Federal Tax Bill Will Increase Inequality in DC, But We Can Fight Back

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Last month, Congress passed a bill that hands out large tax cuts to corporations and the wealthy and puts important social services on the chopping block. DC taxpayers did not ask for these large federal tax cuts or the reductions in federal services likely to accompany them. In fact, Americans overwhelmingly opposed the tax bill. Meanwhile, DC residents face unmet needs in education, affordable housing, health, homelessness and human services.

Yet, media coverage of possible state and local responses to the tax bill has been focused on shielding high-income taxpayers from the few provisions of the bill that do not benefit them.

Instead, DC policymakers should pick up where the federal government is leaving off, by recapturing lost federal revenues to fund our city’s needs and make our own tax code more progressive – reducing taxes for the poor, not the wealthy.

According to recent estimates from the Institute for Taxation and Economic Policy (ITEP), District of Columbia residents can expect to receive a $850 million federal tax break this year. Nearly 60 percent of this benefit, or almost $500 million, will flow to the top five percent of DC taxpayers. 

News coverage has focused on how the bill limits the amount of state and local taxes that can be deducted on the federal tax return (known as the State and Local Tax deduction, or SALT), meaning that people who pay more than $10,000 per year in DC property and income taxes will lose some federal tax benefits. But the same high-income taxpayers most affected by SALT are getting tax cuts from other income tax, corporate tax and estate tax cuts in the law. On net, the top one percent of DC taxpayers will get an average federal tax cut of over $67,000.

If DC doesn’t act, these large tax cuts tilted toward the wealthy will increase DC’s severe income inequality, which is already the fifth-highest in the nation among large cities. But we have an opportunity to fight back and invest in our city, using the revenue the federal government is giving up.

Building a More Inclusive DC
DC should use smart, progressive tax policy to turn these unasked-for federal tax windfalls into investments in the District.

For example, because last-minute congressional negotiations resulted in a 2.6 percentage point cut to the top federal income tax rate, DC could increase its own top income tax rates to fund progressive investments. This would still allow the richest households to pay less in total taxes this year than last, while raising substantial new revenue for DC priorities.

California and New York have offered plans to shield higher-income taxpayers from the federal SALT changes by, for example, providing a dollar-for-dollar credit on state taxes for charitable contributions to state programs like public education. This lets high-income taxpayers deduct their payments to the government as charitable contributions on their federal tax returns.

This is not great policy on its own, as it skews tax cuts even more toward the wealthy. But a new bill introduced in the DC Council turns the idea into a progressive revenue boost for the city. The bill would allow taxpayers to contribute to a DC education fund, but only give a 90 percent credit on DC taxes. For taxpayers in high federal tax brackets, it’s worth paying DC 10 percent more (the contribution, plus the taxes left over after the 90 percent credit) in order to deduct the contribution from their federal return and get back up to a 37-percent refund from Uncle Sam. For the city, it’s a chance to raise more revenue – potentially a lot more – from our richest residents, while lowering their overall tax bill.

The DC resident taxes that the federal government is giving up could change the trajectory of our city. With additional revenue, DC should remove barriers to healthcare for thousands of immigrants who are currently forced to wait in line all day at service centers to sign up for insurance. We should put money toward paying childcare providers what they need to give low-income kids the same high-quality early education their high-income peers have access to. We should increase education funding to give every kid what they need to be successful, both inside and outside the classroom. And we should take bold new action to end homelessness and meet our city’s growing need for affordable housing.

Action Needed to Keep Our Code Progressive
ITEP estimates that federal tax changes will increase DC personal income taxes by approximately $80 million this year. This does not include effects on DC’s corporate tax, which are uncertain.

The federal law eliminated the personal exemption, a deduction that taxpayers take for each member of their household. This change increases DC taxes for most households, while other provisions decrease DC taxes for many households. According to ITEP, all together, about 40 percent of DC taxpayers will pay slightly more to DC in personal income taxes, and 60 percent will pay the same or less.

Some lower-income families will be hurt by the removal of the personal exemption, and policymakers should consider protecting them. But there are more progressive options than bringing back the personal exemption. We should use this opportunity to fight inequality, not just keep the status quo.

The personal exemption reduces taxes by decreasing the amount of income that your tax rate is applied to. This means that it is more valuable to higher-income taxpayers – who pay higher tax rates – and doesn’t help the lowest-income taxpayers who may not owe DC income taxes but pay sales and property taxes as well as federal payroll taxes.

In contrast, a refundable personal credit gives the same tax cut to all taxpayers, regardless of their tax rate or how much tax they owe. A child credit would also address economic inequality, lifting some of DC’s 31,000 poor children – 27 percent of DC kids – out of poverty. Either of these options could be structured to give a larger boost to lower-income taxpayers. Similarly, increases in the Earned Income Tax Credit or DC’s Schedule H, which provides direct assistance with property taxes and rent, would be well targeted to families that need relief.

Additionally, the federal law cuts the estate tax dramatically by doubling the threshold below which an estate isn’t taxed at all, to $10 million. Because the DC estate tax is connected to the federal rules, this change will reduce DC revenue, with fewer wealthy households paying the tax. DC should act quickly to protect our most progressive revenue source.

Congress has moved to dramatically cut taxes for the wealthy, which will increase inequality in DC and put pressure on services that are critical for residents. DC should fight back with smart tax policy and bold investments.

 

Kitty Richards is acting executive director and Claire Zippel is a policy analyst at the DC Fiscal Policy Institute (www.dcfpi.org). DCFPI promotes budget and policy solutions to reduce poverty and inequality in the District of Columbia and increase opportunities for residents to build a better future.