Maryland Plunges to a New Low: It Ranks 46th in the State Business Tax Climate Index

The Tax Foundation just released its 2022 State Business Tax Climate Index—and, unfortunately, Maryland continues its downward slide. It now ranks 46^th overall among the states and the District of Columbia due to bottom-half ratings in each of the measured subcategories. This is Maryland's lowest ranking since at least 2014 and possibly marks its all-time low. It should be a clarion call of the need for tax reform in the state.

States compete with other states for businesses, residents, investment, jobs, and revenues by implementing business-friendly tax policies, and Maryland's rank as 46^th shows serious room for improvement. As the Tax Foundation explains, a business-friendly tax environment does not mean tax-free anarchy. It means structuring major taxes with "low rates and broad bases." The broader the "base," meaning the total amount of economic activity subject to a specific tax, the lower the rate a state needs to impose to achieve its revenue target.

The Tax Foundation's State Business Tax Climate Index assesses a state's overall performance based on five major areas of taxation that affect business: corporate tax, individual income tax, sales tax, property tax, and unemployment insurance tax. Some states do not assess all of these taxes, but that fact does not guarantee strong performance on the Index. Utah and Indiana, both of which rank in the top 10, impose all of the major taxes as Maryland does, but they avoid "complex, nonneutral taxes with comparatively high rates" that detract from Maryland's economy.

Maryland could improve in virtually every area, because its 46^th overall rank reflects its bottom-half performance in every category:

• Unemployment insurance tax (46^th)
• Individual income tax (45^th)
• Property tax (43^st)
• Corporate tax (33rd)
• Sales tax (26^th)

Over the years, Maryland has been a consistent bottom-tier performer with unemployment insurance taxes, because it does not have "rate structures with lower minimum and maximum rates and a wage base at the federal level," which cause uneven burdens on employers. Maryland has the highest minimum unemployment insurance tax rate in the country at 2.2% and one of the highest maximum rates at 13%. It also relies on a wage base above the federal level. These factors lead to non-neutrality in the unemployment tax by assessing more tax on struggling businesses and industries with endemic turnover, like retail. It makes little sense to burden struggling businesses with high unemployment taxes when doing so risks more unemployment.

Maryland also has a high progressive individual income tax that places it in the bottom 10% of states in this category. This is a problem for Maryland's business climate because "a significant number of businesses, including sole proprietorships, partnerships, and S corporations, report their income through the individual income tax code." Progressive taxes disincentivize labor over leisure for high income earners, which means Maryland's tax code encourages wealthy individuals to spend money on activities like travel and entertainment instead of hiring workers and investing in Maryland's economic growth. This disincentive is especially concerning at the state level, where individuals can "vote with their feet" by relocating to lower tax jurisdictions. Maryland's income tax also ranks poorly because it is not indexed to inflation, includes a marriage penalty, and double-taxes capital gains and dividends. Maryland could improve its business environment by eliminating or reducing the extent of these problems.

Maryland's property tax regime falls in the bottom-10. Property taxes are not just taxes on ownership of real property—they also include any tax assessed to tangible or intangible property, such as business inventory taxes, real estate transfer taxes, estate taxes, and inheritance taxes. Maryland's poor performance on the Business Tax Climate Index is largely attributable to its property taxes that distort business decisions. For example, Maryland taxes business inventories, a tax that has the effect of discriminating against retailers and forcing businesses to factor tax minimization into sales and procurement strategies. Maryland also taxes real estate transfers, which increases compliance costs and distorts decisions when businesses or individuals seek to transfer non-liquid assets, including small business and family-owned property. Maryland is also the only state in the country to levy both an estate tax and an inheritance tax, often causing double-taxation of inherited property. These taxes cause businesses and individuals in Maryland to make decisions about property based on tax strategy rather than economics, so they should be eliminated.

Maryland's corporate tax ranking is not quite as abysmal as it is in the previous three categories but it still needs work. High corporate tax rates with progressive bracketing discourage businesses, especially when nearby states have lower taxes. In Maryland, corporations pay an 8.25% tax rate on business profits. Imposing a single rate is positive. But 8.25% is a relatively high rate compared to other states, so businesses may be deterred from locating in Maryland, especially when nearby Virginia has a lower 6% rate. Additionally, Maryland does not conform with federal policy for deducting depletion, which adds complexity for businesses that deal with natural resources. Maryland should reduce its corporate rate and conform with federal depletion policy to attract business.

Maryland's sales tax regime earned the state's best subcategory ranking, but this ranking was still relegated to the bottom-half thanks to "including too many business inputs, excluding too many consumer goods and services, and imposing excessive rates of excise taxation." For example, Maryland's 6% sales tax rate could be reduced if it didn't provide a wide variety of sometimes seemingly arbitrary exemptions for various goods and services. Meanwhile, Maryland taxes business production inputs like leases, information services, and office equipment. Businesses likely pass taxes imposed on these items to end users of finished products, on whom the sales tax might apply again. Maryland could improve its ranking by eliminating exemptions for consumer goods and services while exempting inputs—creating a broader base that allows for overall lower sales tax rates.

The harmful effect of Maryland's 46^th place overall ranking becomes clear when you consider the more competitive rankings of adjacent states. All of the states bordering Maryland have better Business Climate Index rankings, except for the District of Columbia. These states include Delaware, Pennsylvania, Virginia, and West Virginia. Delaware's 16^th place ranking is the best, and this might help explain why Delaware has the highest population growth rate among Maryland and its neighboring states. Virginia ranks 25^th on the Index and also has a higher population growth rate than Maryland. While Maryland has faster population growth than Pennsylvania (29^th) and West Virginia (21^st), the potential for these states to outcompete Maryland for business and residents solely because of Maryland's unduly high tax rates and overly burdensome tax policies should alarm lawmakers.

