DC Tax Revision Commission
Fact Sheets on Final Recommendations
May 2, 1998

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DISTRICT OF COLUMBIA
TAX REVISION COMMISSION
1755 Massachusetts Avenue, NW, Suite 550
Washington, DC 20036
Phone (202) 518-7275 Fax (202) 466-7967

FACT SHEET

Business Taxes

• Abolish the four existing business taxes: corporate income, unincorporated business, tangible personal property, and professional license fee taxes.
• 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 measure – 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 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 .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 (perhaps the second round of triennial assessments), 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, and 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 all 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

Each of the following recommendations has been made 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.

May 4, 1998

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FACT SHEET

How the Recommendations Will Affect D.C. Residents

The Commission recommends making residential property tax rates more equitable and replacing the multiple property tax relief programs (measures that reduce property taxes) with a single program based on ability to pay.

To achieve these goals, the Commission recommends: (1) consolidating the .96 percent owner-occupied rate and the 1.54 percent rate on rental properties into one .96 percent tax rate; (2) repealing the $288 homestead exemption for owner-occupied properties and the senior citizen 50 percent tax reduction programs; and (3) replacing existing exemptions and income-related relief measures with a single, more generous program. A separate recommendation simplifies the process of calculating District personal income taxes.

Recommendation: A single .96 percent residential property tax rate
District residents should have an equitable tax system, which includes a single, uniform rate for all residential property taxes. Currently, owner-occupied residences are taxed at a .96 percent rate, rented residences at a 1.54 percent rate. The Commission recommends reducing the 1.54 percent rate to .96 percent.

Recommendation: Repeal existing relief measures and exemptions; replace them with a single, generous relief program
The Commission believes that all residents of the District receive the benefits of government services and are entitled to equal treatment, regardless of whether they rent or own, or are old or young. Further, the greatest reduction should go to those who need the most help paying their taxes.

Right now, the District provides property tax relief — lower property taxes — for a variety of reasons, including age and physical condition. The formulas for these relief programs are complex and hard to understand. Moreover, they don't necessarily reduce the taxes of those who need the most relief. Therefore, the Commission recommends repealing these measures, as well as the $288 homestead exemption and 50 percent senior citizen tax reduction, and replacing them with a measure that reduces the taxes of those who need the most relief.

The $288 homestead exemption
Repeal of the homestead exemption will not create significantly higher property tax bills for any district homeowners. Under the Commission's proposed plan, many homeowners will have lower property tax bills. Some will have slightly higher property taxes, but the maximum increase for any homeowner will be $288.

In the District's current property tax system, homeowners' taxes are reduced in two ways: (1) owner-occupied residences are taxed at a .96 percent rate, a reduction from the 1.54 percent rate for rented residences; and (2) homeowners receive a $30,000 break on the assessed value of their homes. This produces a savings of $288 for every homeowner ($30,000 x .96 percent). The homestead exemption refers only to the second item — the $288. The bulk of homeowners' property tax savings comes from the lower tax rate, and under the Commission's proposed plan, owner-occupied residences would continue to be taxed at the .96 rate, the lowest property tax rate in the District.

Generous, means-tested property tax relief
ad of giving every homeowner the same across-the-board $288 reduction in property taxes, the Commission proposes a means-tested reduction. Homeowners with incomes lower than $85,000 can receive a reduction of up to $1,000 in their property taxes. The Commission believes the circuit breaker should be simple, and the sole criteria for eligibility should be ability to pay, not age or physical condition. Therefore, the Commission recommends a single relief measure in the form of a generous circuit breaker, a measure that reduces taxes when certain criteria are met. The Commission proposes a circuit breaker with the following characteristics:

1. A sliding scale that is based on the owner's household income bracket and specifies the percentage of property tax that will be relieved for each bracket.
2. Maximum relief for any individual taxpayer of $1,000.
3. Relief that is provided to both owner-occupied properties and to renters, using the assumption that 15 percent of the rent paid is for property taxes.
4. For owner-occupied properties, credit that is returned through an offset to property tax liability, as is done in Maryland.
5. For renters, credit that is claimed on personal income taxes and is refundable if the income tax liability is smaller than the credit.

Recommendation: Base District income tax on federal net taxable income
District residents use the same adjusted gross income for their federal and District income taxes. The net taxable income, however, is different because the District has lower personal exemptions, standard deductions and allowable itemized deductions. The Commission recommends that District residents calculate their District income tax liability using the net taxable income amount from their federal tax returns.

This change will simplify the process of calculating District tax liability, and lower or remove the income tax burden from poor families. It also will increase the income level at which tax is first owed and thereby allow an estimated 40,000 District residents to stop filing tax returns. Because no District taxpayer with income below the poverty level would have to file a tax return, the District's current Low Income Credit would no longer be necessary.

