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Tax Revision Commission Summary Report
May 1998

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Chapter 3. Recommendations on Tax Reductions

Tax reductions

The law creating the Commission directed it to consider "the possibility that general rates might be reduced." The source of funding for such reductions was not identified.

Rate reductions may stimulate a growth in tax bases over time, but the Commission believes rate reductions will not be able to offset immediate revenue losses within a reasonable time. To recommend rate reductions, therefore, the Commission must find a source of funds to offset the lost revenues. There are three possibilities: (1) excess revenues may be available in the budget to pay for reductions; (2) the Commission can recommend new revenue sources or increased rates in some taxes to pay for reductions in other taxes; (3) the federal government can provide additional funds. The Commission is recommending only those reductions that can be accomplished within the District's current revenue-raising powers. Possible reductions that could be financed by changes in federal policy are discussed in a separate section (see page 76).

The Commission is not in a position to estimate the availability of revenue in the District's budgets to pay for rate reductions, but funding from this source does not appear to be an assured permanent answer.

Based on the official revenue projection of the D.C. Office of Tax and Revenue, local revenues will increase less than 2 percent annually through 2002 (Figure 36). This projection may be conservative because it projects continued stagnant property taxes and a decline in nontax revenues (Figure 37) despite some evidence of improvement in property values. Nevertheless, the District's economy and the historic performance of the tax system indicate that revenue growth rates over the next few years are not likely to exceed the inflation rate. It also is unclear whether this rate of growth even will be sufficient to provide necessary services.

Figure 36

DC Projected Total Local Revenues

Figure 37

DC Projected Local Revenues

The District has not determined the amount of spending that will be required in fiscal year 1999 or in future years. The preliminary baseline budget spending estimate--which does not include pay raises, management improvements, or other new spending — is about $200 million less than 1999 estimated revenues (Figure 38). This amount is available for deficit reduction, spending increases, or tax reductions. The mayor, District Council, and Financial Authority are deciding how to allocate the surplus.

The Commission recommends that any available revenues be used to reduce and eliminate the accumulated deficit without the use of long-term debt; to maintain and improve District services to retain residents and businesses; to reduce tax rates. These long-term goals are important because:

No long-term economic recovery will be assured until the District is financially healthy. Eliminating the accumulated deficit will change the District's image both locally and nationally.
Another important element of financial health is the commitment of the government to financing high-quality basic services used by residents and businesses. The cost of providing good services is difficult to predict because quality services require both improved management and adequate financial resources.
Of concern to the Commission is an equitable and productive revenue system that is viewed by businesses as reasonable for paying the costs of government. Therefore, the District should consider reducing taxes to eliminate inequities discussed in earlier sections and to make the tax system more competitive with adjoining jurisdictions.

Because the Commission cannot be sure that funding will be available in the budget to reduce taxes, the Commission's tax reduction recommendations are limited to reducing the rental property tax rate from 1.54 percent to 0.96 percent, and combining classes 3, 4, and 5 into a single commercial rate no higher than 1.92 percent or double the residential rate. The two property tax reductions should be made as soon as revenues are available for tax reductions.

Figure 38

DC Revenue Expenditure Comparison

Chapter 4. Taxes to Modify or Maintain

Sales of goods and services

The Commission is concerned that the District's sales tax base is small relative to personal income and has significantly declined during the 1990s. Several causes for the restricted base were identified, including a wide variety of exemptions that represent over 60 percent of sales, the presence of the federal government and international organizations that neither pay nor collect sales taxes, the ability of residents to shop in Maryland and Virginia, and perhaps lapses in administration.

The Commission considered but rejected several possible changes to sales tax policy, including broadening the tax base by taxing additional services and food, decreasing the tax rate, creating one uniform rate, and taxing organizations that now are exempt.

Sales tax changes considered, but rejected

Tax more services. The Commission considered increasing the types of services subject to the sales tax because services are the fastest-growing component of the national and District economies. In addition, if the sales tax base is to expand at a rate equal to the overall economy, it needs to include more of the services sector.

