Hell Freezes Over: DC Passes Tax Reform

Nick Zaiac R Street Institute
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Quick, where in the country was the last major tax reform passed? Somewhere in the Midwest? Maybe one of the Rust Belt states finally fixed their broken tax system?

No, it was somewhere even less expected: Washington, DC. You read that correctly. Yesterday, the nation’s capital passed a major raft of tax reforms that seemed to come out of nowhere.

As the Washington Post notes, the reforms are the final version of a list of tax reform proposals that came out of a commission in December, but were long thought to be dead in the water, thanks in part to Mayor Vincent Gray’s strong opposition.

The reform is one of the most comprehensive Americans have seen out of any state or local body in recent memory, rivaled only by the Kansas’s 2012 changes to their tax code. Most notably, the reform adds two income tax brackets. The first new bracket will tax residents earning $40,000-$60,000 at a 6.5 percent rate. The current rate of 8.5 percent, which currently starts at $40,000, will continue to apply to those earning over $60,000. The second new bracket will tax residents earning $350,000-$1 million at a rate of 8.75 percent, lower than the current 8.95 percent rate. To make matters even better, the standard deduction was raised to match federal levels. While the changes to the upper brackets matter, these tax cuts will largely benefit the middle and lower class of DC residents. DC’s many entry-level young professionals will end up with a sizeable tax cut.

The reform package also included positive changes to the District’s estate tax, raising the minimum threshold for the tax to kick in to match the federal level of $5.25 million from $1 million. Normally estate taxes are a low-priority reform, but it is important to remember that DC has, for better or worse, seen housing prices skyrocket. This has brought ever more households into the range where estate taxes apply, especially those with family homes in the city’s fast-gentrifying neighborhoods.

The final, and possibly most notable of the reforms is a major cut to the Business Franchise Tax, DC’s version of the corporate tax. The current rate of 9.975 percent will drop to match Maryland’s 8.25 percent rate in a bid to increase the city’s tax competitiveness. As with all corporate tax reform, small changes help, and a 1.7 percent rate cut is absolutely nothing to laugh at. The previous rate was one of the highest among states, and, while still high, will now be less of a deterrent to businesses in the city.

While the reform does raise some taxes to pay for the tax cuts, the increases could be far worse. The most notable of these was an expansion of the sales tax to a new set of good and services previously exempted. A simple base expansion like this is about the least harmful way to raise revenue one could imagine, and taxing previously untouched items like car washes and bowling seems uncontroversial. Moreover, the reform failed to enact some of the tax reform commission’s more harmful measures like raising the sales tax rate and a $100 per employee tax on businesses.

All of this is well and good, but one of the more interesting aspects of the reform is how it is paid for. The cuts will be funded largely by less spending on streetcar construction. DC has a plan to build a 37-mile streetcar network, and this money would otherwise be spent to accelerate its construction. While urban planners will complain about the slowing of construction, few can argue that a broad-based tax reform targeted at the lower and middle classes will benefit more people than any streetcar network ever could.

Tax reform has come to the nation’s capitol, and there is little to complain about. No matter the political motives of those involved, the council has succeeded in making the DC tax system more competitive and lowering the burdens on some of those who need it most. It’s not often that one gets the chance to praise the DC City Council, but hats off to them. They did well this time. Here’s hoping they keep it up.