Mahlon Straszheim gives Gov. Martin O'Malley his due. At least he has proposed a plan to deal with the state's fiscal problem instead of just hoping it would go away.
"The state's budget deficit problem is real," said the economics professor. "This is not an imagined problem. We face very difficult actions if we are going to balance our books here."
In recent weeks, O'Malley rolled out a series of tax proposals designed to raise money to make up for the deficit caused mainly by the promises made to public schools in the Thornton legislation, promises that came without funding. The governor has called a special session of the state legislature to consider his ideas later this month.
Straszheim has been on the faculty of the University of Maryland, College Park since 1971, but he does not look at these issues from the ivory tower. For one, he is quite involved in Montgomery County, where he lives, advising the county executive and County Council on economic matters.
On the state level, Straszheim delivers reports on Maryland's economy to the comptroller's office. He has often testified before legislative committees and was an adviser to Democratic Govs. William Donald Schaefer and Parris N. Glendening.
"It is not easy to propose a tax increase that is equal to more than 10 percent of the general fund," he says of what O'Malley faces in making up a $1.5 billion structural deficit. "I would say that the governor gets a lot of credit for putting something on the table." Overall, what do you think of the O'Malley tax proposal?
When you have to raise taxes like this, it is a time when you can look at the whole state tax structure and try to make changes. But every time you change the structure of the tax code, you make a lot of political enemies. It is very difficult to reduce taxes in some areas and raise them in others.
The governor has not really made much of a change to the state tax structure. In that area, he has two main proposals on the table, one a very modest broadening of the sales tax base and then a major proposal on slot machines, an issue people have very strong opinions about. Do you think he should have gone further?
I think the most important structural issue is broadening the sales tax base, which is still designed for a manufacturing economy when we have moved to a service economy. Few services pay sales tax, but that is the engine that drives the economy today.
In principle, you want as broad a tax base as possible . That keeps the marginal rates down and reduces distortions in the economy caused by high or unequal tax rates. If you have a broad base, you can have low tax rates across a wide range of activities. That is one of the key principles of public finance. I think further broadening of the sales tax is one of the major issues that the state needs to think about. But didn't the governor propose doing just that?
As I say, only modestly, including tanning and massage service, physical fitness facilities and real estate property management. I would recommend going further. This is a difficult challenge because you want to focus on taxing consumer services and avoid taxing business services, which would run the risk of driving some businesses elsewhere.
I would try to include more consumer services in the sales tax, like automobile repairs, household repairs, appliance repairs, tax services, landscape service, personal care, things like hair and nail salons, amusement activities. But anything you propose to tax creates a lot of opposition.
One thing that broadening the base to include more services would do is lessen the regressive aspects of the sales tax, the fact that it now hits lower income people more than richer ones. It is higher-income taxpayers who are buying landscape services and things like that. What do you think of the proposal to raise the sales tax by 1 percentage point?
It is appropriate, not out of line with our neighbors. But I would prefer to see more revenue raised by broadening the tax base. Then perhaps we would not have to go down the slots road, which is a difficult one. You do not like the slots proposal?
Well, it is not very carefully spelled out. It is a little difficult to know just how many facilities are involved and so forth. But there are a lot of serious economic arguments that are not in slots' favor. Instant games and slots are the form of gambling that most disproportionately played by the lowest income households. It is a very regressive way to raise tax money.
It is also uncertain just how much money would be raised by taxing slots and video lottery games. The growth in lottery revenue nationwide has definitely slowed down. . And economic studies clearly show that people spend money on gambling at the expense of other items in their budget. States that started lotteries saw a reduction in the growth of their retail sales taxes.
So, I think slots are a very regressive way to raise money and as a long-term revenue source may not provide much growth. O'Malley has also proposed some changes to the income tax system. Do these make it, as advertised, more progressive?
It is a very interesting proposal and a step toward progressivity. He basically calls for reducing taxes on those making under $22,500 a year, which is progressive, but does not really give that much money back. He calls for keeping the tax rate constant for the 75 percent of taxpayers who make between $22,500 and $200,000, and then raising the marginal rates on those making over $200,000, which is only 4 percent of state taxpayers. So the net increase in income tax revenue, which is pretty modest in this proposal, about $200 million, comes out of people making more than $200,000 a year.
The problem with that is that when you add the local taxes on top of the state's top marginal rate, you can get a marginal tax rate of 9.7 percent on those rich taxpayers. Very few states are at this level. That may cost the state some people who may choose to live in another jurisdiction. You could alternatively make the income tax more progressive by spreading rate increases throughout the income distribution. That is a judgment the people of the state are going to have to make.
There is also a geographic impact. About 50 percent of the people in the over-$200,000 bracket live in two jurisdictions, Montgomery and Howard counties. Since the sales tax is a regressive tax, the higher-income counties pay significantly less proportionately in sales tax . So when you raise the sales tax, you raise the burden on the poorer counties. This income tax proposal raises the burden on the richer counties. So this is a balancing act. What about the rise in the corporate income tax rate?
That is a superb proposal. It's a growing source of tax revenue. Corporate income has been growing rapidly as a share of national income over the last five to eight years and this is very likely to continue. The state corporate income tax rate, 7 percent, is below most neighbors. So, some businesses may not like it, but I do not think there is a grave risk of a huge exodus of corporations. Is there anything else you wish the governor had dealt with?
I think in terms of structural reform, the state should think very carefully about its inheritance and estate taxes. Maryland is one of the few states that retains an inheritance tax. And in 2001, it became one of the few states that decoupled the state estate tax rules from the federal rules when the federal estate tax was reduced. So the result is that Maryland has dramatically higher estate taxes than most states.
Is this good public policy? We do know that estate taxes are paid by the highest-income taxpayers, which is one reason some would say we should not be concerned about higher estate taxes. On the other hand, those high-income taxpayers are the ones who have the choice to move to other jurisdictions. This is particularly pertinent as, over the next ten to 20 years, many people are going to be retiring. You want to make the state attractive to high-income retirees. I would rather have used this opportunity to cut the estate tax instead of taking 3 cents off the property tax.
I also think an opportunity was missed when this proposal was silent on the gas tax. I view it as a principal user charge to finance transportation, a very effective tax that has not been raised since 1992. We have a crying need for infrastructure throughout the state. I think the vast majority of citizens would support an increase in the gas tax. It is far superior to raising the tax on titling cars. For one, the titling tax does not tax people coming through our state, using our highways. Increasing the gas tax is critical. Do you think we need a special session for this, or should it just be taken up in the regular session next year?
The special session is really important for a couple of reasons. If the state waits until 2008 to make any changes, it could cost us something like $500 million. You can make the income tax retroactive, but you can't do that with the sales tax.
And if the tax issue has not been dealt with, it would totally dominate the next General Assembly session. It would be difficult to deal with any other concerns because everybody would be spending all their energy on taxes.
michael.hill@baltsun.com