By Idara Nickelson and Ed Lazere

Transcription

1 April 15, 2004 TRENDS IN TAX RATES IN THE DISTRICT OF COLUMBIA By Idara Nickelson and Ed Lazere This report analyzes changes in DC tax rates and collections from the 1970s to the present. It finds that over the past two decades, rates for the District's major tax sources the individual income tax, the real property tax, and the sales tax have been reduced or remained stable, and that a number of deductions, credits, and other forms of tax relief have been adopted. Tax rates for some smaller revenues sources have increased, while others have remained stable or declined. This analysis also finds that total tax collections as a share of the DC economy, which tend to fluctuate as the economy rises and falls, are at a relatively low level historically. Income Tax: The top marginal tax rate was reduced from 11 percent to 9.5 percent in the late 1980s, and all tax rates were reduced further after 2000 under the Tax Parity Act. In recent years, the District also enacted a substantial Earned Income Tax Credit for low- and moderate-income workers. On the other hand, DC's personal exemption and standard deduction have not been adjusted for inflation for more than a decade. Overall, tax liabilities for low-income residents have fallen substantially since the early 1990s, primarily as a result of the EITC. Income tax liabilities have remained relatively stable for middle-income families and have declined somewhat for higher-income families. Property Tax: The tax rate for homeowners fell from $1.83 per $100 of assessed value in 1975 to $1.22 by 1989 and then to $0.96 in The tax on residential rental properties was reduced from $1.83 per $100 of assessed value in 1975 to $1.54 by The tax was then reduced substantially to the $0.96 rate applied to homeowner properties as a result of the Tax Parity Act. The property tax on commercial properties has fluctuated significantly, but the current rate $1.85 per $100 of assessed value is basically the same as the rate of $1.83 in In addition to rate reductions, the District established a homestead deduction, which now shelters the first $38,000 of home value for taxation. There also is a 50 percent tax break for seniors with incomes below $100,000; and a tax credit for low-income residents with significant property tax burdens. Since 2001, a cap has been set on annual property tax increases for homeowners, which means that many homeowners are paying tax on less than the full assessed value of their home. The cap is now set so that increases in taxes cannot exceed 12 percent a year. Sales Tax: The general sales tax rate was set at six percent in 1980 and was reduced to 5.75 percent in 1994; the rate has not been changed since then. Over time, the sales tax base has been expanded gradually to cover a greater share of retail purchase, such as newspapers and dry cleaning. 1

2 In addition to the major tax sources, tax rates for some smaller revenue sources have increased, while tax rates for others have remained stable or declined Tax rates that have increased: The District s gross receipts tax a tax on utilities that is passed through to consumers has jumped sharply. Since 1992, the gross receipts tax rate has increased from 6.7 percent to 11 percent. Deed recordation and transfer taxes were set at one percent in 1976, raised to 1.1 percent in 1989, and then to 1.5 percent in The latter increase includes a trigger to lower the rate when overall revenue growth exceeds certain targets. The tax on restaurant meals has risen from eight percent to 10 percent since 1989, and the hotel tax has grown from 10 percent to 14.5 percent since then. In both cases, a portion of the increase was dedicated to fund the new Convention Center and the latter is paid in significant part by tourists. Tax rates that have remained stable or declined: The corporate income tax rate is modestly lower today than at any point in the 1980s or 1990s, and the parking tax has remained unchanged since The gas tax, which is set at a per-gallon rate, has increased since the 1970s, but at less than the rate of inflation. Changes in tax rates and bases and other factors, such as changes in DC's population and economy, have affected tax collections in the District. Figure 1 shows that tax collections as a share of personal income have fluctuated in DC since the 1970s. In part, the fluctuations reflect economic cycles. Taxes as a percent of personal income rose during the economic recoveries of the 1980s and the late 1990s, and they fell during recession of the early 1990s and the recent downturn that started in Nevertheless, it appears that the overall trend has been a decline in DC taxes as a share of the economy since the late 1980s. Total tax revenues as a share of personal income peaked most recently in 2001 at 14.0 percent. This stemmed from the strong economy of the late 1990s and the tremendous increase in capital gains resulting from the stock market boom. Yet this peak was lower than the peak in previous economic recovery, from 1987 to 1989, when taxes reached 14.7 percent of personal income. Tax collections in 2001 were nearly $200 million lower than if they had reached the late-1980s level as a percent of income. Tax revenues fell from 14.0 percent of DC s total income in 2001 to 13.3 percent in 2004 as a result of the recent economic downturn and the decline in the stock market. Taxes as a share of income in 2004 are nearly as low as in the period when the District s faced a severe financial crisis and lower than in any other year since the early 1980s. 2