The District already taxes services more broadly than surrounding jurisdictions, but there are some services not taxed in the District that are taxed by other jurisdictions, such as barber and beauty services, coin-operated laundries, and interior and decorating services (see Appendix H for information about services not taxed by the District). The Commission concluded, however, that the revenue generated by taxing these services would be minor and not worth the administrative problems that would be created. Moreover, many of the inputs in the production process of these services already are subject to taxation.

The larger component of untaxed services is professional services, such as legal, medical, and consulting. Other states have had little success in taxing these services. The Commission concluded that these services would be particularly difficult to tax in the District because of the close proximity of Maryland and Virginia, which do not tax professional services.

Tax all food. Extending the sales tax to food for home consumption also would broaden the tax base. Food for home consumption is taxed in Virginia but not in Maryland or the District. Taxing all food purchases would make the sales tax easier to administer and would provide more revenue stability in economic downturns. However, the Commission concluded that these benefits would not offset the increased burden that a tax on food would place on low-income households. It also noted the changes would yield only $18.5 million additional revenue.

Alternatively, the Commission considered taxing food and offsetting the additional burden with an income tax credit for low-income persons. However, a credit would be cumbersome to administer and would not be available at the time purchases were made. In addition, the credit would consume a substantial portion of the estimated $18.5 million that would be gained from including food for home consumption in the sales tax base.

The Commission considered whether snack foods should be taxed at the 10 percent rate used for food for immediate consumption. It concluded that drawing the line between what is food for home consumption and what is food for immediate consumption will always be a problem as long as some food is exempt. Because there would be a loss of revenues from exempting snack foods and the exemption does not appear to provide administrative savings, the Commission recommends no change in the policy of taxing snack foods.

Decrease tax rate. The Commission considered decreasing the sales tax rate to make it comparable to the rates of neighboring jurisdictions as a way of stimulating more taxable sales in the District. The small geographic area of the District makes it easy for residents and businesses to make purchases in nearby states with lower rates. Even though the use tax should provide revenues to the District for these purchases (the use tax applies to products purchased outside the District for use in the District), it is difficult to enforce the use tax except for some business purchases.

Even though sales tax rates usually influence buying patterns, the Commission's research found that the high sales tax rate has not been the principal cause of the District's declining share of retail activity. Instead, the decline is attributable to the District's loss of population.

Therefore, the Commission concludes that any decrease in rates could be expected to have only long-term effects because shopping habits and locations have been formed over many years and would change slowly. The Commission also notes that more than 50 percent of the sales tax revenues are paid by tourists and businesses. A rate reduction would result in an immediate loss of revenues from those sources over the short term, and the Commission is not able to recommend a source to replace them.

Reduce complexity. The Commission also rejected reducing the complexity of the sales tax by replacing the five existing sales tax rates with one uniform rate. To maintain existing revenues, combining the taxes would result in a 7.6 percent sales tax. The Commission found the benefits of a uniform rate were not sufficient to justify the potential shift in sales tax burden from visitors and commuters to residents. This shift would result because the rates of taxes most likely to be paid by visitors and commuters — parking, restaurants, meals, hotel rooms, and alcoholic beverages — would be lowered. The Commission recommends retaining the selective sales tax rates on cigarettes, gasoline, and alcoholic beverages for the same reasons.

Tax organizations that are now exempt. The Commission also rejected changing the legal incidence of the sales tax so it is imposed on the seller rather than on the purchaser. This shift would have expanded the base of the tax to include sales to the federal government, international organizations, and nonprofits. And there is some precedent in that the District uses this procedure so these organizations pay the utility gross receipts tax. In addition, New Mexico has successfully taxed sales to the federal government by imposing its tax on the seller.

The Commission believes, however, that if the District used such an approach to tax sales to the federal government and surrounding jurisdictions did not, District businesses would lose sales to their competitors in Maryland and Virginia. Therefore, the Commission concludes that changing the sales tax from the buyer to the seller should only be done on a regional basis.

