This blog has been changed to reflect two clarifications. Please see bold highlights below.
Mayor Gray made the right decision this week to veto an amendment that was added to next year’s budget just before the DC Council’s summer recess. That amendment would have maintained, for one more year, a tax break for residents who have invested in non-DC municipal bonds, even though the Council voted to eliminate this tax break in its first budget vote of May 25th and reaffirmed that decision on June 14th. More important, the amendment would have funded this tax break by dipping into city reserves, reneging on a provision just adopted by the Council to start rebuilding our cash reserves. That would be fiscally irresponsible and could threaten DC’s bond rating, as indicated in strongly worded warnings from DC’s Chief Financial Officer.
DCFPI supports eliminating the tax break on interest earned on out of state bonds for several reasons. The District is the only state* in the country to give a tax break to residents who invest in municipal bonds outside home borders. Making bonds from other cities and states tax-exempt creates an incentive to invest in other places rather than home. Some have suggested that removing the tax break hits retirees harshly, but data indicate that only one-in-four households with tax-exempt bond interest had retirement pension income, and approximately 70 percent of residents who hold out-of-state bonds have incomes over $100,000. (There are likely to be some retired residents who do not have pension income, but these households were not identified in the CFO data. The full number of retirees with out-of-state bonds is likely to be higher than indicated from the CFO data, but it cannot be determined precisely.)
The Council decided in this budget season to set a priority to rebuild the city’s savings. To that end, the FY 2012 budget passed on May 25th and affirmed on June 14 included a provision that 50 percent of any increase in revenue from the June and September revenue forecasts would be used to replenish the city’s Cash Flow Reserve Account. Dr. Gandhi and Mayor Gray supported that approach.
For the Council to now ignore its concerns over the District’s reserve fund in the name of a tax cut primarily targeted towards wealthy residents is fiscally irresponsible. Dr. Gandhi indicated in a fiscal impact statement that reversing a just-adopted savings plan puts DC’s bond rating at risk.
The amendment adopted in July that Mayor Gray vetoed would have eliminated the tax break, beginning in January 2012 rather than January 2011, making the tax change prospective rather than retroactive. While this is a reasonable policy issue, the manner for addressing it was not. The Council could have considered another approach to making this tax change prospective. Indeed, an amendment to create a new income tax bracket for high-income households was slated to be considered by the Council in its July legislative session. That tax change would have allowed the District to eliminate the bond interest exemption solely for new investments, protecting all current investors. But the lead sponsor for that amendment, Council member Cheh, ultimately did not bring it up for a vote.
That was unfortunate, unlike the elimination of the out-of-state bond tax break, which was discussed only toward the conclusion of the budget debate, the high income tax was debated widely and received widespread support from residents. A Hart poll found that 85 percent of DC voters supported the tax, including 91 percent of residents from Wards 2 and 3.
DCFPI agrees with the large majority of DC residents that our elected leadership needs to take a balanced, judicious approach to our budget. In order to move forward out of these difficult economic times, the District needs to maintain key investments in our residents and our infrastructure. The Mayor and Council need a budget that provides for our critical investments, rather than pay for tax breaks that threaten our city’s fiscal health.
*Utah taxes out-of-state bonds, but has an exception for Utah residents who invest in bonds from states that do not tax interest earned on Utah bonds. These states include the seven states without an income tax, as well North Dakota and the District. Once the DC provision to eliminate this exemption goes into effect, Utah will start taxing income earned by its residents on DC bonds.