3 Total Tax Revenues as a Percentage of Personal Income, * 16.0% 14.0% 12.0% 12.2% 14.6% 14.7% 14.4% 14.2% 14.2% 14.0% 13.8% 13.7% 13.8% 13.6% 14.0% 13.6% 13.1% 13.2% 12.9% 13.1% 13.1% 13.3%13.3% 10.0% 9.9% 10.8% 9.8% 8.0% 6.0% 4.0% 2.0% 0.0% * Breaks in the sequence of the years reflects years where data could not be collected. Tax Rates for DC s Major Taxes Have Fallen or Remained Stable in Recent Decades The District s main revenue sources are the personal income tax, the real property tax, and the sales tax. Together, they provided 74 percent of DC s total local revenues in Over the past two decades, the rates for all of these sources have remained stable or fallen. Individual Income Tax The individual income tax is the largest source of tax revenue for the District, providing 31 percent of local source revenues in fiscal year In the mid-1970s, the DC income tax had numerous brackets, with marginal tax rates ranging from two percent to 11 percent. This tax has been modified significantly at two points since then in the late 1980s and the late 1990s. Starting in 1987, the following changes were adopted. In 1987 and 1988, the numerous tax brackets were reduced to three. The top marginal tax rate for taxable income over $20,000 was reduced from 11 percent to 9.5 percent, and the other two brackets were set at six percent and eight percent. (The lower tax brackets that were eliminated had applied to just the first $4,000 of income.) 3

4 The personal exemption was increased from $885 to $1,370 between 1987 and 1991, and the standard deduction was raised from $1,000 to $2,000 in A tax credit for low-income residents was established in The credit entirely eliminated DC income tax liability for DC residents with income below the federal income tax threshold. These changes were made following the federal Tax Reform Act of 1986, which had an indirect effect of increasing tax collections in the District and many other states that tied their income tax in part to the federal income tax. The federal legislation eliminated many deductions from income in the federal income tax. Because DC and many states generally defined income by using the federal definition, the federal changes resulted in an increase in net taxable income. The District s reduction in tax rates and expansions of deductions and exemptions was a response to this expansion of its income tax base. Given the changes in both rates and definitions of income, it is difficult to assess the combined effect on taxpayers at different income levels. Between the late 1980s and late 1990s, the main features of DC s income tax the tax rates and brackets, personal exemption, and standard deduction remained unchanged. During that period, the value of the standard deduction and personal exemption decreased over time after adjustment for inflation. Moreover, the fact that tax brackets remained unchanged meant that some families could have moved into higher tax brackets even if their incomes rose only at the same rate as inflation. The Tax Parity Act of 1999 lowered all of DC s income tax rates and adjusted some of the tax brackets. It called for reductions in income tax rates through 2004, but implementation was suspended in 2002 as a result of the economic and fiscal downturn. The implemented reductions include the following: The lowest tax rate on the first $10,000 of taxable income was lowered from six percent to five percent. The middle tax rate was lowered from eight percent to 7.5 percent. The middle tax bracket, which had applied to income between $10,000 and $20,000, was expanded to include income up to $30,000. The top tax rate was reduced from 9.5 percent to 9.3 percent. It now applies to taxable income above $30,000, up from $20,000. The Tax Parity Act did not alter the personal exemption or standard deduction, which means that their values have continued to decline. If they had been adjusted for inflation every year since they were last raised in the late 1980s, the personal exemption would equal $1,880 in 2004 and the standard deduction would equal $3,290. 4