Under the Commission's proposed rates, the poorest 60 percent of taxpayers would experience a 0.3 percent to 1 percent tax reduction. The next highest 20 percent would see no change. Taxes of the top 20 percent would increase about 0.2 percent. Of course, individual taxpayers whose returns have unusual financial characteristics could experience changes in liability outside the average effects.

Taxpayers would be required to file District returns using the same filing status used in their federal returns. Thus, the District's married-filing-combined-separate status would be eliminated.

May 4, 1998

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FACT SHEET

The Commission recommends a fundamental change in the way the District taxes businesses. Its plan broadens the tax base, lowers business tax rates, makes business taxes more equitable and lowers commercial real property tax rates. In addition, the proposed plan provides a foundation for a simpler, more predictable, stabler revenue system, making D.C. more competitive for jobs and residents.

Recommendation: Introduce a business activities tax
The Commission recommends introducing a new business activities tax that would replace existing business taxes — corporate income tax, unincorporated business tax, tangible personal property tax, and business and professional licensing tax. The proposed system taxes business activity value, which is common to all businesses operating in the District.

The business activities tax will be imposed on a base that includes three elements: compensation, interest and dividends. These elements represent the business enterprise's outlays for the use of capital and labor in the District, i.e., the value added.

The Commission is recommending a low business activities tax rate — 1.50 percent — that will raise the same amount of revenue as the taxes it replaces. Business enterprises with gross receipts below a minimum amount will be tax-exempt.

Benefits of the business activities tax
Nonresidents use district services in their roles as consumers, suppliers, workers or shareholders, but they cannot be taxed directly. Businesses are the intermediary through which they can be taxed. There are several ways to tax businesses. The District's current system is based on net income, or profits. Some states tax gross receipts of sales of goods and services. The Commission recommends a business activities tax — a tax based on the value added from all economic activity that happens in the District — because it will have the following advantages:

1. Fairness. Taxing value added is the best way to make taxes proportional to the benefits derived from the District. For example, under the current profit-based system, large firms that place significant demands on city services often pay little in corporate income taxes. A gross receipts tax also is a poor measure of economic activity; a firm with significant sales but few employees, for example, would face high taxes despite using few services.
2. Revenue Stability. The business activities tax will generate more certain and predictable revenues than a profits-based tax. Profits can vary widely with fluctuations in the economy. The business activities tax base, however, has a stabler base because it is dominated by labor compensation, which tends to be stable over time.
3. Administrative Ease. A business activities tax is easy to collect and will result in lower compliance costs for taxpayers and lower administrative costs for the District.
4. Economic Neutrality. A business activities tax would be fairly neutral with respect to decisions made by businesses. For example, absent other taxes, a firm that operated only in the District would find little tax advantage in changing its mix of inputs. In addition, the business activities tax eliminates the bias against investment inherent in a business income tax. In its 1991 ruling on Trinova Corp. v. Michigan Dept. of Treasury, which addressed Michigan's single business tax, the U.S. Supreme Court noted, “One of the acknowledged advantages of value added as a measure of taxation is its neutrality . . . Under a pure VAT, all forms of business organization bear the same tax burden.”

The business activities tax will apply to all enterprises that operate within District boundaries and thereby derive the benefits of District services. A business with activities that are taxable both in and outside the District will apportion its business activities tax base and allocate the appropriate portion to the District.

Potential legal challenges
Because the business activities tax includes compensation in its base, some may question whether it violates the Home Rule Act, which prohibits taxing any portion of nonresidents' personal income. Such a challenge is unlikely to succeed. The proposed tax is not a tax on income or payrolls, a position supported by the U.S. Supreme Court. In Trinova Corp. v. Michigan Dept. of Treasury, the Court ruled that Michigan's single business tax was not a tax on the component pieces of the base, but was “an indivisible tax upon a different, bona fide measure of business activity, the value added.” The Michigan tax uses a base that is similar to the one proposed for the new District tax.

Recommendation: Introduce a single, lower commercial property tax rate
The District currently has five real property tax classes, one on vacant property, two commercial and two residential. The highest rate is roughly four times the residential rate.

The Commission recommends eliminating the multiple classes and having a two-tier system with one commercial rate and one residential rate. Moreover, the rate on commercial property should be no more than double the residential rate.

Under the Commission's plan, the commercial rate would be 1.92 percent, assuming the residential rate is maintained at .96 percent. The estimated net cost of moving to one commercial property rate is about $36 million. The Commission has not been able to identify a source to offset this lost revenue, but recommends that this change be made as soon as the fiscal situation permits it.

The Commission also noted that the current high commercial rate reflects the District's inability to tax incomes at their source. The District cannot assess nonresidents who use District services, so it taxes the properties where they work. If, at some future time, the District is allowed full access to its tax base, a single property tax should be considered.

May 4, 1998