Jessica Cooper, state director for the National Federation of Independent Businesses, one of the groups that endorsed Hogan during the election, said she expects to see legislation introduced in the near term, to at least start the discussion.
"There's no reason to wait," said Cooper, adding that rolling back the stormwater fee that's become known as the rain tax is another priority for her members. "He ran on a campaign message that he's going to roll back taxes and despite this big financial situation that's looming … we believe he's going to be able to do it. He's got the will and he's got the voters' support that the legislators cannot ignore."
Maryland, which was 40th in the Tax Foundation's most recent ranking of state business climate, would not be the first state to lower taxes on pass-through entities.
In 2012, Kansas passed a bill exempting nonwage income from taxes. In 2013, Ohio and Missouri created exemptions for some pass-through income.
Benjamin Orr, executive director of the progressive Maryland Center on Economic Policy, said there's little evidence in those states that the change led to economic growth.
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In Ohio, for example, where owners of pass-through entities could exempt half of the first $250,000 of Ohio income from their personal tax return, the change resulted in average savings of just over $1,000, Orr said: "Not zero, but nowhere close to helping those businesses hire new employees."
Scott Drenkard, an economist for the Tax Foundation, said Maryland has other options that could improve its tax code, such as lowering the corporate rate or eliminating the double whammy of both inheritance and estate taxes.
Carve-outs for pass-through entities don't represent best practices, he said, because it adds complexity to the code and picks favorites.
"It's a gimmick. It's a substitute for real tax reform," Drenkard said. "It costs a lot in revenue and it doesn't improve your overall tax code for everybody. … I think you'll be better off with the bread and butter approach of broadening the base and lowering the rate."
Poffenberger and others said trying for holistic reform of the code is unrealistic and in the short-term small businesses need relief.
"Generally it's safe to say that we would like to see more equitable tax structure overall … but you can't boil the ocean," Poffenberger said. "If you want tax policy that encourages job creation, this is a place to start."