5 DC Individual Income Tax Rates Current Tax Brackets Tax Rates Tax Brackets Tax Rates $0 to $10, % $0 to $10, % $10,001 to $20, % $10,001 to $30, % Over $20, % Over $30, % In addition to these changes, the District adopted a refundable earned income tax credit (EITC) modeled on the federal EITC in The credit provides tax relief to low-income workers, especially those with children. In 2001, the credit was increased from 10 percent of the federal EITC to 25 percent. Roughly 44,000 individuals and families claimed the DC EITC in 2003, collectively receiving about $21 million. As a result of the changes, income tax liabilities have fallen or remained stable for DC residents at all income levels. The tax burden for lower-income families fell significantly between 1991 and 2004, largely as a result of the DC Earned Income Tax Credit. A family of four with income of $15,000, for example, paid $287 in income tax in 1991 but received an EITC-based refund of $660 in (In these calculations, both income and tax liability figures were adjusted for inflation to be in 2004 dollars.) For a family with income of $50,000, the tax burden in 2004 $2,239 is virtually the same as the 1991 tax liability of $2,213. For families at this income level, the reduction in tax rates was offset by the failure to adjust parts of the income tax for inflation, including the personal exemption and the lowest tax bracket. The income tax liability for a family with income of $100,000 in 2004 is $6,094, or three percent lower than the tax liability of $6,282 in DC Income Tax Liability for a Family of Four At Different Income Levels, 1991 and $15,000 $25,000 $50,000 $100, * $287 $956 $2,213 $6, $660 refund $367 $2,239 $6,094 * Income and tax figures are adjusted for inflation to equal 2004 dollars. Real Property Tax The real property tax is the second largest source of tax receipts for the District government, accounting for 27 percent of total local source revenues in fiscal year With the recent boom in the city s real estate market, property tax revenues have increased significantly. Nevertheless, 1 These calculations assume the family of four consists of two married workers and two children. These calculations also assume that families at $15,000 and $25,000 claim the $2,000 standard deduction. Families with income of $50,000 are assumed to have $8,000 in itemized deductions, and families with income of $100,000 are assumed to have $12,000 in itemized deductions. 5

6 property tax rates have been lowered or remained stable for all classes of property, and property tax collections remain lower than in previous real estate booms. In 1975, the property tax rate for all types of properties was $1.83 per $100 of assessed value. Since then, rates have declined for residential properties, and the tax rate on commercial properties has both risen and fallen and is now roughly at the 1975 level. The property tax rate for DC homeowners was reduced to $1.22 per $100 of assessed value by the mid-1980s. 2 Between 1989 and 1991, the rate was lowered to $0.96, and it has remained unchanged since then. The tax rate for residential rental property renters was lowered from $1.62 per $100 of assessed value by 1995 and to $1.54 by The Tax Parity Act of 1999 subsequently reduced the property tax rate on residential property substantially to $0.96 per $100 of assessed value in 2002 bringing it in line with the rate for homeowners. The tax on commercial properties was raised to $2.13 per $100 of assessed value in By 1995, the commercial rate had been increased to $2.31, and a separate class for hotels was set at $1.81 per $100 of assessed value. The hotel rate was raised to $1.85 by As a result of the Tax Parity Act, the tax on commercial properties was reduced to $1.85 by 2002, so that hotels and other commercial properties are now taxed at the same rate. For non-hotel properties, this is somewhat lower than the tax rate in effect throughout the 1980s and 1990s and roughly the same as the property tax rate for all properties in In 1990, a separate tax rate of $3.29 per $100 of assessed value was applied to vacant land. The rate was increased to $5.00 in This separate property class was eliminated in 2003, with rates for vacant property set at the residential or commercial rate depending on the type of property. However, this class was re-established in 2003 with a tax rate of $5.00 per $100 of assessed value. DC Real Property Tax Classification and Rates, 2004 Class 1 Residential property $0.96 per $100 of assessed value Class 2 Commercial property $1.85 per $100 of assessed value Class 3 Unimproved or abandoned property $5.00 per $100 of assessed value The District also has established a variety of property tax relief provisions for homeowners. The homestead deduction for DC homeowners was set at $6,000 in The deduction rose to $30,000 in 1990 and remained at that level through 2003, which means that its value had fallen over time relative to inflation. In 2004, the deduction was raised to $38,000. This is modestly lower than if the homestead deduction had 2 District documents on historical tax rates do not appear to provide complete documentation, and it is difficult to trace all changes in property tax rates. In this example, documents show that the owner-occupant tax rate stood at $1.83 per $100 of assessed value in 1975 and $1.22 in 1988, but does not identify the specific changes that led to this reduction. 6

