Tuesday, January 12, 2010

Can Teacher Pensions be Fixed? Part Two

Delegate Roger Manno (D-19) has introduced a bill that would keep teacher pensions at the state level, but pay for them with an extension of the millionaire tax and combined reporting for corporations. That strategy creates a cascade of budgetary and economic questions that goes far beyond the pension system itself. We’ll begin asking those questions today.

1. Are the millionaire tax and combined reporting enough to pay for pension cost increases?

The state’s October Spending Affordability Briefing reports that to maintain solvency of the teacher pension fund, the state must increase its contribution from $676 million in FY 2009 to $928 million in FY 2011 – a $252 million increase in just two years. The employee pension fund, which would also benefit from the new revenues recommended by Manno, must have its contributions increased from $258 million in FY 2009 to $393 million in FY 2011 – a $138 million increase. The briefing is silent on additional increases in the out years, but they are sure to be substantial.

Manno’s bill has no fiscal note yet, so we will have to rely on other sources to calculate the additional revenues raised by a millionaire tax extension and combined reporting. The millionaire tax, which in its current form is actually a three-year surcharge starting in Tax Year 2008, was estimated to raise a peak annual amount of $154.6 million in FY 2009 with declining amounts thereafter. The drop in the number of Free State millionaires, caused almost entirely by the recession, suggests that the tax raised substantially less than projected. And while only about 2% of the state’s millionaires have moved out because of the surcharge, many more could leave – and many more could never move in – if the tax was made permanent. However much a permanent tax might collect, what is clear is that it is a VERY volatile source of revenue. And the pension system needs a reliable and increasing source of contributions.

As for combined reporting, the Comptroller’s Office recently estimated that the state would have collected an additional $109-170 million in tax year 2006 if combined reporting had been in place. But the Maryland Chamber of Commerce noted:

Tax year 2006 represented the highest level of corporate income taxes ever collected by the state ($868 million) during a robust economy. What would be the impact of combined reporting during the current recession when millions in tax losses could be imported into the state from out of state entities?
Moreover, if combined reporting did raise a large amount of money soon after its enactment, business would not sit still and simply absorb the losses. It makes sense that at least some of them would restructure their operations to adapt to combined reporting and minimize their tax liabilities. Some who could not sufficiently adapt might move out. So combined reporting could collect less over time. Further, corporate income is almost as volatile as top-level income tax revenue, generating more questions about contribution volatility in the pension system.

Based on the above, we believe that a permanent millionaire tax and combined reporting together could well generate tens, or perhaps even a hundred million dollars or more per year. But their tendency to experience huge swings with the business cycle suggests that more stable revenues need to be found to augment them to keep the pension system’s funding ratio from swinging like a pendulum.

2. What about the state’s tax competitiveness?

In considering any new taxes on business or the wealthy, policy makers must consider the consequences for the state’s ability to retain and attract jobs. Maryland could use some help on that score. From 1998 to 2008, Maryland added 272,600 jobs, an 11.7% growth rate, according to the Bureau of Labor Statistics. Over the same period, Virginia added 437,500 jobs, a 13.2% growth rate and D.C. added 91,300 jobs, a 14.9% growth rate. Maryland’s seasonally adjusted employment in October was 2,533,700, a decline of 3.1% from its all-time high of 2,616,000 in February 2008. Maryland’s seasonally adjusted unemployment rate has exceeded 7.0% for seven months starting in May 2009, the first time that has happened since 1983.

The 2007 special session’s tax increases for high income earners and corporations caused Maryland’s tax competitiveness to fall from 24th to 45th among U.S. states according to the Tax Foundation. Maryland remains at 45th in their latest survey. The principal reason for Maryland’s low ranking is its top income tax rate, which the Tax Foundation believes discourages entrepreneurship. Here’s how Maryland’s top rate compares to neighboring states.

Pennsylvania: 3.07% flat rate
Virginia: 5.75% over $17,000
Maryland: 6.25% over $1 million
West Virginia: 6.5% over $60,000
Delaware: 6.95% over $60,000
District of Columbia: 8.5% over $40,000

D.C.’s rate is not a fair comparison since the District government performs the functions of both a state and a local government.

Take away Maryland’s millionaire tax and it performs slightly better against Virginia. While Virginia charges 5.75% on income over $17,000, Maryland charges 4.75% on income between $3,000 and $150,000 and rates varying from 5% to 5.5% after that. But Virginia does not allow its counties to levy income taxes. Maryland does, and its counties can charge up to 3.2% as a flat income tax rate.

Here’s how taxes compare across several jurisdictions in the Washington D.C. area.

Like it or not, Maryland is in tight competition with Virginia and other surrounding states for jobs. Will retention of the millionaire tax have an employment cost over the long run? Furthermore, Delaware, Pennsylvania and Virginia do not have combined reporting. If Maryland enacts it, will those states get a competitive advantage?

We do not have the answers to these questions yet. But they should be answered before Maryland considers imposing a permanent millionaire tax or combined reporting. The latter issue is one of many now being examined by a commission established during the special session.

We’ll look at some more questions tomorrow.