Chairman Evans, other members of the Committee, thank you for the opportunity to speak today. My name is Ed Lazere, and I am the executive director of the DC Fiscal Policy Institute. DCFPI engages in research and public education on the fiscal and economic health of the District of Columbia, with a particular emphasis on policies that affect low”‘ and moderate”‘income residents.
I am here to offer my strong support for bill 16-35, which would couple DC’s standard deduction and personal exemption with the federal standard deduction and personal exemption. This bill would provide tax relief to all DC residents subject to the income tax, but it would focus relief on low- and moderate-income families. It also would improve the DC tax system by ensuring that these basic elements of the income tax are adjusted for inflation this year, and it would simplify the District’s tax system. It is important to note that these changes were recommended in 1998 by the DC Tax Revision Commission.
At the same time, this bill would have substantial costs in terms of lost revenue. Even with the strong state of DC’s finances, it may not be possible to implement it fully at this time.
The standard deduction and personal exemption are critical components of a progressive income tax. They exempt a specified amount of earnings from taxation, and if set at sufficient levels, they can eliminate income tax liability entirely for many low-income households. The standard deduction is particularly important for low-income households, because it is a deduction for those who do not have enough allowable deductions to itemize. Three-fifths of DC taxpayers claim the standard deduction, and more than 90 percent of them have adjusted gross income under $50,000.
At the federal level, the combined standard deduction and personal exemption for a married couple with two children is $22,100. (This stems from a $9,700 standard deduction and a $3,100 personal exemption for each of the four household members.) Households with incomes below this level pay no federal income tax, and tax liability is relatively modest for households with incomes just above this threshold. Under the DC income tax, by contrast, the standard deduction and personal exemptions for a family of four total just $7,480, less than half the poverty line for a family of that size. (DC’s standard deduction is $2,000 and the personal exemption is $1,370.) Partly as a result of these modest deductions, the income tax liability on DC households with incomes equal to 125 percent of the poverty line is higher than in all but 12 states.
Bill 16-35 thus would raise the District’s tax threshold substantially. It would reduce taxes most notably for lower-income households, while providing some relief to all households because all households claim the personal exemption. The table in my testimony shows, for example, that bill 16-35 would provide $744 in tax relief to a family of four earning $25,000, or three percent of income. For a family of four with income of $75,000 or more, the relief would be roughly $600 (assuming the family does not claim the standard deduction). That is 0.6% of income for a family earning $100,000 or 0.3% for a household earning $200,000.
| Household income* | Tax Relief Under Standard Deduction/ Personal Exemption | Tax Relief As a Percent of Income |
| $15,000 | $375 | 2.5% |
| $25,000 | $744 | 3.0% |
| $50,000 | 1,096 | 2.2% |
| $75,000* | 607 | 0.8% |
| $150,000* | 623 | 0.4% |
| $200,000* | 623 | 0.3% |
| * assumes these households itemize deductions | ||
Targeting tax relief on lower-income residents is important because the overall DC tax system ‘ including sales, excise, property, and other taxes ‘ is regressive. According to data from the Institute for Taxation and Economic Policy, DC households with incomes between $15,000 and $42,000 pay nearly 12 percent of their income in DC taxes, compared with 6.3 percent of income that the top one percent of DC households pay in local taxes.
Coupling the DC personal exemption and standard deduction with federal levels would have several additional advantages. In response to the low level of DC’s standard deduction and personal exemption, the DC income tax includes a “Low-Income Credit” that wipes out the tax bill for any household below the sum of the federal standard deduction and personal exemptions. This credit helps families below the federal tax filing threshold but offers no aid to families just above the threshold. For example, a married couple with income of $15,900 owes nothing in DC income tax due to the Low-Income credit. But if the household had income of $15,901, its DC income tax would be $588. Bill 16-35 would eliminate this tax cliff and would eliminate the need for the Low-Income Credit.
Bill 16-35 also would allow families with children to take fuller advantage of the DC Earned Income Tax Credit, which is now set at 25 percent of the federal credit. Under current law, much of the DC EITC benefit is offset by a family’s income tax liability. A single parent with two children and $15,000 in income qualifies for a $1,023 DC EITC but owes $376 in DC income tax, resulting in a net EITC benefit of $647. If the parent earned $20,000, the $760 EITC benefit would be used mostly to offset the family’s $689 income tax liability. Under bill 16-35, by contrast, the family at $15,000 would receive the full $1,023 EITC benefit and the family at $20,000 would be able to receive $735 of its $760 EITC.
A final advantage of the bill to couple DC’s personal exemption and standard deduction to federal provisions is that it would ensure that these critical tax provisions would not lose ground to inflation. The DC standard deduction of $2,000 has not been changed since 1987, and the personal exemption has not been adjusted since 1991. Federal tax provisions, by contrast, are adjusted for inflation each year.
It is my understanding that this bill would result in annual revenue reductions of as much as $90 million. Even though DC’s finances are strong, the cost of this bill could consume nearly all of a projected surplus in FY 2006. Any tax relief provision must be considered in the context of the city’s overall finances and should be balanced with investments in needed services. For these reasons, it may be appropriate to consider implementing bill 16-35 in stages. If a phased-in approach is taken, raising the standard deduction could be considered as the first step, since this is the component of bill 16-35 that provides the most targeted relief for low-income households.
Bill 16-115, the “Standard and Itemized Deduction Filing Election Act of 2005″
Bill 16-115 would allow DC residents to claim the standard deduction or itemized deductions on their DC income tax, regardless of the type of deduction claimed on their federal taxes. Under current DC law, residents must claim the same type of deduction on their DC income tax return as claimed on their federal income tax return.
Under current law, some households may not have sufficient to itemize deductions on their federal return but would benefit by itemizing on their DC return. For example, a married-couple household with $7,000 in possible deductions would not itemize on their federal return, where the standard deduction is $9,700, but they would want to itemize on their DC return where the standard deduction is $2,000.
There may be administrative complexities involved in this bill. Families that do not itemize on their federal return would have to complete the itemized deduction schedule and submit it to the District. The District’s tax office may need to devote new resources to auditing these returns, since the accuracy of claimed itemized deductions would not be verified through IRS mechanisms. I defer to officials in the CFO’s office as to the significance of this issue.
It is important to note that bill 16-35 would eliminate the discrepancy between the DC and federal standard deductions, thereby eliminating this type of situation. This is another argument for coupling DC’s standard deduction to the federal.
Even if bill 16-35 to couple DC’s standard deduction to the federal deduction is adopted, bill 16-115 would help another type of family, those for whom allowable itemized deductions are dominated by their DC income taxes. Since DC income taxes are not allowed as an itemized deduction on the DC income tax return, some such families may not have enough allowable itemized deductions to justify itemizing on their DC return. This would be true, for example, if a household had $9,000 in DC income taxes and $1,000 in other itemized deductions. For this family, it would be more beneficial to claim the $2,000 DC standard deduction. The number of tax filers in this situation is likely to be small, but it would increase if DC’s standard deduction was raised to match the federal level. It would appear administratively easy to allow these families to claim the DC standard deduction.