The News Journal | by Matthew Albright
State leaders say they have little choice but to raise taxes in 2017. The debate now is over who bears the greater burden.
Gov. John Carney and most members of the General Assembly are unwilling to erase the state’s $386 million budget gap solely by slashing spending. Carney has called for raising income taxes, corporate franchise taxes and tobacco taxes to fill half that gap. The remainder could come from budget cuts.
Carney’s idea is to spread the income tax pain by raising every bracket’s rate, eliminate itemized deductions and increase the standard deduction by more than half.
Even those in the lowest income bracket — whose taxable income is between $2,001 and $5,000 — would see rates go up, though that increase would be blunted in many cases by the changes to deductions.
“We think there is a fundamental issue of fairness,” said Carney, who has repeatedly described his budget as a shared sacrifice. “Our proposal asks everybody to pay a little bit more.”
Some members of the General Assembly want a different approach. They have called for new, higher tax brackets for wealthier taxpayers, leaving residents in lower brackets untouched.
The fact that Delaware’s top tax bracket starts at $60,000 means residents who are squarely in the middle class are paying the same rate as millionaires, argues Rep. John Kowalko, D-Newark.
“We have been squandering opportunity after opportunity to have a sustainable economy that can weather the storm,” said Kowalko, who has sponsored several bills proposing two new, higher brackets. “The only way to do that is with a proper progressive personal income tax structure that doesn’t demand an arm and a leg from the wealthy but does ask the wealthier to pay a little bit more.”
Carney and his top lieutenants fear that Kowalko’s plan pushing top wage earners into a rate of 7.8 percent would cause wealthy Delawareans to leave the state – particularly with Pennsylvania’s 3.07 percent flat income tax rate looming right over the border.
Rick Geisenberger, Carney’s secretary of finance, said the maximum tax brackets proposed by Kowalko also could scare off major companies from building and hiring here.
“That top tax rate, regardless of other factors, is one of the big headlines when employers are looking at where they will locate,” Geisenberger said.
Businesses don’t want their top employees — including the executives who make decisions about where to locate — to pay more tax.
Some legislators, such as Sen. Margaret Rose Henry, D-Wilmington East, don’t fear an exodus of wealthy residents and businesses. They point out that Delaware has one of the lowest total tax burdens in the country, and that Pennsylvania’s property taxes dwarf Delaware’s. Significantly, the First State has zero sales tax.
“I think when you look at the whole picture with all the taxes, we would still be very low,” said Henry, who is co-sponsoring with Kowalko bills to create new rates for those making $125,000 and $250,000.
Tax experts say Carney and the General Assembly are walking a tightrope.
“I certainly wouldn’t want to be doing [Carney’s] job,” said John Sterling, director at the accounting firm Master, Sidlow and Associates. “He needs to raise revenue, but he has to be careful not to hurt the economy while doing it. It’s a very delicate balance to strike.”
The Carney plan
Carney has proposed eliminating itemized deductions, which would raise $28.1 million, and raising income taxes, which would bring in an additional $36.5 million.
Even if the General Assembly implements all of Carney’s income tax plans, the moves would absorb only $64 million of the $386 million shortfall.
Middle-income taxpayers would see the biggest rate increases, while the top and low brackets would see the smallest rate increases. Yet those in the top brackets would still pay more because the eliminated deductions.
When people do their taxes, they figure out whether they will save more money by taking itemized deductions — for things like mortgage interest or charitable donations — or by taking the “flat” standard deduction.
About 62 percent of Delawareans currently take the standardized deduction — including almost everyone in the lower income tax brackets.
Carney wants to end itemized deductions but make the standardized deduction about 50 percent more generous. That would cushion the effect of the increased rates on those who take the standardized deduction but increase the tax burden on many people who itemize deductions.
The upshot: Eliminating itemized deductions would generally hurt wealthier taxpayers and helps lower-income residents.
“I think there’s this perception that our plan isn’t progressive, but that’s because people are just looking at the rates,” Carney said. “When you look at the whole picture, we are asking a lot more from people on the higher end.”
About 80 percent of the money Delaware would raise by eliminating deductions would come from people in the top tax bracket, according to the Department of Finance.
“Eliminating the deductions is, in my opinion, the more radical part of the proposal,” Sterling said. “For people who itemize, that could have a pretty significant impact.”
