Accolades for FY 2015 Council budget, tax reform package continue to mount

Last summer, when the Council passed the $12.7 billion Fiscal Year 2015 budget, it included what some saw as an unexpected element: the most substantive tax reform in decades.  In reality, this reform was no surprise, having its roots in the recommendations of a Tax Revision Commission headed by former Mayor Anthony Williams.  In assembling the tax package, a careful balance had to be struck—the tax reductions had to be substantial enough to constitute real relief to District residents and businesses, guided by progressive principles to help those most in need, while not triggering worries in the financial markets that the District was abandoning the balanced budgets and fiscal restraint that have become the trademark of our municipal finances over the past decade and a half.

In the months that have followed the passage of the budget, praise for the tax reforms have poured in from a number of important sources. As we prepare to enter the budget process for the next Fiscal Year, we wanted to take this opportunity to look back on some of the positive feedback we have received.

Bond Rating Agencies Boost District’s Credit Rating, and are not Bothered by Tax Cut Package

Some important accolades for the Council’s package of tax reforms were those that were also the most muted.  When the nation’s three major bond rating agencies speak, their words have great import: each change in the District’s credit rating can result in millions of dollars in savings, because the higher the rating, the less it costs to borrow funds. Because of the impact of their words, much like the Federal Reserve, they tend to speak in moderate tones.

In describing the state of the District’s finances, the rating agencies use terms that would have been beyond the realm of possibility, let alone credibility, several years back.  The agencies praised the District’s strong economy, budgetary flexibility, financial performance, liquidity, cash levels, reserves, and management practices.

All of this received extensive coverage back in the fall. Back in September, there was extensive media coverage of decisions by Fitch and Standard & Poor’s to increase the District’s bond ratings.  (Moody’s, the third rating agency, had increased the District’s rating in the previous review cycle, and chose to maintain that higher rank in the present cycle.)

But what had been missed in all earlier media coverage of the bond rating increases were the rating agencies’ direct references to the significant resident-friendly and business-friendly tax reforms included in the budget passed by the Council.  Rating agencies value stability, and therefore reserve their strongest support for prudent and sober budgets that emphasize savings over spending.  Tax cuts are not normally their cup of tea.  Yet, in their fall reports, the agencies spoke directly to the tax cuts, voicing (admittedly in their expected muted tones) their support for, or at least non-opposition to, the Council’s tax reform package.

In the Moody’s report, they outline the changes, cite their benefits and staged phase-in, and then state “We expect the overall impact of the tax cuts on the District’s bottom line to be small and manageable.” The Fitch report cites “notable reductions to personal income and business franchise taxes,” but continues on to say that they “anticipate[s] the revenue effect to be manageable for the District without materially affecting financial performance.” The staging of the tax cuts, and the careful ongoing review of revenue numbers, were deemed by Fitch to “help offset [the] limited risk,” and thus are “not a credit concern.”  Finally, in Standard & Poor’s report, they firmly state that the totality of the planned tax changes “do not affect our view of future performance.”

While this praise may seem faint, given the source, and given the credit agencies’ traditional opposition to tax cuts, their decision to boost our bond rating is high praise indeed.

National Awards for Tax Cuts’ Progressive Impact

The Council’s budget, and the underlying work of Mayor Williams’ Tax Revision Commission, were integral in identifying the various challenges that the District’s existing tax system placed on residents and businesses, as well as recommending a path forward that would make the District a more inclusive, progressive, and competitive place in which to reside or do business.

It was just this underlying spirit that was recently applauded by two prominent national awards:

• The Institute on Taxation and Economic Policy (ITEP), emphasizing “tax justice and fairness for working families,” selected the District as “the number one spot for enacting a progressive tax reform package.” They indicate that low income District residents currently pay the second smallest share of their income in taxes in the nation, and when all anticipated future cuts are implemented, they will pay the lowest share in taxes of the residents of any of the 50 states.  They summarized the revisions as follows:

Unlike other jurisdictions that have used the guise of “reform” to cut taxes for the wealthy, the D.C. City Council cut the personal income tax rate for middle-class residents and expanded a number of provisions to assist working families, including the property tax circuit breaker and standard deduction. The council also expanded the city’s EITC for childless workers, one of the most effective strategies for lifting workers out of poverty and a longtime ITEP recommendation…Many additional changes are tied to revenue triggers, ensuring that the reform measures won’t wreck the city’s finances.

A recent New York Times article on progressive state taxes referenced the ITEP study when it singled out the District for praise, saying ours is “the only system that taxes the poorest 20 percent less than the top 1 percent.”  This kind of distinction, where the District literally leads the nation, is indeed noteworthy.

• The nonpartisan Tax Foundation presented Chairman Phil Mendelson with the 2014 Outstanding Achievement in State Tax Reform for the package and described the tax revisions as “some of the most impressive we’ve seen this year” and “mark[ing] a strong commitment to smarter and more principled tax policy.”

Review of Enacted Tax Reforms

Many of the tax reforms became applicable on January 1, and are having an impact on the lives of our residents. This year, the following tax changes go into effect:

Income Taxes

• The rate on the new individual income tax middle bracket of $40,000 – $60,000 has been reduced to 7.0%, improving the economic picture for middle-class families and singes.
• The local EITC has been expanded to cover single workers, providing additional support for low-income workers.
• The standard deduction has been increased to $5,200 for singles, $8,350 for married residents, a reform that has the most impact on low-income residents.
• Certain tax expenditures have been eliminated, broadening the tax base and increasing the fairness of the tax code.
• The personal exemption now phases out by 2% for each $2,500 above $150,000, with a complete phase out at $275,000, establishing a more progressive tax structure.

Business Taxes

• The Unincorporated and Incorporated Business Franchise Taxes have been reduced to 9.4%, improving the District’s commercial competitiveness.
• The franchise tax apportionment method has been changed to a single weighted sales formula.
• Passive investment vehicles have been exempted from the Unincorporated Business Franchise Tax.

Sales and Use Taxes (went into effect Oct 1, 2014)

• Personal income tax returns will now capture use taxes.
• The general sales tax is being expanded to cover certain services, broadening the tax base and leveling the playing field among business types.
• Taxation of tobacco products has been unified and improved.