Cut the income tax, Mr. Ehrlich, not the sales tax

August 15, 2010|By Jay Hancock

As Marylanders enjoyed a sales-tax "vacation" on clothes and shoes last week, Robert L. Ehrlich Jr. reminded them he wants to cut sales taxes permanently on everything.

The Republican gubernatorial hopeful would reverse Gov. Martin O'Malley's decision to increase the tax from 5 percent to 6 percent, which took effect in 2008. It's the centerpiece so far of an Ehrlich economic plan that also includes talking about small businesses and giving taxpayer money to movie and TV producers.

But the sales tax is the wrong one to roll back.

Of all the O'Malley tax increases from the 2007 special legislative session, Ehrlich has chosen to undo the least harmful. Maryland's long-term economic health would be measurably improved if instead he annulled O'Malley's increase of the personal-income tax, which pushes capital and jobs to Virginia as surely as the Potomac flows into the Chesapeake.

Politically, the sales tax is a natural target. It takes higher portions of resources from the poor and middle class than from high-income folks. Everyone pays it. Each shopping trip reminds voters of the government grab.

But Northrop Grumman didn't decide to put its headquarters in Virginia instead of Maryland because Virginia's sales tax is a penny less. Venture capital isn't shifting from Maryland to Virginia because the general partners get a few cents' discount on toilet paper and laundry soap. Millionaires aren't leaving Maryland so they can save a few hundred dollars in the sales tax on Cadillac Escalades.

Ehrlich says he supports small businesses and the entrepreneurs who are creating the Maryland economy of tomorrow.

But entrepreneurs don't care about sales taxes. Entrepreneurs care about personal-income taxes. Startups and other small businesses are generally organized as S corporations or limited liability companies, whose income is taxed at personal-income rates in Maryland and elsewhere. (Full disclosure: My wife owns and operates a small LLC.)

Maryland's top state personal-income rate is 6.25 percent. Local rates of as much as 3.2 percent push the total pain close to 10 percent, among the highest levels in the nation. In Virginia, meanwhile, there is no local income tax, and the top state rate is 5.75 percent.

So Maryland taxes the economic future nearly twice as hard as Virginia. Small businesses also pay much lower income tax in Delaware, Pennsylvania, West Virginia and North Carolina, all economic competitors. Large corporations such as Northrop Grumman are drawn to these places because their top executives can save hundreds of thousands of dollars on personal-income tax.

The disappearance at the end of 2010 of Maryland's "millionaire tax," which will bring the top state bracket from 6.25 percent down to 5.5 percent, will do little to change this. (The top state rate was 4.75 percent when Ehrlich and his Democratic predecessor, Parris N. Glendening, were governors.)

"I'm not going to say that the personal tax burden is irrelevant," Ehrlich said in an interview. He's focusing on the increased sales tax, he said, because he hears frequent complaints about it from businesses, especially those near Delaware, where the sales tax is zero.

"Besides being the most regressive tax, the sales tax is a prominent element with regard to our business reputation," he said. In the "border counties," he added, "the small retail merchants are obviously getting hit, and they know it and feel it."

By aiming first at the sales rather than the income tax, Ehrlich is rejecting decades of supply-side orthodoxy from his Republican colleagues. Many claims by supply-side economists and politicians are nonsense, including the assertion that income-tax cuts from present levels will pay for themselves through greater economic growth.

But the idea that high income taxes discourage savings and enterprise, especially in a small state where capitalists have nearby, lower-tax alternatives, is not controversial.

"Over the long term, I would say that cutting the income tax would be preferable for Maryland's economic growth," says Tax Foundation economist Gerald Prante, although he says sales-tax cuts can boost demand in the shorter term.

"If you want to create more income and wealth and jobs, you want to roll back the income tax," says Johns Hopkins University economist Steve Hanke, who's known for promoting free markets and was on Democratic Gov. Marvin Mandel's board of economic advisers in the 1970s.

But Hanke, who said he has been approached by the Ehrlich campaign but hasn't given any substantial advice, said Ehrlich should cut spending and overhaul Maryland's entire fiscal structure, not just one or two taxes.

"You have to look at the whole picture, starting with government spending," Hanke said.

Ehrlich responded by saying he doesn't subscribe to the "meat ax approach" to government.

"I don't disagree with the observation that the cost of government plays a role here," he said. "On the other hand, a bunch of parole and probation people just left my office, and I can guarantee you that their offices are undermanned, which is a public safety issue."

Maybe. But if high income taxes are repelling entrepreneurs who might be hiring parolees and paying Maryland taxes, that's a problem, too.

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