Simplicity and Fairness for Businesses

Abolish the four existing business taxes
Enact a business activities tax on value added at a rate of 1.50 percent
Introduce a single commercial property tax rate

Simplicity and Fairness for Individuals

Reduce complexity by conforming the District income tax to federal net taxable income

Making Residential Property Taxes More Equitable

Introduce a single 0.96 percent residential property tax rate
Replace current property relief measures with a generous low-income tax credit (circuit breaker)

Recommendations for the Federal Government

Allow the District to tax income at its source
Make a payment in lieu of taxes for federally owned property
Adopt a formula federal payment
Ensure that the District is compensated for GSEs' federal exemption from District business taxes

Chapter 3. RECOMMENDATIONS ON TAX REDUCTIONS

Tax reductions

Chapter 4. TAXES TO MODIFY OR MAINTAIN

Sales of Goods and Services

Repeal tax on sales of manufacturing equipment
Enforce collection of sales tax on goods sold by federal entities and nonprofits to nonexempt purchasers

Electronic Commerce

Follow four principles in addressing sales by electronic commerce
Continue to tax charges for internet access

Nonprofit Organizations

Continue to exempt nonprofits from property taxes

Utility Services

Tax all functionally equivalent services uniformly

Property Assessment

Return to annual assessments
Improve assessments of cooperative housing
Change performance measures

Split-rate Property Tax

Do not impose a split-rate property tax at this time

Earmarking

Reduce or eliminate earmarking

Recordation and Transfer Taxes

Tax transactions involving cooperative housing

Superseded Recommendations

APPENDICES

Appendix A: D.C. Tax Revision Commission Reports
Appendix B: Criteria and Conceptual Framework
Appendix C: Summary of the New Federal Tax Incentives for the District
Appendix D: Revenue from D.C. Taxes and Other Sources
Appendix E: Comparison of Proposed and Current Income Tax Forms
Appendix F: Potential Legal Challenges to the Business Activities Tax
Appendix G: Federally Tax-Exempt Organizations Subject to the Business Activities Tax
Appendix H: Services Not Taxed in the District
Appendix I: Dissents and Additional Views from Commissioners

Richard Halberstein
Jacquelyn V. Helm
Walter Nagel
Matthew S. Watson

List of Figures

1 D.C. Population, 1900-1996
2 Changes in Federal Employment in D.C.
3 Percent Change in Earnings of D.C. Residents and Nonresidents
4 Percent Change in Federal Spending by Sub-State Area
5 Number of Households in D.C.
6 Migration Patterns Out of and Into D.C.
7 Change in D.C. Household Size Categories
8 Change in D.C. Household Income Categories
9 Changes in Property Tax Values
10 Property Values in D.C.
11 Difference in D.C. Revenues from Major Taxes
12 D.C. Operating Revenues Less Expenditures
13 D.C. Taxes as a Share of Family Income
14 Per Capita Personal Income
15 Real Property Tax Bases of Major U.S. Cities Compared
16 D.C. Region TANF Cases
17 Business Activities Tax Rates Required to Replace Existing Taxes
18 Revenue Stability: Business Activities Tax Base Compared to Corporate Income Tax Base
19 Change in Business Sectors Relative to Total D.C. Economy
20 Business Income Tax Payments Relative to Share of Economic Activity
21 Service Sector as a Share of the D.C. Economy
22 Business Activities Tax Base and Existing Business Tax Base Compared
23 Revenue Effect of a Single Commercial Property Tax Rate
24 Commercial and Residential Rental Property Tax Rates as a Percent of the Owner-Occupied Rate
25 Total D.C. Taxes as a Percent of Family Income
26 Proposed D.C. Personal Income Tax Rates
27 Existing and Proposed Income Tax Rates Compared
28 Impact of Proposed Rates on Tax Burden
29 Effective Residential Property Tax Rates
30 Use of Existing Circuit Breakers
31 Proposed Sliding-Scale Circuit Breaker
32 Property Tax Relief: Proposed Circuit Breaker Compared to Homestead Exemption
33 Property Tax Relief: Proposed Circuit Breaker Compared to Homestead Exemption and Senior Citizen Relief
34 Federal Payments on Behalf of the District
35 Effect of Federal Property Tax Payment on Commercial Property Tax Rate
36 D.C. Projected Total Local Revenues
37 D.C. Projected Local Revenues, by Type
38 D.C. Revenue/Expenditure Comparison
39 Nongovernmental Tax-Exempt Property

