The Regular Person’s Guide to Maryland’s Tax System

Overview

State taxes pay for education, healthcare, police and other public safety services, and many other public goods and services. Maryland’s state tax system is balanced among major tax sources. Income and sales taxes are important at the state level. For local governments, income taxes and property taxes are important.

Maryland is among the nation’s wealthiest states. Maryland taxes are below the US average as a share of income, but larger than average if measured on a per capita basis.

High-income Marylanders pay a smaller share of their incomes in state and local taxes than do low- and middle-income Marylanders. However, this “regressive” effect is less severe in Maryland than it is in the average state. Maryland’s reliance on state and local income taxes and the progressive rate structure of the state income tax offset the regressive effects of sales and property taxes.

Like all Americans, Marylanders contribute to three levels of government.

Over $44 billion goes to the federal government. The biggest sources are federal income tax and payroll taxes for social Security and Medicare.   In addition to social security benefits, most of this money is used for national security, medical care and other “safety-net programs,” and other federal government expenses.

Local governments include counties, cities, school systems and special districts like park and water-and-sewer districts. In 2007, local governments collected about $12 billion in taxes. Most of this was used for education (including public schools, community colleges and libraries), public safety (including police, fire protection and jails), and transportation.

The State government collects about $15 billion per year in taxes, and uses most of it for education (including local public schools and colleges and universities), healthcare, transportation and public safety.

State Tax Sources

Individual income tax and the 6% general sales tax are the largest state tax sources. The following chart shows the estimated level of state taxes in 2010.

Non-tax revenue

Taxes are not the only sources of government revenue. In addition to taxes, governments receive user fees, lottery and gaming, bond proceeds and aid payments from other levels of government, for example. About half of Maryland’s budget comes from non-tax sources.

User fees. The largest type of user fee I the state budget is tuition and other revenues at state colleges and universities. These totaled $1.25 billion in fiscal year 2009.  User fees are also important sources for state services like parks and environmental programs, and business and professional regulation and development.

Lottery and gaming. Maryland and 47 other states derive revenue from legal wagering. The state lottery provides approximately $600 million annually in state revenues, from about $1.7 billion in sales of lottery tickets. Beginning in fiscal year 2011, the state will derive revenue from video lottery terminals (slot machines). Slot machine revenue could ultimately reach the neighborhood of $600 million as well when all five authorized locations are up and running.

Where Maryland Ranks

There is a lot of controversy about whether Maryland is a “high-tax” state. Based on 2007 Census Department data (the most recent available for state and local governments), the answer can range from 8th highest to 40th highest. The first consideration is how to adjust for size. There are two commonly used approaches. One is taxes “per capita”--dividing total tax revenue by population. This gives the average amount of taxes collected per person. Of course, the mathematical average may bear little relation to the amount paid by any particular person.

Looking only at state-level taxes, Maryland ranks 16th among the 50 states if one looks at taxes per person.

Maryland Tax Ranking (2007 US Census Data)

The other commonly used method of adjusting for size is taxes as a percentage of personal income. This equals total tax collections divided by personal income – the total of all salaries, wages, rents, royalties, interest, dividends and transfer payments received by Maryland residents during the year.  This approximates the share of the state’s economy that taxes constitute. Maryland has one of the highest per capita incomes of any state, so Maryland can have an average amount of tax per capita and a below-average percentage of income towards taxes. Adjusting for income also helps to recognize that most public services are more expensive to provide in higher-income states (because governments must pay police, teachers, treatment workers and other employees a competitive wage in their region).

Maryland’s state taxes as a percent of income ranks 40th among the 50 states.

However, it’s not fair to look only at state taxes. Different states have different financial arrangements between state and local governments. Many states (particularly in the Northeast and Midwest) rely more heavily on local property taxes to fund local schools. State taxes are high in Hawaii (among other reasons) because the state funds 100% of school budgets there. Maryland permits counties and municipalities to levy local income taxes, a tax source not available to local governments in most states. Most researchers combine local and state taxes together when making state-to-state comparisons.

