The District of Columbia weathered the pandemic with stable tax collections, down less than 1 percent in FY 2020 while recovering above pre-pandemic levels in FY 2021. Yet, even as lawmakers in eleven states have cut income taxes this year, the D.C. Council has responded to surpluses and growth by voting to include substantial income tax increases in the budget.
Soon, Washington, D.C. will have some of the nation’s highest income tax rates—rates which people can avoid if they live in Maryland or Virginia, even if they commute into the city for work. Those who remain—particularly small business owners in the District—will feel the brunt of the tax increase, both directly through higher tax payments, and indirectly through the consequences of outmigration and the tax hike’s effect on economic growth.
In addition to steady own-source revenues, the District was buoyed by federal aid equal 37 percent of what Washington, D.C. typically collects in taxes each year. D.C. ended FY 2020 with a surplus of more than $550 million, and revenue forecasts anticipate tax revenue growth of about 3.5 percent per year for the next four years.
Higher income taxes have been on the agenda in D.C. for several years, though rationales have shifted. When Councilmember Charles Allen (D-Ward 6) proposed a tax increase last year, it was intended to fund violence interruption programs, rental assistance, and domestic violence shelters. Prior proposals were specifically for childcare. And the most recent proposal, which was incorporated into the budget by an 8-5 vote, would fund higher wages for childcare workers, additional housing vouchers, and monthly checks to low-income families, in addition to the District’s existing Earned Income Tax Credit (EITC).
Regardless of the spending priority, critics cannot help but notice that as the priorities change the funding mechanism—higher taxes—does not. The additional $175 million a year the tax hike is intended to raise by 2025 pales in comparison to the $2.8 billion in federal aid the District has received since last spring, about $2.5 billion of which is still available.
Moreover, even without a tax increase, D.C. tax revenue is projected to rise by $1.14 billion by 2025—six and a half times the amount the tax increase is expected to generate.
Under the budget provision, the top marginal rate in the District of Columbia would be 10.75 percent, matching New Jersey’s recent tax hike and falling just under New York’s 10.9 percent (the result of the only other income tax increase this year), Hawaii’s 11 percent, and the 13.3 percent top rate in California. The D.C. policy, like New York’s, appears to view higher tax rates as an end in themselves, not just a means to an end; in New York, policymakers vaguely defended rate increases by reference to badly outdated pandemic-induced revenue fears, despite stable revenue in 2020 and substantial revenue growth thus far in 2021.
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Imposing some of the nation’s highest income taxes carries risk in any jurisdiction, but the pitfalls are even more pronounced in the District of Columbia. D.C is an area of 68 square miles in which commuters from Maryland and Virginia pay income tax to their home state, even if they work in the District. A decade ago, the Washington, D.C. population swelled 79 percent every weekday after accounting for commuters, and while some of that trend seems to have reversed in more recent years, large tax increases could reinvigorate a shift to the suburbs, particularly given a rise in remote and flexible work opportunities.
The District of Columbia has a reciprocity agreement with Maryland and Virginia, by which all three jurisdictions agree that only the domiciliary state can tax an individual’s income, regardless of where it is earned in the region. (Notably, D.C. cannot simply opt out of this arrangement, which is dictated by Congress.) The reciprocity agreement supersedes the general rule that the state (or other jurisdiction) where income is earned may tax it, typically offset by a credit against liability in one’s home state.
What does this means for D.C.? It means that a high earner who moves to Alexandria, Virginia won’t have to pay a dime in D.C. income taxes, even if she commutes to an office in the District every weekday.
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Should the District of Columbia adopt a 10.75 percent top rate, however, proponents in the city won’t be the only ones celebrating a win. They will be joined by the real winners: taxpayers in Maryland and Virginia.
D.C.’s Income Tax Hike Helps Maryland and Virginia, Not D.C.
Forward!