Sales tax solution

The Baltimore Sun

Gov. Martin O'Malley said yesterday that he expects the state will increase the sales tax and expand it to cover services as part of a solution to Maryland's $1.5 billion budget shortfall.

Underscoring the politically painful decisions the budget crisis will entail, the governor also said he might not include the full amount required by the Thornton education funding law in next year's budget. That would effectively cut $137 million in aid planned for local schools.

"All of this is going to require a lot of courage, a lot of fortitude and a lot of foresight on behalf of all of our leaders in the General Assembly in order to make votes that are unpopular today but are the right thing to do for tomorrow and the next generation," O'Malley said in an interview on WYPR-FM's Marc Steiner Show.

O'Malley has been talking for months about the need to modernize Maryland's tax code to make it "inclusive and fair." He has yet to offer a specific proposal, but he said yesterday that based on discussions with legislative leaders, an expansion and increase in the sales tax will likely be a part of the final compromise. Maryland's sales tax, designed when the state's economy was dominated by manufacturing, does not tax most services, such as shoe repair, haircuts and advertising.

"I think consensus lies in doing both things, a slight increase as well as a broadening," O'Malley said. "I think that's probably where we'll end up."

The idea of broadening the sales tax - "Some would call it closing loopholes," he said - has been debated in Annapolis for years. But the change has proved politically difficult because the interest groups that would be affected by it have mustered strong lobbying efforts in opposition.

Of the 168 service categories tracked by the American Federation of Tax Administrators, Maryland taxes 39, more than Virginia but fewer than its other neighbors. Business groups say changing Maryland's sales tax structure could make the state uncompetitive. Republicans are likely to oppose the expansion, as they have all other tax increase proposals.

"The burden of the expansion will be borne by small-business owners," said Ellen Valentino, Maryland state director of the National Federation of Independent Business. "For example, if you're taxing accounting services, if you're taxing advertising services, taxing attorneys' fees, these are all services that are generally necessary for small-business owners to operate."

The political difficulty of sales tax expansion was on display this spring when the House Ways and Means Committee held a hearing on the issue. Although the committee chairman, Montgomery County Democratic Del. Sheila E. Hixson, said she had no intention of letting the bill reach the House floor, hundreds of real estate agents who feared they, too, would be subject to the sales tax descended on Annapolis that day.

Underscoring the point, John Grant, the owner of Secret Sound Studio, where O'Malley's Celtic rock band has recorded CDs, called the governor while he was on the air to say that taxing services would be a disaster for his business.

"As a small-business owner, that's the kind of thing that really squeezes us middle-class taxpayers," Grant said.

O'Malley assured him that recording studios weren't a part of the bill that was considered last year. But that sort of pressure from businesses, ranging from advertising to fingernail painting, has proved effective before.

Senate President Thomas V. Mike Miller said he had the votes to include carpet cleaning in the sales tax during the state's last major fiscal crisis in the early 1990s, only to watch a key senator flip his vote at the last minute. But Miller said he's confident an expansion will work this time.

"We're going to make it happen," he said.

Miller said he agrees with O'Malley "100 percent" on the sales tax and on scaling back the Thornton formula's requirements for next year. Miller said the state will need to find "several hundred million" in additional cuts.

O'Malley made fully funding the Thornton formula a key part of his 2006 campaign, and he strongly criticized his opponent, then-Gov. Robert L. Ehrlich Jr., for failing to do so.

What Ehrlich didn't fund was an optional component of the formula known as the Geographic Cost of Education Index, which is designed to compensate districts where education is more expensive. O'Malley also failed to fund that in his first budget, though he said he will phase it in over the next few years.

But yesterday he said he is considering the first break from the core funding formula, saying the state budget crisis would make it unwise to include a $137 million increase for inflation.

"In this year's budget, we provided record levels of education funding, far in excess ... of inflation," O'Malley said, referring to a $580 million increase.

"The $400 million we put into the public school construction and renovations was also a record level," O'Malley said. "There remains to be funded the Geographic Cost of Education Index that will be phased in. Whether we will be able to go forward with the inflation kicker to the degree that it was locked in five years ago ... remains to be seen. I'm not sure that it would be prudent."

Sen. David R. Brinkley, the minority leader from Frederick County, applauded that idea, which Republicans began advocating in the spring.

"We have already invested a tremendous amount of money into education," Brinkley said. "It's just unreasonable for us to continue those rates of increase going forward."

O'Malley said he would try to phase in the inflation factor after the GCEI, calling the annual increases a "forgotten" part of the Thornton formula.

But Alvin Thornton, the man who chaired the commission that developed the formula, hasn't forgotten it, and he said the state would do well not to forget it either. To do so, he said, would mean the state is lowering its standards for children's education.

"If the state decides and the state Board of Education decides that we're not able to finance the Bridge to Excellence or the so-called Thornton formula, that's fine. We just have to make adjustments in the performance expectation on which it's based," Thornton said. "That's not the decision I would make."

Former state Sen. Barbara Hoffman, who was integral in developing the formula and getting it enacted in 2002, said the annual increases aren't based on some theoretical guess at inflation but on the actual increase in costs that school districts face.

"If you cut it, you have to understand you're asking the counties to do more with less buying power," the Baltimore County Democrat said. "If he chooses not to fund it, then he can't claim to be fully funding Thornton."

Sales tax options

The governor says he expects the state will increase the sales tax and expand it to cover services to help close a budget gap. Here are some services that have been considered in the past and the amount of annual revenue that would be raised if they were taxed at 5 percent.

Cable television, $56.4 million

Auto repair, $68.8 million

Engineering, $174.0 million

Haircuts/salon services, $18.4 million

Management consulting, $59.5 million

Parking, $8.6 million

Tanning/massage/gym memberships, $27.5 million

Tax preparation, $9.8 million

Direct mail, $17.2 million [Source: Department of Legislative Services]

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