Looking at state and local taxes together, Maryland ranks 8th in taxes per capita, and 30th in taxes as a percent of income. Overall, state and local taxes as a percent of income may be the most revealing of these statistics. It can still be misleading, particularly in the case of states that are able to “export” a lot of their taxes to other state’s residents. Examples include states with a lot of tourism (Hawaii) or minerals (Alaska).

Maryland and at least 30 other states have increased taxes since 2007, so these ranking could change in the future.

Total Revenue and Non-tax Revenue

Because of fees and charges and intergovernmental aid, total state and local government revenue differs from taxes. Maryland’s state and local government revenue per capita is in the middle among states, ranking 25th. As a percent of personal income, the rank is 48th. Maryland ranks 46th per capita for fees and charges (49th as a percent of income) and 32nd for intergovernmental revenue (49th as a percent of income).

Other Rankings

Many organizations rank, grade or score states based on their tax systems. Each of these introduces subtleties and complexities into its measures, so it is important to understand what is being measured before evaluating the results.

Tax Foundation – “hospitable to businesses and economic growth.”

One of the best-known ranking systems is the Tax Foundation’s State Business Tax Climate Index. Maryland’s 45th ranking is often cited as a critique of Maryland’s tax system (the number one rank is the best for businesses, thus the Foundation ranks Maryland as 6th worst). However, the Tax Foundation index is not really a clear measure of a state’s tax burden. The index is meant to indicate “which states’ tax systems are the most hospitable to business and economic growth.” The Tax Foundation goes on to state that its index ”does not attempt to measure economic opportunity, or freedom, or even the broad business climate, but the narrower business tax climate.”

This means that the ranking looks at the means of providing revenue, but does not compare the benefits to business or the general public from the use of that revenue. Differences in the public investments funded from tax receipts--the quality of a state’s education system, transportation network, and healthcare resources, for example--do not factor into the index.

The State Business Tax Climate Index measures a state’s degree of conformance with the Tax Foundation’s policy prescriptions. The Tax Foundation encourages broad taxes with low rates. It discourages progressive tax provisions that apply different tax rates to different income classes. States are penalized for reliance on progressive income taxes, or for exempting necessities (such as groceries) from the sales tax, for example.

Many states with relatively high incomes (Maryland, New York, Connecticut, and New Jersey, for example) rank in the bottom ten in the Tax Foundation index. The states in the Tax Foundation’s top ten tend to be sparsely-populated, mineral-rich states (South Dakota, Wyoming and Alaska are the top three), and/or states that attract a lot of travel and tourism revenue (Nevada and Florida). Most of the top-ranking states achieve a high score by forgoing the income tax, the sales tax or both. Many researchers believe that applying all major taxes in a balanced scheme provides the fairest system.

Maryland’s low rank on this index is directly related to Maryland’s reliance on a progressive income tax. In the Tax Foundation’s weighting scheme, individual income tax-related factors account for 30.09% of the final score, even though other taxes (and particularly property taxes) are much larger shares on businesses’ overall tax bill. The Tax Foundation ranks Maryland above average on corporation taxes (14th), and sales taxes (10th).

So, Maryland’s widely-reported ranking of 45-out-of-50 is based on a narrow range of criteria which rewards tax policies favorable to businesses and high-income earners. It does not consider overall fairness, or the value to citizens and businesses of public investments financed with tax dollars.

Council on State Taxation/Enrst and Young – costs and benefits to businesses.

The Council on State taxation (COST) is a group of 600 major national and international businesses.  Each year, they commission the accounting firm of Ernst & Young to estimate the amount of taxes paid by businesses in each state.  For Maryland state and local business taxes amounted to 4.2% of gross state product in 2009, compared with 4.7% for the United States overall. On this measure Maryland is in a 3-way tie for the 12th lowest business tax burden.

The study found the property tax to be the largest tax on business – accounting for 36% of all state and local taxes paid by businesses. In Maryland, property taxes were 26.1% of all state and local taxes, while individual income taxes were 9.9% and corporation taxes were 8.7%.

The study also estimated the amount of expenditures benefitting business. On this measure, Maryland businesses had the best “bang for the buck” on their tax dollar (in a 2-way or a 3-way tie, depending on the assumption about what share of public education expenses benefit businesses).

Who Pays?