7 been adjusted for inflation each year since 1990 in which case the deduction would be $43,000 this year. In 1987, a provision that gives a 50 percent property tax break to senior citizens was created. In 1992, this relief was limited to senior citizens with incomes below $100,000. In 1976, the District established a tax credit for low-income households with excessive property tax burdens relative to income. This credit, also known as the Schedule H credit, is similar to property tax "circuitbreakers" offered in many states. The maximum Schedule H credit was raised to $750 in 1979 and has not been increased since then. If the credit had been adjusted for inflation since then, it would have a maximum value of $1,900 in In 2002, a provision to limit annual increases in property taxes for low-income homeowners who have lived in their homes for seven years or more was enacted. The cap, which is set at five percent per year, was implemented in In addition to these targeted tax relief provisions, the District has adopted broad-based limits on annual tax increases in recent years, in response to rapidly rising assessments. In 2001, the District switched from a triennial assessment system that had been in effect since 1997 under which homes were appraised once every three years back to an annual assessment system. Because market values have increased significantly in recent years and the previous system tended to undervalue homes, many District homeowners now are facing substantially higher property assessments and tax bills. In light of this, the District placed a 25 percent cap on annual increases in property taxes paid by homeowners, regardless of the size of the assessment increase. In 2004, the DC Council lowered the cap to 12 percent, in addition to increasing the homestead deduction to $38,000. As a result of the cap, most DC homeowners are now paying taxes on less than the full value of their home. It is worth noting that despite rapid increases in assessments and in property tax collections, the District s property tax revenues remain below the level reached in the real estate boom of the 1980s. Real property tax collections in 2004 will be $895 million. In 1992, at the end of the previous real estate boom, property tax collections equaled $1,090 million, when adjusted for inflation to equal 2004 dollars. General Sales and Use Tax The general sales tax is currently 5.75 percent and is imposed on a wide array of retail sales. The sales tax applies primarily to purchases of goods but also applies to a number of services, such as dry cleaning and laundry services. Groceries and both prescription and non-prescription drugs are among the items exempt from the sales tax. The sales tax provides about 21 percent of local revenues in Between 1973 and 1979, the rate was five percent. It was then increased to six percent in

8 In 1994, the sales tax was reduced to 5.75 percent, after a temporary increase to seven percent that same year. Therefore, the current sales tax rate is now lower than at any time since 1980 and somewhat higher than the rate of the 1970s. Since the 1970s, the sales tax base was expanded to include previously exempt services, including all publications and newspapers, data processing and information services, as well as laundering, courier, employment, and certain telecommunications services. Tax Rates for Some Smaller Revenue Sources Have Remained Stable, While Some Have Increased In addition to the major tax sources, the District levies a number of smaller taxes. As described below, the rates for some have increased, while rates for other taxes have been relatively stable. Taxes that Have Increased Deed Recordation and Transfer Taxes: These taxes equaled 1.0 percent of property value between 1976 and 1989, when the rate for both taxes was raised to 1.1 percent. In 2003, the rate was raised to 1.5 percent as a result of the budget shortfall in 2003, although the higher rate did not apply to residential properties under $250,000. The most recent increase included a trigger mechanism to reduce the rate back to 1.1 percent if the District s overall revenue collections meet certain growth targets. Gross Receipts Tax: This tax is levied on the gross receipts of gas, electric, and local telephone companies serving city residents. The tax is subsequently passed on to consumer on their utility bills. Between 1973 and 1983, the public utility tax rate was increased to 6.7 percent. The rate was increased to 9.7 percent in 1992, to 10 percent in 1994, then to 11 percent in Other changes in the public utility tax include an expansion in 1992 to include cable television, video, radio, and other services. Alcohol Tax: The tax on liquor sold for off-premise consumption was increased from five to six in 1973, and then remained unchanged for nearly 20 years when it was raised to eight percent in The rate was subsequently increased to 9 percent in 2003 to address the city s budget shortfall. Restaurant Meals Tax: The tax on restaurant meals and on-premise alcohol consumption was increased from five percent to eight percent in It was increased to nine percent in 1989 and to 10 percent in The last increase was tied to funding the city s new Convention Center. Hotel Tax: From 1973 to 1989, the hotel sales tax was increased from 5 percent to 10. The rate was increased in 1995 to 11 percent, with a portion used to finance the Convention Center. In 1999, the rate was raised to 14.5 percent reflecting the need for increased funding for the Convention Center. 8

9 Car Rental Tax: The use tax on the renting or leasing of vehicles was set at 8 percent in 1980 and has since been raised to 10 percent. (It is not clear when the increase was enacted.) Cigarette Tax: This tax was increased numerous times from 1976 to 1993, from three cents per pack to 65 cents. In 2003, the tax was increased to $1 per pack. Taxes That Have Remained Stable Corporation Franchise Tax: The corporation franchise tax is collected from businesses that conduct business and trade in the District or receive income from District sources. Between 1974 and 1979, the tax rate was increased from 8 percent to 9.9 percent. In 1985, the rate was raised to 10.5 percent and remained at that level for most of the next decade. In 1994, the rate was lowered to percent and has been unchanged since then. 3 Parking Tax: The tax on parking motor vehicles in commercial lots has been 12 percent since Motor Fuel Excise Tax: The tax on gasoline and other motor fuels increased from 10 cents per gallon in 1976 to 20 cents in 1993 (through a series of small increases). It has remained at this rate since then. The value of this tax has declined substantially relative to inflation. If the 10 cent per-gallon tax had been adjusted for inflation since 1976, it would equal 33 cents per gallon in If the tax had been adjusted for inflation since it was raised to 20 cents per gallon in 1993, it would equal 26 cents per gallon in Since 1996, the corporation franchise tax has consisted of a basic rate and surtax. Both the tax rate and the surtax rate have varied since then. The current combined corporate franchise tax rate reflects a 9.5 percent base rate and a five percent surtax. 9

