New Md. taxes may drive some to smoke in Pa.

PERSONAL FINANCE

September 23, 2007|By EILEEN AMBROSE

Gov. Martin O'Malley's concern is trying to eliminate a $1.7 billion budget shortfall, but his tax proposal unveiled last week might have unintended consequences on the behavior of the rest of us.

People are funny about taxes. We take all sorts of measures to sidestep them. Sometimes those measures cost us more than the taxes we'd otherwise pay. Take the investor who won't sell a stock destined to crater because he doesn't want to pay capital gains tax.

If taxes go up in Maryland - and that's a safe bet - you can be sure there will be people trying to lessen the bite. All the details of the governor's proposal aren't out, but tax experts are speculating on what moves consumers are likely to make in response.

Let's start with the sales tax. The governor wants to raise it from 5 percent to 6 percent. This hits all of us, although it's more painful for lower-income families who spend more of their paycheck on the basic necessities subject to sales tax.

Maryland collected about $3.4 billion in sales taxes in the past year, or $1,660 per household.

A 20 percent increase in the sales tax means an extra $332 for each household. That's a rough estimate, of course. How much more you pay in sales tax will depend on how much you spend.

One thing worth noting: The governor softened the sales tax blow to low-income workers with children by proposing an expansion of the refundable earned-income tax credit. This is basically a tax refund for the working poor who earn too little to pay taxes.

Raising the refund from 20 percent to 25 percent of the federal earned-income tax credit can eliminate the impact of a higher sales tax, according to figures from the Center on Budget and Policy Priorities. For example, a couple with two children and earning $20,000 would pay $113 more in sales tax under the governor's proposal but receive an extra $208 from the expanded credit.

More than 214,000 Marylanders in 2005 claimed the refundable credit for a total of $92.3 million, says Clinton Macsherry, director of public policy at the Maryland Committee for Children. The governor's tax proposal makes it all the more important for lower-income families to claim this credit.

For the rest of us, the sales tax rise could easily wipe out the small income tax cut the governor proposes for many taxpayers.

A married couple with two children and taxable income of $50,000 would save $175 on income taxes under the governor's plan. But "a 6 percent sales tax can eat up that $175 in a hurry," says John Bacci, a financial planner with Foundation Financial Advisors in Linthicum.

Indeed, many expect tax-adverse Marylanders to jump in their cars to shop out-of-state. Pennsylvania, for instance, doesn't charge a sales tax on clothes. Delaware has no sales tax.

"Although it sounds very nominal, some Marylanders are very frugal with their money. They can take a day trip across the border," says Keith E. Huebel, certified public accountant with his own firm in Bel Air.

Of course, what they save on tax might be eaten up several times over by gas. But Huebel says that doesn't always matter to people when taxes are involved. "People don't pull it all together."

While they're on the road, out of state, they might pick up a carton of cigarettes. The governor wants to double the tax on cigarettes to $2 a pack. This, too, is considered a regressive tax because lower-income households spend a greater portion of their income on tobacco than the wealthy.

Of course, the silver lining might be the tax increase finally gives smokers the incentive to quit.

Not a chance, says Curtis Dubay, an economist with the Tax Foundation in Washington. "Smoking is an addiction. Higher prices won't stop them," he says.

More likely, smokers will either suck up the cost or take to their cars.

The tax on cigarettes in Virginia is 30 cents, or $1.70 less than what it would be in Maryland under O'Malley's proposal, Dubay says. A carton of cigarettes with 10 packs will cost $17 more in Maryland. "It's certainly worth a trip across the border," he says.

Strong motivation

The increase in the state income tax for high-income households could cause Marylanders to make their most drastic move - to move.

The governor would create two new tax brackets - 6 percent and 6.5 percent - for the highest earners. The 6 percent rate would kick in, say, for a married couple with more than $200,000 in taxable income. The 6.5 percent rate applies to taxable income above $500,000.

Add on local taxes, and the income tax rate for some would be 9.7 percent, says Edward Ben, a partner with the accounting firm of SC&H Group in Sparks. "It's a pretty high tax rate, almost 10 percent of your income."

That would make Maryland's individual income tax rate the third highest in the country. If income taxes are your worry, don't move to California or Rhode Island.

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