Maryland needs an evaluation of tax structure and spending processes

By Donald C. Fry

Business leaders were recently asked by the Greater Baltimore Committee at its Chesapeake Conference of CEOs to identify key strategic priorities to make Maryland more competitive for economic growth and job creation.

Their consensus top priority? By a sizable majority, the answer was Maryland needs to restructure its taxes to fit today’s economic trends and to improve spending efficiency. Specifically, create an independent, private-sector commission to study Maryland’s tax structure and spending. Then, identify ways to adjust the tax structure and spending processes to benefit the state’s competitiveness, business leaders recommended.

The GBC is in the process of putting together such a commission of experts to take a look at these issues based of the report of these and other recommendations for economic competitiveness the GBC published in August.

It’s understandable if the idea of a tax study spawns skepticism. In Annapolis, many lawmakers get defensive whenever the issues of taxes and business climate come up in a policy discussion. These are uncomfortable topics under the State House dome.

Beyond Annapolis, the notion of restructuring Maryland’s taxes probably prompts nervousness among others who, no doubt, view such exercises as a ploy to raise taxes.

But the GBC’s proposal is intended to neither increase nor decrease overall tax revenue. The key concept that will drive the work of the GBC’s private-sector tax study consists of two words: “revenue-neutral.”

In other words, match today’s tax system to today’s economy and today’s business growth trends.

For example, the two largest sources of Maryland tax revenue – the state income tax and the sales tax – were created in 1937 and 1947, respectively. But except for an income tax rate reduction in 1997 that was later repealed, the only adjustments to those taxes have generally been to increase tax rates or make adjustments to income categories to raise additional revenue.

The most beneficial outcome for changing Maryland’s tax structure would be to achieve a framework where economic growth translates more efficiently to state revenue growth without the need to continually increase tax rates in a manner that directly inhibits economic growth.

For instance, a key potential outcome within such a framework could be to reduce the state’s personal income tax rates as applied to small business entities including sole proprietorships, Sub-chapter S corporations, LLCs and other business entities whose earnings are “passed through” on the income tax returns of individuals owning the businesses.

Business executives and economic development experts in Maryland say current state tax rates on “pass through” earnings have increased to the point that they are significant impediment to business development.

Of course, adjusting the tax structure to achieve such goals is not an easy task. And it can get controversial, depending on what adjustments are proposed.

But here’s why such an effort is worth it.

Maryland’s tax structure is widely cited by business leaders and nationally published surveys as having a significant negative impact on the state’s climate for business location and growth.

Published rankings that consistently report Maryland is a high-tax state – particularly in the area of personal income taxes – detract from the high rankings our state achieves when it comes to many other business-climate categories.

Published rankings almost universally show Maryland’s significant competitive strengths to include technology and innovation, education and quality of workforce. But most rankings – even those touted by elected leaders as favorable to Maryland – also consistently report that, from a competitive standpoint, Maryland’s tax structure ranks near the bottom.

A study of our state’s tax structure must be accompanied by a thorough evaluation of the state’s spending decisions, business leaders said.

For example, budgeted operating expenditures from state funds have increased 58.6 percent over the last 10 years, during which the personal income of Marylanders increased just 40.9 percent, according to data from the Department of Legislative Services.

What are the dynamics driving this disparity and how does it relate to tax policy and funding government operations?

Among significant budget challenges facing Maryland policymakers is the reality that the top three state operating budget categories – health and mental hygiene, K-12 education and higher education – consume 62.4 percent of the FY 2013 budget, according to state budget data.

Percentage budget shares of other categories in the state’s FY 2013 operating budget range from 10.5 percent for transportation to less than 1 percent each for the departments of Labor, Licensing and Regulation; Juvenile Services; and Business and Economic Development.

Also, what are the state’s spending checks and balances?

The Maryland General Assembly has a Spending Affordability Committee charged with ensuring that the state’s rate of spending growth does not exceed the rate of growth of the state’s economy.

The committee’s mission, however, is mostly limited to mathematically determining how much in annual spending and debt increases the state can tolerate – not how it should spend its revenue, which is left entirely up to the governor and state lawmakers.

One optimal outcome for an examination of state spending could be to evolve Maryland’s budgeting process away from a mathematical exercise to more of a strategic one.

Given the hyper-competitive nature of the 21st-century economy, it’s time for a fresh evaluation of our state’s tax structure and spending processes.

Working toward palatable alternatives is far preferable to Maryland’s status quo.

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