10 APPENDIX Table A-1 Fiscal Year 2004 Major Local Revenues (In thousands) Revenue Source Individual Income $979,510 Real Property $895,270 Gross General Sales $723,239 Deed Recordation and Transfer $215,672 Public Utility $167,544 Corporation Franchise $147,284 Motor Vehicle $38,914 Cigarette $21,884 Alcohol $4,495 All Other Taxes $309,512 Total $3,193,812 Table A-2 DC Total Tax Revenues and Personal Income, (In millions) Fiscal Year Total Tax Revenue Personal Income Total Tax Revenue as Percentage of Personal Income 1973 $471 $4, % 1974 $500 $5, % 1977 $700 $6, % 1981 $1,027 $8, % 1986 $1,661 $11, % 1987 $1,848 $12, % 1988 $1,994 $13, % 1989 $2,198 $14, % 1990 $2,249 $15, % 1991 $2,342 $16, % 1992 $2,355 $17, % 1993 $2,523 $18, % 1994 $2,434 $18, % 1995 $2,356 $18, % 1996 $2,403 $18, % 1997 $2,490 $19, % 1998 $2,732 $19, % 1999 $2,799 $20, % 2000 $3,084 $22, % 2001 $3,265 $23, % 2002 $3,201 $24, % 2003 $3,352 $25, % 2004 $3,503 $26, % Source: DC Fiscal Policy Institute, March

11 Table A-3 DC Individual Income Tax Revenue and Personal Income, (In millions, adjusted to equal 2004 dollars) Fiscal Year Income Tax Revenue Personal Income Income Tax Revenue as Percentage of Personal Income 1973 $526 $19, % 1974 $523 $19, % 1977 $620 $20, % 1981 $654 $17, % 1986 $759 $20, % 1987 $844 $20, % 1988 $937 $21, % 1989 $909 $22, % 1990 $913 $22, % 1991 $846 $22, % 1992 $826 $23, % 1993 $762 $23, % 1994 $821 $23, % 1995 $790 $22, % 1996 $821 $21, % 1997 $877 $22, % 1998 $989 $22, % 1999 $1,069 $23, % 2000 $1,170 $24, % 2001 $1,159 $24, % 2002 $986 $25, % 2003 $944 $25, % $26, % Source: DC Fiscal Policy Institute, March

12 Table A-4 DC Real Property Tax Revenue and Personal Income, (In millions, adjusted to equal 2004 dollars) Fiscal Year Real Property Tax Revenue Personal Income Real Property Tax Revenue as Percentage of Personal Income 1973 $569 $19, % 1974 $523 $19, % 1977 $472 $20, % 1981 $481 $17, % 1986 $746 $20, % 1987 $790 $20, % 1988 $860 $21, % 1989 $962 $22, % 1990 $951 $22, % 1991 $1,101 $22, % 1992 $1,094 $23, % 1993 $1,201 $23, % 1994 $922 $23, % 1995 $802 $22, % 1996 $744 $21, % 1997 $720 $22, % 1998 $708 $22, % 1999 $671 $23, % 2000 $664 $24, % 2001 $668 $24, % 2002 $755 $25, % 2003 $836 $25, % 2004 $895 $26, % Source: DC Fiscal Policy Institute, March

13 Table A-5 DC General Sales Tax Revenue and Personal Income, (in millions, adjusted to equal 2004 dollars) Fiscal Year General Sales Tax Revenue Personal Income General Sales Tax Revenue as Percentage of Personal Income 1973 $409 $19, % 1974 $406 $19, % 1977 $435 $20, % 1981 $500 $17, % 1986 $616 $20, % 1987 $629 $20, % 1988 $618 $21, % 1989 $647 $22, % 1990 $668 $22, % 1991 $621 $22, % 1992 $589 $23, % 1993 $531 $23, % 1994 $579 $23, % 1995 $596 $22, % 1996 $558 $21, % 1997 $562 $22, % 1998 $602 $22, % 1999 $608 $23, % 2000 $696 $24, % 2001 $711 $24, % 2002 $691 $25, % 2003 $701 $25, % 2004 $723 $26, % Source: DC Fiscal Policy Institute, March