Working poor need a tax break Misuse of tax credit turns Maryland into a high-tax state

February 09, 1997|By Robert I. Keller

THE WAY the working poor are taxed in Maryland is, to say the least, bizarre. A typical family of four in Maryland (husband, wife and two children) with $22,500 of income (and both spouses working) will pay no state or local tax in 1996, making Maryland one of very few states to exempt taxpayers at that income level.

But if husband and wife earn an additional $6,000, that couple, now with $28,500 of earned income, will pay about $1,300 in state and local income taxes. Instantly, they achieve new status: they're among the highest taxed families at that income level (if not the highest) in the United States.

In this quick movement from lowest to highest taxing state, Maryland is taking approximately 22 percent of the family's additional $6,000 of income. When federal income tax and employment taxes are added, the three levels of government -- federal, state, and local -- are taking almost 66 percent of the additional income, or approximately $4,000 of the $6,000 increase. There is certainly little incentive at that level for these taxpayers to earn more.

Moreover, although Maryland has chosen to provide its taxpayers with a credit equal to 50 percent of the federal earned income tax credit -- a federal "workfare" program designed to subsidize the income of taxpayers below or near the poverty level -- not a single Maryland taxpayer below the poverty level receives a penny from the state because of this credit.

How does this happen in a state that prides itself in its compassionate tax treatment of low-income persons -- a state that has a unique poverty level deduction and the highest state earned income tax credit in the country?

The answer is complex, but lies generally in Maryland's structural misuse of the federal earned income tax credit, combined with its basically flat rate tax system that imposes unduly high rates on low- and middle-income Maryland taxpayers.

A comparison of the federal and Maryland earned income tax credits reveals Maryland's problems. The federal credit is often described as a workfare program, to distinguish it from welfare. In most instances, it delivers cash assistance to low-income working families with children. The more a family earns (up to $8,890), the greater the cash payment from the federal government.

Thus, the credit provides some income security for low-income workers without the stigma of going through the welfare process. It also gives a work incentive for welfare recipients and offsets the effect of regressive federal taxes such as Social Security taxes. The primary beneficiaries of this federal program are working families with incomes up to about $12,000. But higher-income families also receive some benefits, in decreasing amounts, until the program is completely phased out at an income level of about $28,500.

In Maryland, a taxpayer is entitled to one-half of the federal earned income amount, but that amount can be used only to reduce a Marylander's tax liability. A Maryland resident who otherwise pays no state or local income tax will receive no cash assistance under the Maryland program.

In the Free State, a family of four pays no taxes until its income exceeds $15,500. Therefore, whether a Maryland working family has $100 or $15,500 of earned income, it will pay no tax and receive no cash assistance from the state under its earned income tax credit.

To put it plainly: Maryland's program entirely excludes those taxpayers who are the intended beneficiaries of the federal program. The only families of four who benefit are those with incomes above $15,500 -- people who receive a federal credit only because they are part of a necessary phase-out group.

Here are some of the changes Maryland should make to resolve these problems:

1. Maryland should make its earned income tax credit refundable. That would mean that the state, like the federal government, would actually be paying cash assistance to low-income workers. Maryland would then be doing its share to encourage welfare recipients to move into the workplace, a goal obviously consistent with recent federal welfare changes.

2. Making the credit refundable (that is, actually making cash assistance payments to low-income workers), and keeping it at its present level of 50 percent would, almost surely, be too expensive for Maryland because so many people would then be receiving direct cash payments from the state. Therefore, any change to refundability will have to be accompanied by a substantial reduction in the percentage credit. In 1993, it was estimated that a refundable credit of 15 to 17 percent would be the same revenue-wise for the state as the current 50 percent nonrefundable credit. If Maryland is blessed today with a surplus of revenues, as seems to be assumed by politicians, it might even consider raising the refundable credit to 20 percent or thereabouts.

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