This study of the District's economy and revenue systems relied heavily on the help of others. Marcia Howard provided early staff assistance in planning and research. The written reports of the consultants, who are listed in Appendix A, along with their oral presentations to the Commission were of critical importance and are greatly appreciated. The willingness of these consultants to provide continuing help and counsel during Commission deliberations is especially appreciated.

The staff of the D.C. Office of Tax and Revenue, headed by Dr. Natwar M. Gandhi, provided assistance that was essential to the Commission's work. Individual thanks are especially due to the following staff: Arthur Chisley, Kim Coleman, Modibo Coulibaly, Mark Gripentrog, Mohammed Hassan, Carolyn Lynch, David Meyer, Preston Niblack, Donal Parks, William Henry Riley, Kathy Sternberg, Raun Soloman, Stephen Swaim, and Edward Wyatt.

Other people throughout the District government provided help. While it is not possible to acknowledge everyone, we would like to extend special thanks to: the staff of the Financial Responsibility and Management Assistance Authority, including John W. Hill Jr. and Andrew Reece; the Chief Financial Officer, Anthony A. Williams and his staff including Norman Dong, Beth Solomon, and Laura Triggs; and Councilmember Frank Smith, Jr. and his staff including Anne Hargrove and Darrell Doss.

We would also like to thank the staff at KSA Group for their assistance with the final report, including: Adam Kernan-Schloss, Andrea Sussman, Joanne Olson, and Kathy Ames. Our thanks also go to Melinda Patrician for her help in arranging for the release of the final report.

In addition, the Commission was aided by the help of many private citizens and local business leaders who testified at public hearings or who submitted written statements.

The studies of the District economy would not have been possible without the help of John Ross and a grant from the U.S. Department of Housing and Urban Development.

The Commission appreciated the generous hospitality of George Washington University for providing meeting space for most Commission meetings.

The final report and its recommendations are, of course, solely the work of the Commission and its staff.

About the D.C. Tax Revision Commission

Creation of the D.C. Tax Revision Commission

The mayor and the District Council created the D.C. Tax Revision Commission in 1996 to recommend comprehensive changes in District taxes and other revenues. The law establishing the Commission, the Tax Revision Commission Establishment Act of 1996, was effective June 13, 1996. The Commission is composed of 20 members, nine appointed by the mayor, nine members plus a chair appointed by the District Council, and an ex-officio member from the Office of Tax and Revenue. It began deliberations in September 1996 and has held 19 meetings, all of them open to the public. The Commission also held three public hearings at the beginning of its work. The law creating the Commission assigned six duties:

To analyze the District's current tax system in terms of revenue productivity and stability, efficiency, equity, simplicity of administration, and effect upon the District's economy;
To propose innovative solutions for meeting the District's projected revenue needs while exploring possibilities for reducing general rates;
To identify economic activities that are either beneficial or detrimental to the District's economy and that should be either encouraged or discouraged through tax policy;
To recommend changes in the District's current tax policies and laws;
To establish criteria and a conceptual framework for evaluating current and future taxes; and
To conduct an analysis of a split-rate approach to real property taxation together with a recommendation as to how it could be structured with minimal effect on the average payer's taxes.

A small staff and several expert consultants performed the Commission's work. Completing this work will cost about $900,000. This amount includes a $50,000 grant from the Department of Housing and Urban Development for the Commission's studies of the District economy, with the balance coming from the District government.

