Taxes: Maryland does it backward

February 25, 1997|By Mahlon R. Strasheim

THE PROPOSED 10 percent reduction in Maryland's personal-income tax is the single most important economic policy the state could enact to turn around its economy and offer a more competitive business environment.

There can be little doubt that the state's economy needs the help. In the early 1990s it seemed possible that the economy would emerge from recession in 1991 and resume its growth performance of the 1980s. This has not happened.

Employment growth has been below the national average for seven years -- only three states showed slower growth than Maryland in the year ending with the third quarter of 1996. A sudden resurgence is nowhere on the horizon. The Washington suburbs confront stiff competition from Northern Virginia, which is attracting a huge share of the growth in business and professional service jobs. Growth prospects are little better in the Baltimore region.

The state has advantages to envy, including the third-highest fraction of workers with college degrees, excellent public services, desirable amenities and a highway infrastructure that is less congested and better maintained than those of our neighboring states. We have the benefit of access to the premier federal scientific agencies that have fostered a competitive advantage for high-tech, professional firms.

The state's principal liability is a high personal-income tax, with an 8 percent marginal rate in many jurisdictions, and the fourth-highest overall income-tax burden among all the states. A state-by-state comparison of income-tax payments and employment growth rates provides compelling evidence that high-tax states pay an enormous growth penalty.

The seven states, including Maryland, with tax burdens of 3.5 percent or more, recorded an average employment growth of just .76 percent from 1991 to 1995. The national average is a percentage point higher. The eight states with tax rates under .5 percent recorded average employment growth of 2.64 percent.

In the 1980s, a boom in construction and retailing occurred virtually everywhere, regardless of tax levels. But the 1990s presents a different world of increasing competition, downsizing larger firms and the growing importance of smaller, mobile firms whose owners can respond to personal-tax rates.

Critics mistakenly point to Maryland's overall tax burden, which is close to the national average because of our narrow sales-tax base (excluding household services) and low sales-tax rate. But different types of taxes are viewed differently; an income tax burdens earnings and opportunity; a sales tax is viewed as part of the price of something we wish to buy.

The high-growth states actually have high sales taxes, but low income taxes. Maryland does just the reverse, imposing a crippling income-tax burden and an outdated sales-tax system for today's service-based economy.

Every industry and region

An income-tax reduction would reduce labor costs, help small businesses invest, and encourage existing firms to stay and new firms to come into the state. A broad-based tax reduction would help every major industry and region. A tax reduction would complement more aggressive state growth policies developed over the last three years, including regulatory reform, joint state and local government development projects, and incentives for selected areas and targeted firms.

I estimate that an income-tax reduction would increase employment in the state by 5,000 jobs each year once it was fully phased in. Over five years the increase of 25,000 jobs would represent an entire year's job growth at the state's present pace. These projected gains are not a ''supply-side miracle'' as promised in the 1980s, but rather the benefit of making Maryland more competitive with its neighbors.

With Maryland's nearly ''flat'' tax, a rate cut will provide benefits proportionately to a large number of taxpayers. Maryland's personal exemption of $1,200 is not much below the national average of $1,564 and should not be altered. The evidence is clear that there is no relationship between the size of personal exemptions and economic growth. States with the highest exemptions in 1994 grew at the same rate as the average of all states.

The tax cut is affordable, after three years of prudent government budgeting since 1994 that have reduced entitlements growth, while preserving essential public services. The state's commitment to aid local governments can be maintained by decoupling a state tax reduction from the local piggyback tax. Ultimately, the strength of our public sector rests on a vibrant and growing private-sector economy, which is increasingly at risk with our inaction.

Mahlon R. Strasheim is chair of the Department of Economics at the University of Maryland.

Pub Date: 2/25/97

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