The 46^th place ranking on the State Business Tax Climate Index should be a wakeup call to Maryland's government officials and its citizens. This bottom-dwelling ranking suggests that Maryland's tax code pushes investment, job growth, and revenue, as well as jobs and potential new residents to other states. And because Maryland's ranking has continually declined over the last decade, it appears other states are taking the benefits of tax reform more seriously.

Adoption by the legislature of the tax reforms suggested above, and others discussed in the Index, would stop Maryland from losing further ground to other states, including its neighbors, and would help spur more economic growth that would benefit all of Maryland's residents.

Repealing SALT Deduction Should Improve Maryland’s Economy in the Long-Run

The House of Representatives and the Senate passed different versions of the Tax Cuts and Jobs Act. Both versions of the tax reform bill would repeal the state and local tax deduction (SALT) for income and sales taxes. Although this repeal might hurt some Maryland taxpayers in the short-run, it should be a spur to create greater fiscal responsibility in Maryland. If so, this ultimately would benefit Maryland taxpayers and help grow the state’s economy.

“SALT” is the acronym referring to the deduction for individuals who itemize certain tax payments to state and local governments on their federal tax returns. SALT is essentially a wealth transfer from residents in states with relatively low tax rates to residents in states with relatively high tax rates. Additionally, because residents who live in states with relatively high tax rates benefit disproportionately more from the SALT deduction, they have less incentive than they otherwise would to hold their public officials accountable regarding tax and spending policies.

Many Maryland residents benefit from SALT because it allows them to pay less taxes. According to a Tax Foundation study, residents in Maryland receive the 5^th highest SALT deduction as a percentage of adjusted gross income, behind residents in New York, New Jersey, Connecticut, and California. But SALT encourages Maryland policymakers at the state and local levels to spend even more than they otherwise would absent the SALT deduction because many residents will not be as adversely impacted.

In this way, over time, the SALT deduction promotes more fiscal prolificacy, less accountability regarding government spending, and diminished economic growth. So while many Maryland residents may think they are better off because of SALT, the longer-term negative effects of SALT may slow economic growth, ultimately making those same residents worse off.

As I stated in a July 2017 blog, Maryland’s fiscal health, ranking 46^th in the country in fiscal solvency in one study, remains poor. But the moral hazard of the SALT deduction only tends to exacerbate Maryland’s excessive spending problem. Regarding SALT, Jared Walczak of the Tax Foundation says:

The residents of some localities are willing to accept higher levels of taxation in exchange for greater government service provision; others prefer a smaller government which necessitates lower rates of taxation. Taxpayers may be supportive of increased levels of spending if part of the cost is borne by others; conversely, they may reduce expenditures if they believe that some of the benefit of that spending will be conferred on others. Federal subsidies thus place a thumb on the scale, distorting local decision-making.

Interestingly, the Congressional Budget Office (CBO) published a November 2013 blog titled “Eliminate the Deduction for State and Local Taxes.” The CBO said: “The deduction for state and local taxes is effectively a federal subsidy to state and local governments; that means the federal government essentially pays a share of people’s state and local taxes. Therefore, the deduction indirectly finances spending by those governments at the expense of other uses of federal revenues.” The CBO also stated:

Another argument [against SALT] is that the deduction largely benefits wealthier localities, where many taxpayers itemize, are in the upper income tax brackets, and enjoy more abundant state and local government services. Because the value of an additional dollar of itemized deductions increases with the marginal tax rate (the percentage of an additional dollar of income from labor or capital that is paid in federal taxes), the deductions are worth more to taxpayers in higher income tax brackets than they are to those in lower income brackets. 

If and when SALT is repealed, whether in whole or in part, the positive economic effects will not happen overnight. In fact, an October 2017 report published by The Heritage Foundation states that repealing SALT will only boost economic activity if it is also “accompanied by more efficient state tax-and-spending policies.” As of my January 2016 blog, Maryland had the 7^th highest state and local tax burden in the United States.

Governor Larry Hogan has made it his mission to reform Maryland’s burdensome regulatory and tax climates, and he already has succeeded to some extent. A recent CNBC study, “America’s Top States for Business 2017,” found that Maryland moved up eleven spots from 36^th to 25^th, since Governor Hogan took office.  However, more support is needed from the Maryland General Assembly for lowering tax rates and cutting spending in order to improve Maryland’s fiscal climate. If the SALT deduction is repealed, Maryland legislators will have a greater incentive to reduce excessive taxes and spending, stimulating economic growth in the long-run.

Senate Tax Bill Will Stimulate Maryland’s Economy

Earlier this month, the Tax Foundation published a study on the Senate’s version of the Tax Cuts and Jobs Act, finding that the plan would grow the economy while simplifying the tax code and reducing marginal tax rates.  Using the Tax Foundation’s Taxes and Growth macroeconomic model, the study finds that the proposed tax plan will create 925,000 new full-time equivalent jobs and will increase GDP by 3.7% over the next decade. Accounting for the increase in GDP, after-tax incomes will rise by 4.4%.

The Tax Foundation also published a state-by-state impact analysis of the Senate’s proposed plan. In Maryland, the study projected 17,322 new full-time equivalent jobs over the next decade and an average increase in after-tax income for middle-income families of $3,245. Lower marginal tax rates will complement Governor Larry Hogan’s efforts to reform Maryland’s business climate. This will further stimulate Maryland’s economy and improve its long-term fiscal health.