State leaders are considering the first changes to Maryland's income tax brackets in 40 years to make them more progressive - and to help erase the state's projected $1.5 billion budget shortfall.
The tax is essentially flat - the highest bracket kicks in at $3,000 in income - and the top rate of 4.75 percent is the seventh-lowest in the country.
Gov. Martin O'Malley said this week that he wants to find ways to make the state's tax structure more progressive, and key legislators, including Senate President Thomas V. Mike Miller, have expressed support for at least a temporary tax increase on top earners, such as one that helped Maryland weather its last major fiscal crisis, in the early 1990s.
"I believe in progressive taxation," O'Malley, a Democrat, said last week.
But the reality of Maryland's income tax is that it is not as low as it may seem.
Maryland's income tax brackets were set in 1967 at $1,000, $2,000 and $3,000 and have not changed. Anyone who makes less than $8,450 a year does not have to file a tax return so, effectively, every taxpayer in the state is in the top bracket, said Christine M. Duray, a spokeswoman for Comptroller Peter Franchot.
And though the state's top tax rate is relatively low, Maryland is one of just a few states in which counties levy income taxes. When those are considered, Maryland catapults into the top tier of income tax rates.
Counties were given the ability to piggyback on the state income tax in the early 1990s when the state passed on significant personnel costs to local governments as a way to solve its budget problems.
According to the Tax Foundation, a nonpartisan research center in Washington, the local income tax in Maryland averages nearly 3 percent, bringing the combined rate to about 7.5 percent.
Put another way, the state's tax rate and flat structure puts Maryland in the same league as Alabama and Mississippi. But factor in local taxes, and Maryland starts to look more like high-tax states such as Hawaii, Minnesota and Vermont.
In the Baltimore area, local income tax rates are 2.6 percent in Anne Arundel County, 2.8 percent in Baltimore County, 3.1 percent in Baltimore City and Carroll and Harford counties and 3.2 percent in Howard County.
The local income tax rates push Maryland well above its neighboring states. Virginia's top rate is 5.75 percent, West Virginia's is 6.5 percent, Delaware's is 5.95 percent, and Pennsylvania's is 3.07 percent. Local taxes in Pennsylvania bump that up to about 3.6 percent on average.
What's more, with the exception of Pennsylvania, which has a flat tax, all the neighboring states have more progressive structures than Maryland. A West Virginia or Delaware resident would have to earn at least $60,000 a year to pay the top rate.
That means that not only are Marylanders paying a higher rate than their neighbors, they are paying it on more of their incomes.
Maryland does have a lower sales tax rate than many states, and counting all state and local taxes, it ranks 23rd, according to the Tax Foundation. That is about the same as Pennsylvania but higher than Delaware, Virginia and West Virginia.
Speaking Monday to the Frederick County Chamber of Commerce, O'Malley said that he would be mindful of Maryland's neighbors as he evaluates the tax code.
"We have to look at our revenue streams to make sure they're modern, they're inclusive and that they're fair," he said. "We will also be mindful of what other states are doing on these scores. We do not want to be a state that finds ourselves at a competitive disadvantage for attracting jobs, keeping jobs with the states that surround us."
Maryland will find itself at a disadvantage if it raises its rates on top earners, said Del. Gail H. Bates, a Howard County Republican who is an accountant. "Wealthy people do pay more," Bates said. "My clients pay a lot of tax, and part of the reason I keep doing tax returns for people is because I hear from the ones going, 'You know, you guys are spending too much.'"
Maryland's revenue figures suggest that it is the spending, not the antiquity of the income tax code, causing its financial problems, said Christopher B. Summers, director of the Maryland Public Policy Institute, a market-oriented think tank.
When the state cut its income tax rate by 10 percent in 1998 - a move O'Malley has called a mistake - fiscal projections showed the reduction was easily affordable, Summers said. Only the passage of a huge education spending program and growth in entitlement programs caused budget problems, he said.
Income tax collections have been a rare bright spot in the state's revenue picture. Individual income tax receipts grew by 6.3 percent last year, about in the middle of the pack nationally, while sales tax receipts grew by 3 percent. State lottery revenues were flat, and revenue from corporate income tax returns - which has enjoyed double-digit growth in states such as Connecticut, Illinois and New York - has dropped in Maryland.
Advocates for changing the structure say they look at the idea as a way to inject fairness into the tax code, not just as a revenue raiser.
A group of liberal-leaning state senators sent a letter to O'Malley this week appealing to him to shift "the relative burden off of working families, small businesses and those on fixed incomes." Their idea of modernizing the tax brackets would mean spreading them out so that people at the lower end of the economic scale pay less and people who can afford to pay more.
"Probably most college students will make enough during their summer break to make the top bracket in Maryland," said Sen. Richard S. Madaleno Jr., a Montgomery County Democrat and an authority on budget matters. "The system actually has brackets at $1,000 and $2,000 in income. The structure is so old that it dates back to a time when those were meaningful differences in income."
But proposals to update the system have failed before and could face resistance from both parties.
Del. Kumar P. Barve, the majority leader from Montgomery County, said raising the top brackets in Maryland could doubly hurt some taxpayers because of quirks in the federal alternative minimum tax.
"Changes in the sales tax and corporate tax don't have a negative impact on the taxpayer that way," said Barve, a financial analyst.
Sen. David R. Brinkley, the minority leader from Frederick County, said Republicans are not going to go for the idea. Brinkley, who attended the governor's Chamber of Commerce speech, said the impression he got was that O'Malley is less committed to making the income tax fair than he is to finding a way to sell a tax increase to people.
"The governor is a smart guy, a sharp guy, and I think his advisers are hammering out the details, and he's not aware yet of how this is going to gel," Brinkley said. "They're just floating ideas out there to see the reaction, so this is just another idea for how we raise taxes."
andy.green@baltsun.com