Members of the D.C. Tax Revision Commission

Robert D. Ebel, Chair
The World Bank Group

Timothy C. Coughlin
Riggs National Corporation

Marie Drissel
Institute for Real Property Studies

Bert T. Edwards
Retired Partner, Arthur Andersen, LLP

Thomas Elzey
Howard University

Julia Friedman, ex officio
Office of Tax and Revenue

Richard Halberstein
Halberstein & Byrne

Jacquelyn V. Helm
Law Offices of Jacquelyn V. Helm

James L. Hudson
Offices of James L. Hudson

Iris J. Lav
Center on Budget and Policy Priorities

Rosemary D. Marcuss*
*Resigned February 28, 1998

Walter Nagel
MCI Communications Corporation

Jerome S. Paige
Information Resources Management College, National Defense University

Robert Pincus
Franklin National Bank

Robert Pohlman
Financial Consultant

Carolyn L. Smith
Coopers & Lybrand LLP

Stephen Trachtenberg
George Washington University

Sterling Tucker
Sterling Tucker Associates

Matthew S. Watson
Law Office of Matthew S. Watson

Joslyn Williams
Metro Washington Council AFL-CIO

Staff

Philip M. Dearborn
Executive Director

Stephanie Richardson
Research Assistant

Hanns Kuttner
Consultant

Carol S. Meyers
Consultant

Process, criteria, and conceptual framework

Research for the Commission was carried out by both its staff and outside experts. Eighteen separate reports and analyses were presented at the Commission's meetings. The reports examine the District economy, each of the major taxes, and the federal relationship with the District. (See Appendix A for a list of the researchers and their reports.) This Summary Report from the Commission contains a summary of the research findings and the Commission's recommendations. A full report of the Commission's work and research will follow at a later date.

At the start of its work, the Commission agreed upon the characteristics of a good revenue system and used these criteria to guide its actions. The six general characteristics are summarized below. See Appendix B for the entire Criteria and Conceptual Framework, which guided the Commission's work.

The tax system must be fair in apportioning tax burdens and consistent in its application.
The tax system must be easy for taxpayers to understand.
The tax rates and tax structure must be perceived by District businesses and individual taxpayers as a reasonable cost of locating in the District.
The revenue system should have as its primary purpose raising revenues from the city's overall wealth base to support required basic services.
The District government must have the ability to administer and enforce all parts of the recommended revenue system.
The District's revenue system must be viewed in conjunction with the federal revenue system.

Summary of Recommendations

Business Taxes

Abolish the four existing business taxes: corporate income, unincorporated business, tangible personal property, and professional license fee.
Enact a broad-based general business activities tax on value added (compensation, interest, and dividends) at a rate of 1.50 percent. This tax will replace the four existing business taxes and raise an equal amount of revenue.

Personal Income Taxes

Use federal net taxable income to calculate personal income tax obligations, and enact a new revenue-neutral tax rate schedule.

Real Property Taxes

Repeal the four existing property tax relief measures: the $288 homestead exemption, senior citizen exemption, general circuit breaker, and elderly and disabled circuit breaker.
Enact a new circuit breaker that replaces the four existing property tax relief measures and provides the equivalent amount of total property tax relief.
Consolidate the five real property tax rates to two by (1) reducing the rental residential rate to the owner-occupied rate and creating a single residential rate of 0.96 percent; and (2) combining the other three rates to a single commercial rate.
Limit the commercial rate to no more than twice the residential rate. The $89 million required to accomplish this recommendation is not currently available.
Do not impose a split rate property tax (one with higher rates on land than on improvements) at this time.
At an early date, return to annual assessment for all properties.
Repeal the special statutory treatment of cooperatives and assess them on a fair market value basis.
Reform assessment practices by (1) using all qualifying sales to calculate ratios and coefficients of dispersion; (2) reporting both the old and new methods of computation; (3) calculating and publishing price-related differentials in assessment ratios; and (4) not increasing assessments by a uniform multiplier.
The Commission considered and rejected a proposal to require exempt nonprofit organizations to pay property taxes.

