Yesterday the D.C. City Council voted to raise taxes on those earning over $350,000 a year, creating a new bracket and raising the top rate from 8.5 percent to 8.95 percent on high earners. The logic of sponsoring members Mendelson and Cheh is that this tax will allow the council to “swap taxes” and delay the imposition of a tax on interest income on other-than-D.C. municipal bonds, now slated to go into effect in December 2011. Though the income tax hike is being presented as temporary, at least one member is advocating it be made permanent. The 7-6 vote reveals, “a philosophical divide” among City Council members. Council member Muriel Browser notes the city’s budget has grown by $1 billion since 2008. The income tax hike is projected to bring in $106 million over four years.
On the heels of the increase, Moody’s issued a negative outlook on D.C. GO bonds due to possible federal spending cuts that would reduce federal aid and entitlements in the district. Moody’s decision is unrelated to the tax hike.
But perhaps even more worrying than Moody’s assessment are the factors that will increasingly put pressure on D.C.’s fast-growing budgets. Currently, the District’s pension plans appear over-funded, except they really aren’t. Using accurate assumptions indicates that both the teachers’ and the police and fire plans are funded in the 65 percent range, with a total unfunded liability of $2.17 billion. I had the opportunity to testify before the council this spring and offer my assessment of their pension systems, a matter of concern for several Council members.
D.C.’s higher tax rate on high-earners may have unintended consequences: driving out residents or discouraging in-migration, eroding the tax base and leaving D.C. with future obligations that will be very difficult to pay. A recent paper by Davies and Pulito finds that higher state income taxes cause a net out-migration of not only high-income residents, but of residents in general. They find net out-migration also holds at the county-level when the change is to income levels to which the tax rates apply; that is, when a “millionaire’s tax” is really a tax on those earning much less than a million.