Recommendation: Repeal tax on sales of manufacturing equipment

The Commission recommends repealing the sales tax on purchases of manufacturing equipment. This change will be consistent with the current policy of not taxing purchases of materials incorporated in a product that later will be taxed when sold at retail. By not taxing inputs to manufactured products, the District avoids double taxation or pyramiding. It also adds consistency because the District now imposes the sales tax on sales of manufacturing equipment, but not on rentals of manufacturing equipment. The loss of revenue is estimated to be negligible because there is little manufacturing in the District.

Recommendation: Enforce collection of sales tax on goods sold by federal entities and nonprofits to nonexempt purchasers

Sales made by nonprofits, the federal government, or federal entities (such as the Smithsonian Institution) to otherwise taxable purchasers are subject to the District sales tax, and the District should vigorously enforce its right to tax these sales. For example, if a tourist pays a sales tax when purchasing a gift in a hotel gift shop, he or she should pay the tax when purchasing the same gift at the Air and Space Museum; the tax is on the tourist, not the museum. The tax status of the seller should not exempt it from the duty to collect the sales tax on taxable purchasers.

Current District law, which would not change under the Commission's proposal, exempts most purchases by nonprofit organizations from the sales tax. To be exempt, institutions must be located within the District and carry on activities to a substantial extent within the District. Such activities also must result in substantial benefits to citizens of the District.

The Commission rejected a proposal to impose a stricter standard for exempting nonprofit organizations from the sales tax on their purchases. The administrative process required to enact a stricter standard would be too complex relative to the potential increase in revenues that could be achieved.

Electronic commerce

Electronic commerce poses a new challenge to taxing purchases in the District. When an individual enters a store in the District and purchases a good or service subject to the sales tax, District law requires the seller to collect the applicable sales tax. Electronic commerce, however, involves a different kind of interaction; sales via the Internet may never involve face-to-face contact between buyer and seller. The Commission believes that the place a customer makes a purchase — whether a computer or a store — should not change the tax treatment of the transaction.

If the tax due on Internet sales and other forms of electronic commerce is not collected, the impact will be twofold: (1) electronic sellers will enjoy a price advantage (equal to the 5.75 percent sales tax rate) over District merchants; and (2) the District will lose sales tax revenue.

Recommendation: Follow four principles in addressing sales by electronic commerce

Legislation pending in Congress would limit the ability of the District (and all states) to collect sales tax from electronic sellers. This legislation would impose an unfunded mandate on the District, limiting its ability to collect the tax on sales to consumers in the District. The Commission recommends that the District oppose any legislation that would limit collecting sales tax on electronic sales. The Commission also recommends that the District join coalitions of other state and local governments that oppose this potential unfunded mandate.

The Commission recommends that the District follow four principles in addressing the challenge of electronic commerce:

Electronic presence should be treated similarly to physical presence. Selling and delivering goods and services to persons in the District constitutes economic presence, and the sale should be subject to the applicable sales tax.
The means of the sale (electronic or face-to-face) should not determine the sale's tax status.
The tax should be applied on the basis of the destination of a sale.
Sales should be taxed at the point of final use.

Recommendation: Continue to tax charges for Internet access

The Commission recommends no change in the District's current taxing of charges for Internet access by Internet service providers. Internet access service is similar to many other entertainment and retail services that are currently subject to the sales tax.

Nonprofit organizations

Recommendation: Continue to exempt nonprofits from property taxes

The Commission does not recommend changing at this time the District's policies that exempt nonprofit organizations from paying property taxes. Although the Commission finds that many of these organizations should be required to contribute to the cost of government, it is unable to recommend an administratively and legally acceptable system for differentiating those organizations that should pay from those that should not.

The District government exempts from the property tax a wide variety of privately owned properties that meet nonprofit and other eligibility requirements and that potentially might pay substantial amounts of taxes (Figure 39). In general, the exemptions provided in the District law are similar to those provided by other states and cities. They include churches, schools, higher education and research institutions, hospitals, cemeteries, museums, and other similar facilities, provided the properties are not operated for profit. In addition, federal law exempts some specific properties, such as the American Chemical Society. Some of the properties exempted by federal law also would be exempt under District law. The number of tax-exempt properties in the District is increasing.