Taxes in a state don’t affect every taxpayer equally. In a state, like Maryland, with a progressive income tax, wealthy households will pay a higher share of their income in INCOME TAX than average. BUT, the sales tax works the other way around. Low-income residents pay a larger share of their income for sales tax.

The Institute for Taxation and Economic Policy (ITEP) estimates the “incidence” of state and local taxes on different income groups. “Incidence” means that ITEP estimates who will ultimately bear the burden of a tax, not necessarily who is legally liable. For example, landlords are legally responsible for property tax on rented housing--they have the tax liability. But, they are generally able to pass the cost on to tenants. The renter has the “incidence.”

ITEP estimates of Maryland taxpayers’ incidence is set out in the following chart:

Maryland Tax Incidence 2007

% of Income for non-elderly taxpayers

In Maryland as in most states, the result is that lower income people tend to pay a larger share of their incomes in state and local taxes.  The state and local tax systems tend to make incomes more unequal. This is called a “regressive” effect. The regressive effect in Maryland is less pronounced than in the average state. Indeed, low-and middle-income Marylanders (60% of households, those with incomes up to the low 50,00’s) pay roughly the same share of income in taxes – about 10%. Over this range, the declining share of sales taxes is offset by the increasing share of income taxes.

For the wealthiest 40%, the progressive effect of the income tax does not offset the regressive nature of sales and property taxes. In addition, most higher-income Marylanders benefit from the fact that they can deduct their state and local income tax from their federal tax.

As a result, the top 40% of Maryland earners pay a declining share of income in state and local taxes.

ITEP cites the following features that make Maryland’s system less regressive:

• Progressive income tax rates
• A partially refundable Earned Income Tax Credit for low-income wage earners
• Groceries not subject to sales tax.

Conclusion

The remaining sections of this guide will present information on the largest components of Maryland’s state and local tax system.  The system has built up over the decades, addressing emerging needs and balancing different objectives.  Today, Maryland’s tax system is struggling to provide adequate resources to meet the people’s needs for education, healthcare, public safety and other services. A strong progressive income tax makes Maryland’s system less regressive than most other states. Viewed as a percent of income, Maryland’s taxes are below average for the nation. There are several measures the state should consider to improve the system, and make Maryland’s taxes fairer, more stable, and better able to meet today’s needs.

References

US Internal Revenue Service. Statistics of Income. Table 5. Internal revenue Gross Collections, by Tax and State, Fiscal Year 2009.

Center on Budget and Policy Priorities. Policy Basics: Where Do Our Federal Tax Dollars Go? April 10, 2010. http://www.cbpp.org/cms/index.cfm?fa=view&id=1258

  State & Local Government Finance Data Query System. http://www.taxpolicycenter.org/slf-dqs/pages.cfm. The Urban Institute-Brookings Institution Tax Policy Center. Data from U.S. Census Bureau, Annual Survey of State and Local Government Finances, Government Finances, Volume 4, and Census of Governments (Years).

Department of Legislative Services, Local Government Finances in Maryland, FY 2007. http://mlis.state.md.us/2009rs/misc/LocalGovernmentFinancesInMarylandFY2007.pdf

State & Local Government Finance Data Query System. http://www.taxpolicycenter.org/slf-dqs/pages.cfm. The Urban Institute-Brookings Institution Tax Policy Center. Data from U.S. Census Bureau, Annual Survey of State and Local Government Finances, Government Finances, Volume 4, and Census of Governments (Years).

Maryland Department of Budget and Management. Budget Highlights Fiscal Year 2011. Appendix B.

Based on “General Revenue” as reported in the US Cencus of Governments. This measures includes all governmental revenues except enterprise-type operations like insurance programs, public utilities, and liquor stores. It is different from and much broader than the similar-sounding “general fund revenue.”

Padgitt, Kail m>. background paper; 2010 State Business Tax Climate Index. Tax Foundation, Washington, 2009. http://www.taxfoundation.org/files/bp59.pdf

Ernst & Young and Council on State Taxation. Total state and local business taxes: state-by-state estimates for fiscal year 2009. . March 2010 http://www.cost.org/Page.aspx?id=69654