Governor Hogan Aims to Reduce State Taxes in Response to Federal Tax Reform
Governor Larry Hogan delivered his fourth State of the State address at the end of January. The largely positive address condemned hyper-partisanship, highlighted the economic improvements that coincided with state tax cuts and called on the legislature to provide tax relief to ensure a greater number of residents realize a net benefit following federal tax reform. Gov. Hogan presented the capping of the state and local tax (“SALT”) deduction as an opportunity to cut taxes, rather than misinterpreted as an act of “war” claimed by some left-leaning Northeastern governors.
The week before the address, the Office of the Comptroller issued a report on the potential impact of the federal Tax Cuts and Jobs Act on Maryland taxpayers based on the following three hypothetical conditions: taxpayers seeking to minimize their federal tax burden, taxpayers seeking to minimize their state and local tax burden and 80 percent of taxpayers seeking to minimize the combined federal-state-local tax with the remainder focusing on federal taxes. Under the latter condition, 28 percent of taxpayers could face a net tax increase. The increase is attributable to the new $10,000 dollar cap on the state and local tax deduction and the way Maryland couples the state and federal income tax. Under Maryland’s tax code, residents who take the standard deduction at the federal level, rather than itemizing deductions, must take the standard deduction at the state level as well.
The legislature can accomplish Gov. Hogan’s desire to “protect hardworking Marylanders from the impact that the federal tax overhaul will have on Maryland’s state and local taxes” through several ways. The first is to decouple the state and federal income tax and instead use a complex system of tax credits to replicate the pre-reform effects of the state and local tax deduction. This strategy would involve implementing or increasing tax credits and deductions and increasing the capacity of the state’s revenue department. Residents would potentially be forced to calculate their taxes in four or more ways.
The second method is to double the state’s standard deduction. This would dramatically simplify taxes in Maryland. Although some of the top 10 percent of Maryland income earners would still experience a net increase in total income taxes, the impact would be muted. This would shrink the tax base. Although more income earners would escape any state income tax liability, this revenue would come from other taxpayers, greatly increasing the state’s dependence on high-income earners. This scenario would exacerbate revenue volatility and fuel more frequent budget battles.
The third and most preferable method would be to reduce the top marginal personal income tax rate. Maryland ranked 34th in the Rich States, Poor States ALEC-Laffer State Economic Competitiveness Index, a ranking system which uses 15 variables associated with economic growth such as top marginal income tax rates, public employment as a percentage of total population and tax expenditure limits. The state’s low rank is due in large part to its high top marginal personal income tax rate, ranked eighth highest in the nation. High income earners are the ones most impacted by the progressive state income tax and also by the capping of the federal SALT deduction. Reducing the top personal income tax rate would mitigate the impact of both while simultaneously improving the state’s economic outlook.
Luckily for the residents of Maryland, Gov. Hogan knows that tax cuts work. As he said in his address, “We submitted the first balanced budget in a decade, which eliminated nearly all of the $5.1 billion structural deficit which we inherited. We did it while cutting taxes three years in a row. And we’ve put all that money back into the pockets of hardworking Marylanders, retirees and small businesses and back into our growing economy, which has helped us create an incredible economic resurgence in our state.”