Figure 39

Nongovernmental Tax Exempt Property

Category	Revenue foregone ($ millions)
Religious	$27.1
Educational	37.4
Charitable	6.9
Hospitals	15.2
Libraries	0.3
Cemeteries	2.5
Other	39.2
Total	$128.6

Note: Revenue foregone is based on the 2.15 percent commercial property tax rate using 1996 assessment levels. "Other" includes property exempt by act of Congress and property exempt or partially exempt through District home ownership promotion programs.

Source: D.C. Office of Tax and Revenue, Study of Property, Income and Sales Tax Exemptions in the District of Columbia, 1995.

Arguments for making nonprofits pay taxes

The Commission believes nonprofits should pay taxes for several reasons:

Tax-exempt properties benefit from the same police, fire, and other services as those received by taxable properties.
Exempting properties owned by nonprofit organizations creates inequities in tax treatment between organizations that own their facilities and those that rent space. Nonprofit organizations that rent space pay implicit (or often directly stated) property taxes as part of their rent payment. By owning a property, the tax is avoided and a hidden government subsidy is thereby provided.
Those most able to pay generally own buildings and benefit from the exemption, while those least able to pay generally rent property and are taxed. If the subsidy were a budgeted outlay of the District, the organizations receiving the subsidy undoubtedly would be much different than the organizations now receiving tax exemptions.
The current system also violates tax neutrality because some organizations providing competing services are taxed, while others are not. For example, hospitals and nursing homes may be operated either as profit or nonprofit enterprises, and they compete for the same patients. To some extent, this difference in taxes may be justified if the tax-exempt facilities are providing services to the poor not provided by the taxable facilities. In many cases, however, the benefits provided by tax exemption may not directly equate to services provided, and the taxable facility may provide similar services.

Barriers to taxing nonprofits

The Commission nevertheless recognizes that it would be difficult to recommend taxing all nonprofits uniformly. Some organizations, such as cemeteries, have few or no resources to pay taxes. Others, such as churches, are almost universally not taxed on their actual places of worship. Many nonprofit organizations provide valuable services to District residents that might otherwise have to be provided by the District government; these include nursing homes and day care centers. Others provide national benefits, such as basic research, but provide few benefits locally. The Commission explored, but rejected, the possibility of a tax or payment in lieu of taxes to target those organizations that provide few services to District residents. This approach was rejected because the administrative and legal tests required to distinguish between the national and local benefits are likely to be arbitrary and uncertain, and violate the Commission's goal of tax simplicity.

Other state and local governments have had trouble with policies that require some nonprofit organizations to pay taxes or make in lieu payments. They report difficulty in determining what level of services justifies the exemption and the extent to which those services must directly benefit residents. The design of such legislation for the District would present similar difficulties. Also, the legality of such legislation may be questioned because in a Maine case, the U.S. Supreme Court ruled against state tax exemptions that take into account the proportion of benefits that flow to a state's residents.

Administering a policy that fairly distinguishes exempt from nonexempt organizations would be complex because it would require separately evaluating each applicant. In addition, Pennsylvania's experience shows that nonprofits that are denied exemptions tend to appeal, leading to many lawsuits.

While the Commission is unable to recommend imposing taxes on or requiring other payments by nonprofits, it believes nonprofit organizations should contribute to the cost of the benefits they receive from the District. Therefore, the Commission does not rule out possible payments in the future. In anticipation of this possibility, the Commission urges the District to improve the accuracy of its assessments of nonprofit properties.

Utility services

Recommendation: Tax all functionally equivalent services uniformly

The Commission recommends that the District uniformly tax utility services that are functionally equivalent. This policy requires changing the law that links the gross receipts tax to services classified as "public utility services." Instead, the law should enumerate the services subject to the gross receipts tax and leave the list open to administrative expansion to accommodate new technologies for delivering those services. The Commission also recommends that outside firms — those without a physical presence in the District — that are permitted to sell utility services to District customers be required to pay the District tax, as acondition of market entry.

These changes are required by the changing marketplace. The gross receipts tax on utility services historically involved a single local firm providing all the services taxed: one company provided telephone service, one company provided electricity, one company provided natural gas service. But these markets are being opened to competition. Entry into long-distance telecommunications already is open, and more than 100 firms provide these services in the District — and are taxed for them. As deregulation continues, there may be as many firms providing local telecommunications, natural gas, or electricity services.