Tax experts say eliminating deductions could have a big effect on some residents.
Eliminating mortgage interest deductions could make buying homes more expensive, though the state’s property taxes are still low. Erasing deductions for charitable donations could crimp contributions to nonprofits, though the federal tax incentive would still exist.
It could make some people thinking about retiring in Delaware to reconsider. Delaware taxes retirement income while Pennsylvania doesn’t, but Delaware’s income tax deduction for people who spend a large share of their income on medical expenses keeps it competitive for some.
“A lot of my clients call me as they get closer to retirement and their big question is: Does it make sense to move to another state?” said Jordon Rosen, tax director at the accounting firm Belfin, Lyons & Shuman. “Currently, Delaware is a very retirement-friendly state, but this changes that mix.”
Rosen said some residents may still find the low property taxes enough to counter a loss of deductions.
“I’m not saying that overnight we’re going to scare everybody out of the state,” he said. “But all the small changes add up. People are going to have to reconsider their options.”
When Carney held an event on the budget in Newark on Wednesday, two people complained about the possibility of losing their student loan interest deduction. Another person urged him not to eliminate the deduction for medical costs.
Carney responded that he’d rather not be increasing anyone’s taxes, but said this was the smartest solution.
Some legislators think the state needs to ask more of its richest residents than Carney’s plan would. One way to do that would be to create new top tax brackets.
Delaware’s $60,000 top rate is much lower than Maryland’s, where the top rate starts at $250,000, or New Jersey, where it’s $500,000.
“I see $60,000 as middle income,” Henry said. “If you’re making $60,000, you’re still talking about putting food on the table and worrying about sending your kids to college.”
The bill Henry and Kowalko are sponsoring would create two new brackets – those making between $125,000 and $250,000 would pay 7.05 percent, and those making more than $250,000 would pay 7.8 percent. That bill does not eliminate itemized deductions.
Another bill would add the new brackets and eliminate deductions, but only for payers in the top brackets. And a third would do both, while also lowering rates for all the existing brackets.
Kowalko said he offered multiple bills to give his colleagues some options, but the general theme is that the state shouldn’t be raising rates for low- and middle-income taxpayers.
“There’s no shared sacrifice if you let people who are making well over $60,000 pay the same as people who are making just barely $60,000,” Kowalko said.
Kowalko argues people in the lower and middle classes spend more of their income, which boosts the economy. So he thinks the state should prioritize low rates in those tax brackets.
Rich Heffron, president of the Delaware State Chamber of Commerce, says Kowalko’s plan is “more problematic” than Carney’s because the top bracket number would be significantly higher — and that’s what companies look at.
“From the business perspective, it’s that top rate you’ve got to be sensitive to,” he said. “Wealthy people will leave this state, and they do. We lose enough people to Florida, which has no income tax, already.”
While there would ideally be no tax increases at all, Heffron thinks Carney’s budget is a better solution.
“I know that he tried to be fair,” Heffron said. “People understand that. He’s been pretty honest about the scope of the problem the state is in.”
Kowalko balks at the notion that a few percentage points more on the top brackets will cause businesses to flee.
“Frankly, I don’t think a business makes decisions based on what the burden on their high earning employees is going to be. They look at the overall business climate,” he said. “And our business climate is second to none. I think it’s a straw man argument that all of a sudden all these companies are going to disappear.”
It’s not clear yet how the General Assembly will ultimately act on income tax increases. They could stick with Carney’s plan, approve one of Kowalko’s bills or choose a different solution entirely.
Options seem limited, though.
There is no appetite in Legislative Hall to implement a sales tax, and previous efforts to raise other taxes – such as on gas – have been squelched.
A group of top legislative leaders from both parties, called the Financial Leadership and Accountability Group, has begun meeting to work out the maze of compromises necessary to pass a balanced budget.
Legislators have until July 1 to do that, but some leaders are hoping to enact any tax increases before May 22, when the Joint Finance Committee begins its arduous budget-writing task.
If they don’t use his plan, Carney says legislators are going to have to make other, tougher decisions.
“It’s a zero-sum game at this point,” he said. “If they don’t use what we’ve proposed, they’re going to have to do something else. Somebody is going to walk away from this unhappy.”