Taxing Sales of Goods and Services

The Commission considered and rejected proposals to broaden the sales tax base by adding additional services or taxing food for home consumption. The Commission also considered and rejected proposals to make purchases by all nonprofit organizations subject to the sales tax and to eliminate sales tax on Internet access charges.
For purchases over the Internet, (1) treat electronic presence similarly to physical presence for determining whether the sale of a product is subject to the applicable sales tax; (2) do not determine a sale's tax status based on the means of the sale; (3) apply the tax on the basis of the destination of the sale; and (4) tax sales at the point of final use.
Enforce collection of sales tax on goods sold by federal entities and nonprofit organizations to nonexempt purchasers.
Exempt manufacturing equipment from the sales tax to prevent tax pyramiding.

Utility Services Taxes

Tax all functionally equivalent utility services at the 10 percent gross sales rate by (1) changing the statutory definition of "public utility services" in the D.C. Code to an enumeration of services taxed; and (2) requiring providers to concede nexus as a condition of market entry.
The Commission considered and rejected a proposal to tax prepaid phone card use the same as long distance calls that are billed.

Recommendations to the Federal Government

Lift the ban on the District's ability to tax nonresidents' income.
Make an annual payment in lieu of property taxes to be used to reduce the District commercial property tax rate.
Adopt a formula federal payment.
Ensure that the District is compensated for Government Sponsored Enterprises' federal exemption from District business taxes.

Other Recommendations

Reduce or eliminate earmarking of taxes where legally possible, and discourage future earmarking.
Subject transactions involving cooperative housing units to recordation and transfer taxes.
The Commission considered and rejected a proposal to subject nonprofit organizations to recordation and transfer taxes.

Superseded Recommendations

The Commission was prepared to recommend additonal changes. Each of these, however, has been rendered moot by one of the broader recommendations for change.

Eliminate the notch problem of penalizing tax filers with incomes that are one dollar higher than the eligibility amount for the low income tax credit. This recommendation is superseded by the Commission's recommendation to use federal net taxable income to calculate personal income taxes, which eliminates the need for the low income tax credit.
Correct the unrealistic depreciation schedules used for calculating taxable values for the personal property tax, particularly those for computer equipment. This recommendation is superseded by the Commission's recommendation to repeal the personal property tax.
Make treatment of net operating losses in calculating corporate income tax conform with federal law. This recommendation is superseded by the Commission's recommendation to repeal the corporate income tax.

Introduction: A Time to Embrace Change

The District of Columbia is beginning to recover from a substantial financial and administrative crisis. Real progress will depend on changing course, not making minor adjustments and then reverting to business as usual. In short, this city must embrace change.

Members of the D.C. Tax Revision Commission welcome the opportunity to bring a fresh perspective to long-standing tax practices. Commission members believe the tax system is an expression of a relationship between the people and their government. Building on that public trust, the Commission devised strategies to ensure that the fiscal system serves the city well. The result is a range of recommendations: wholesale change for some elements, slight revisions for others, and no changes at all for those parts of the existing system that function effectively.

All decisions were guided by a straightforward set of principles: The District's tax system should be easy to understand and manage, it should be fair to both residents and businesses, and it should allow the District to attract — and retain — both businesses and residents.

In recent years, the tax and revenue system has developed in a piecemeal fashion as the government took small actions in response to specific concerns. The resulting tax system is burdensome and repetitive and would require reform even if the District had no visible economic problems. Moreover, in the 20 years since the last comprehensive review of the District tax code, the city's economic, demographic, intergovernmental, and political circumstances have changed dramatically. It is time to make the tax code fairer and simpler.

Commission members recognize that the District's problems have many causes unrelated to taxes, and that changes to the tax structure —no matter how significant —are only part of the solution; expenditures, management, and other issues also must be addressed. The recommendations in this report will help the District build on its progress and maximize its strengths. Implementing some of the recommendations may be challenging because they will substantially change the existing system and inevitably cause some redistribution of taxpayer burdens. Nevertheless, the Commission believes it is essential to make changes to improve the District's overall economy and thereby maintain, and advance, the city's recently improved, but still fragile financial health.

Tax Revision Commission Summary Report May 1998

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