Utility tax changes considered, but rejected

The Commission considered but rejected several possible changes to utility taxes, including reducing the gross receipts tax, repealing the sales tax on nonresidential services, and taxing prepaid long-distance phone cards.

Reduce gross receipts tax. The Commission considered and rejected, at this time, reducing the 10 percent gross receipts tax rate. The District's tax is higher than Maryland's and Virginia's. But it does apply to sales to the federal government and tax-exempt organizations. As a result, to offset the attenuated District tax base, the Commission recommends maintaining the current rate, which represents a way of taxing otherwise exempt institutions.

Repeal sales tax on certain nonresidential services. The Commission also rejected, at this time, repealing the 5.75 percent general sales tax that is now added to the gross receipts tax levied on nonresidential services. This combined rate is the highest on any purchase of goods or services in the District. Although the Commission is concerned about this additional tax on top of the gross receipts tax, it has not identified another offsetting revenue to replace the $24 million that would be lost if the 5.75 percent general sales tax were repealed. The Commission recommends, however, that the goal should be to eliminate the tax on commercial consumers if the fiscal situation improves.

The Commission makes no recommendation on imposing user fees to finance "911" services or imposing right-of-way fees on utilities that make use of the public right of way.

Tax prepaid long-distance phone cards. The Commission considered and rejected, at this time, changing the taxation of phone cards. Prepaid phone cards are an example of a new technology's challenging traditional approaches to taxing. Prepaid phone cards now are most commonly purchased in retail outlets and are subject to a sales tax of 10 percent when purchased in the District. But the District does not tax cards purchased in other jurisdictions, even when they are used to make calls in the District. The Commission recognizes that collecting taxes at the retail outlet is the administratively simplest approach. Although phone cards now tend to be convenience purchases, they have the potential to be used on a large scale to avoid the District's long distance telecommunications tax of 10 percent. If this occurs in the future, the Commission recommends that the current policy be reconsidered.

Property assessment

Fair and equitable property taxes must be based on assessments that reflect true value of all properties assessed on a uniform basis. In addition, taxpayers must have credible and clear evidence that such assessment policies are being followed. Much of the dissatisfaction with property taxes stems from taxpayers' belief that properties are not being assessed uniformly. The Commission recognizes that this loss of confidence in the fairness of assessments has been particularly prevalent in the District in recent years.

Recommendation: Return to annual assessments

The Commission notes that the District is undertaking major reforms of its assessment procedures and concurs in general with the changes. However, one of those changes institutes triennial assessments of property. The Commission believes that fair and productive property taxes require annual assessments of value and recommends that the District should return to annual assessments at an early date, perhaps at the end of the second round of triennial assessments.

Triennial assessments mean that, effective with tax year 1999, the city is divided into three geographic areas, with assessments in each area to be conducted on a staggered basis over three years. The new values are to be phased in by equal increments in each of the three years following the valuations. This triennial system is patterned after the one in use in Maryland. The reason cited for the change is the inability of the assessment staff to do "an effective property inspection and data collection process."

At first, the triennial system probably will improve individual property assessments because the assessors will have smaller annual workloads of properties to value. However, because assessed values will be determined and fully implemented over three years, the new system will produce assessed values that are different overall and less uniform than those produced by a good annual assessment system.

In addition, under the triennial system, individual property owners will never see the true market value of their property used as an assessment base for calculating their tax liability. For the year in which the assessment is made, the owner can judge the accuracy of the valuation relative to other properties valued in that year of the three-year cycle. However, the property owner cannot judge the fairness of the value compared to values established on properties in the other two years of the cycle. Thus, two properties with the same market value in any year can have different bases of assessment and will be taxed different amounts in that year. While the relative taxes paid over time may be about the same for the two properties, the triennial system will not provide transparent, fair treatment.

In contrast to the annual assessment goal of full-value assessments for all properties each year, all properties in the triennial system will be taxed on values that are less than true value. This means that when true values of property are increasing, the District's property tax base will always yield less revenue than would have been received from the stated rates, if they were applied to true values. In periods of low inflation, the lower assessments will not seriously erode District revenues. In high inflation periods, however, the District will find it difficult to obtain sufficient revenues from the property tax without raising tax rates.

With full-value annual assessments, a rate increase or decrease will be applied uniformly to all property owners in the classification. By contrast, rate increases or decreases with triennial assessments will cause unequal changes in individual tax liabilities. Properties with the same market value will be assessed and taxed at different levels, creating problems of equity.

As the District relies more on a computer-assisted, mass appraisal system, it will be feasible to return to annual changes in assessed values, where warranted. Annual physical inspection of every property should not be necessary to reflect values accurately.

Recommendation: Improve assessments of cooperative housing

Uniform assessments require that assessors be able to use the most appropriate means to determine the fair current values of properties; legal restrictions or directives that inhibit assessors should be removed. Therefore, the Commission recommends repealing the special statutory provisions for assessing cooperative residences and instead, requiring the assessment office to enact rules for the methods of assessing them. The Commission recognizes that the ownership structure of cooperatives is unique, but it is only one of several factors that must be considered by assessors when establishing values. If a cooperative taxpayer believes an assessment is not accurate, the same right of appeal should be followed as that used by other owners.

Recommendation: Change performance measures

The Commission recommends that, regardless of how well future assessments are made, the public will need solid proof that assessments are uniform. Therefore, the Commission recommends the following changes in performance measures used to evaluate assessments:

In computing sales assessment ratios, all qualifying sales should be used to calculate ratios and coefficients of dispersion. The method currently used includes only the middle 50 percent of the properties arrayed by assessment level. To assure comparability, both the current method (not using all sales) and the recommended method (using all sales) should be reported.

The District should calculate and publish assessment ratios that show the relationship between assessment and price. This will permit residents to observe whether there are biases in assessments related to properties of different values.

Properties of different types and in different areas tend to change in value at different rates because of underlying differences in their attributes. Therefore, assessments should not be increased from year to year by a uniform multiplier.

Split-rate property tax

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

The Tax Commission Establishment Act of 1996 requires the Commission "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 taxes paid by the average taxpayer." The Commission conducted the required analysis, and after reviewing the results, does not recommend a split-rate property tax (one with higher rates on land than on improvements) at this time.

Evidence presented to the Commission found that while higher taxes on land would be neutral relative to development, there is no evidence that they would be beneficial in promoting increased development. For example, Professor Robert Schwab, co-author of a current and landmark study of Pittsburgh's graded tax, concluded that "a land tax did not cause a building boom in Pittsburgh, but it did allow the city government to avoid policies that might have undercut that boom."

To impose a split-rate structure on the existing five-rate classified structure would require either establishing five differential rates on land or eliminating the classification system. Five separate land rates would violate the concept that land should be valued uniformly and not on the basis of its current usage. Eliminating classifications would result in unacceptable, substantial shifts in tax burdens from commercial to residential. Even with a reduction in classifications to two, as recommended in this report, the classification problem would remain.

After reviewing five different possibilities for implementing split rates, the Commission was concerned that there would be large, inadvertent shifts in taxes for individual property owners. While the alternatives examined showed that it would be possible to maintain reasonably equal burdens by classes of taxpayers and by geographic areas, it is impossible to establish a split-rate structure without shifting burdens on individual properties in unanticipated ways.

The Commission also was concerned that a shift to split rates would cause administrative problems for assessors in determining fair land values independent of current use, and would result in substantial legal challenges to the resulting assessments. Some emerging technologies, such as computer-assisted mass appraisals using multiple regression analysis to test accuracy, may be feasible in the future, but they currently are not within the District's capabilities.

Earmarking

Recommendation: Reduce or eliminate earmarking

The Commission recommends reducing or eliminating earmarking revenue sources for particular purposes, whenever legally possible. Earmarking does provide some advantages: It permits a tax to be linked to a specific service, such as using gasoline and motor vehicle taxes to finance highway construction and maintenance, and it also may ensure a minimum level of funding for essential services or for services that are difficult to finance with general revenues.

Nevertheless, the Commission recommends discouraging earmarking because it limits the flexibility of fiscal choices and reduces oversight of spending. Moreover, there is evidence that earmarking reduces long-term support for earmarked services. Also, earmarking creates an administrative burden, diverting staff from what should be their first priority, efficient tax administration.

About 23 percent of the District's revenues are dedicated to earmarked purposes. Earmarks have been used mainly to facilitate the sale of bonds and to meet federal mandates. Ten specific taxes and several other major revenues are earmarked in the District to be used for six different categories of expenditures. Several of the revenues are earmarked for more than one purpose.

For example, about three-quarters of all property tax revenues are earmarked for payment of general obligation debt service in 1998. The MCI Arena construction required earmarking the arena tax on business gross receipts for improvement bonds. The proposed new convention center bonds require earmarking portions of five different taxes. The federal government requires the District to earmark fuel taxes for highways and parts of seven different taxes to provide "stable and reliable" revenue support for the Washington Metropolitan Area Transportation Authority (WMATA). The only nonbond, nonfederal earmarking is the hotel occupancy tax ($1.50 per day) for promoting the District as a travel and tourism destination.

Other states also use earmarks; they account for a range of revenues, from 87 percent in Alabama to 4 percent in Kentucky. The District's percentage is about average. All states earmark taxes on motor fuel. Other frequently earmarked taxes include general sales (33 states), motor vehicle registration (32 states) and tobacco (27 states).

Recordation and transfer taxes

Recommendation: Tax transactions involving cooperative housing

The Commission considered two issues in the transfer and recordation tax. In one area, the exemption of nonprofits from the tax, the Commission recommends no change. In the second, the Commission recommends taxing cooperatives in the same way as other housing transfers.

The District imposes a 1.1 percent tax to record deeds and transfers of real property. In the case of cooperative housing, there is no deed because the purchaser is not purchasing a distinct plot of ground or unit in a building. Instead, the purchaser buys shares in a corporation that owns the housing and a proprietary lease agreement for the unit. The Commission recommends that lease assignments involving cooperatives be treated in the same manner as property transactions that involve deeds. Owners of proprietary leases in cooperatives would be required to register their assignments with the Recorder of Deeds at the time of sale and pay the transfer and recordation taxes. Data from these transactions also will make it possible to implement another of the Commission's recommendations--to assess cooperatives based on fair market value. Data on transaction prices can be used by the District's real property assessors for this purpose.

Superseded recommendations

The Commission was prepared to recommend changes in several other areas. However, in each of these areas, the issue has been made moot by one of the broader recommendations for change.

Personal income tax

The Commission was concerned that the structure of the current Low Income Credit creates a "notch," a point at which only $1 more in income leads to a large increase in taxes. The credit protects low-income individuals and families from D.C. income tax obligations. It applies to taxpayers who have zero federal income tax liability but a positive level of District income tax liability.

As the Low Income Credit works today, having $1 in federal liability causes loss of the entire credit and subjects the taxpayer to the full District tax liability. For a family of four, married filing jointly, that first $1 in federal liability means loss of eligibility for the Low Income Credit and an increase in District tax liability from zero to $602. However, conforming the District's income tax to the federal levels of the personal exemption and standard deduction, as the Commission has recommended, would eliminate the notch in the current law.

Personal property tax

The Commission was concerned that the depreciation schedules for the personal property tax are unrealistic. For example, personal computers are required to be depreciated at a rate of 10 percent per year, and the value is never allowed to fall below 25 percent of the purchase price. Computers made five years ago with 386 processors are being sent to the trash heap as worthless. The District's approach to depreciation clearly departs from economic reality. However, the Commission's recommendation that the personal property tax be replaced with a business activities tax obviates the need to reform depreciation.

Business income tax

District entities cannot use net operating loss deductions from a non-District affiliate firm to reduce their tax liability. The District's treatment of losses should conform to the federal law. The Commission's recommendation that the business activities tax substitute for the business profits tax diminishes the significance of this issue. The proposed business activities tax should permit net operating loss carryovers to be used as credits against the new tax for a three-year transition period.

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Tax Revision Commission Summary Report May 1998